Continuing our discussion of short sales, we will now turn our focus to the purchaser’s perspective and consider the factors a Purchaser must take into account when deciding if this is the right vehicle for him, whether as an investment or for residential purposes.
I advise my clients to treat the opportunity as something akin to a lottery ticket. If you sign a contract to purchase a short sale, you have a chance to buy the property, but there is a very good chance also that the transaction will not be consummated. Like a lottery ticket, the sales price should be sufficiently low and attractive such that you would want to assume the additional risks attendant with such a transaction. I like the analogy of a lottery ticket as it will help you keep in a mind a simple and important rule, that should be your starting point. The rule is, if the purchase price isn’t outstanding, then don’t buy. It is really that simple, and the rest of this post will explain why the rule applies.
There are many risks to be cognizant of when purchasing a short sale property. Before setting forth a list, it helps to explain why those risks are present in the short sale context when they aren’t in a regular garden variety purchase. The reason goes back to the definition of a short sale transaction, which was set forth in an earlier post. The Seller is not receiving any money from the deal, thus there is accordingly no money available to remedy the usual problems that can occur with a regular transaction. Accordingly, as a purchaser you may have to buy with the following problems: Violations, tenants, the property being in poor physical condition, outstanding water bills, outstanding real estate tax bills, judgements against the Seller that you have to pay. A purchaser in a normal transaction would not have to accept the property in such condition or to pay such charges, but as the transaction is a short sale and the seller doesn’t have any money, you have no choice.
You can still safeguard yourself against the above listed issued by simply inserting a clause in the contract that provides that if the seller cannot resolve the said issues by the closing date, then you will have the unilateral right to cancel the contract of sale and receive a full refund of your down payment. Additionally, as a purchaser, you want to make sure that you are afforded certain additional protections in the contract of sale. There are a couple that are important and which you should insist on as a purchaser. First of all, make sure that you pay a minimal amount for your down payment when you sign the contract of sale. You should not pay 10% of the purchase price or anything close. Instead, you probably don’t want to pay more than $10,000.00 and, even better, around $5,000.00. Remember, your seller is in a desperate position and is not going to be receiving any money when the deal closes. You have little recourse against them if they breach the contract of sale as your usual remedy, a lien against the property, will be cancelled by the foreclosure action. Additionally, the Seller may be judgement proof so a monetary judgement won’t help you either. Thus, you have little recourse if the Seller defaults and then uses your down payment as leverage against you to extort a portion of it. The Seller has absolutely nothing to lose typically so he can take very unreasonable positions while you have your down payment at stake.
The next thing to remember is to make sure that you insert an outside date by which the Seller must receive written short sale approval otherwise you will be entitled to unconditionally demand a return of your full down payment. Without such a limitation, the transaction may become overly protracted and may take several months for the Seller to receive a response from his mortgagees. You don’t want to have to continue to wait and lose other opportunities.
One additional thorny problem that comes up often in the purchase of a short sale is that the seller’s mortgagees may make a counteroffer thereby requiring you to pay more money for the property. While you have no obligation to pay such higher amount, the new price may still be quite attractive. However, if you are financing your purchase, closing at the higher price can be quite difficult as you will most likely need to submit a fresh application and wait for a new mortgage approval. Your mortgagee will have to appraise the property at a higher price and you will have to qualify for a higher mortgage principal. The appraisal may be an issue, especially in a declining market, as the typical appraisal is for exactly the purchase price. So if your first appraisal was for the old lower price, the new appraisal is going to have come in higher, despite the fact that prices have been falling.
There are a lot of abuses with short sales, so you have to be wary of those. Some of the most common ones are where the Seller wants money under the table as they aren’t getting any money at the closing. Simply put this is illegal and should not be done. Your broker may also want you to pay them money in addition to the real estate commission that they are receiving from the Seller. This also shouldn’t be done unless your broker is working as a “Buyer’s Broker” and they have had you sign appropriate documentation to such effect. Finally, we be careful that you aren’t involved in a “short sale” flip which is also illegal.
A final note on the difference between purchasing a short sale and a REO. “REO” stands for “real estate owned” and it is a property that is owned by a bank after they have completed the foreclosure process. The advantage to an REO is that as the bank already owns it, bank approval is not required. However, there are some disadvantages. The sales price probably won’t be as attractive as a short sale. You will be required to pay the transfer taxes, take subject to violations and any tenants and you will have to take the property in its “as is” condition and the bank will not make any physical representations concerning the house. Finally, you will typically be given a very short period of time to close, typically 30 days and such date will be “Time of the essence’. Thus, if you aren’t ready to close, you will lose your down payment.
As always, there are a multitude of issues to consider when purchasing a short sale or REO and you should accordingly have experienced and competent counsel to guide you through the entire process.
Should you have any questions, do not hesitate to contact us at (718) 803-4113 or by email at SKAFAX@YAHOO.COM.
SUNIL K. AGARWAL, ESQ.
NATASHA S. AGARWAL, ESQ.
NATASHA S. AGARWAL, ESQ.