With the advent of all the ‘Real Estate Investing Riches’ material comes a new type of ‘niche market’: Short Sale Investors. Anyone interested in ‘the big secret’ behind many of these popular and expensive seminars, books, CD’s, etc., this is the meat of it. There is much more detail involved, but is beyond the scope of this post.

Short selling a parcel of real estate involves purchasing a property from a financially distressed homeowner for less than what they owe the bank (the Note). A purchase price is negotiated between the investor and the banks (loss mitigation department). If accepted the investor enters a purchase agreement with the current homeowner for the negotiated price.

John owes $100,000 on a home worth $105,000. John has defaulted on his mortgage and faces losing his home to foreclosure. The lender has started proceedings to do such.
James is an investor who found Johns pending situation posted at the County courthouse, or some affiliated listing service. James does his research, deems the property physically and economically viable for purchase, and engages John with his offer/ strategy. John accepts the offer to purchase (negotiated with the lender) of $90,000.

John avoids foreclosure, maybe James leases it back to John, kicks him a little cash, or nothing at all.

James acquires a property worth $105,000 for $90,000 and $15,000 in equity.

All very legal and widely practiced, including by moi. A post on Active Rain had me consider the transaction that put John into the home James eventually obtained. The broker, risky borrower, and appraiser on the front side of this transaction can catalyze the ‘mitigated’ fraud that too often results in foreclosure proceedings.

Lenders will cut their losses instead of spending the cash to solve the ultimate problem of moving dead weight off their books. My guess is that it is a wash or falls within allowable portfolio loss ratio’s. In any case it’s safe to say the banks are still making theirs, not that they prefer things this way, it’s just a fact of business.

So, investors are rightfully happy to create equity through below value acquisitions…which drives down ’sale’ prices, which drives down local market future values, which can spread geographically, to create localized depreciation or slowed appreciation? Could this contribute directly to ‘Bubble-istic’ conditions?

Remember, James bought a property for $90k that was appraised at $105k. The next appraisal in the neighborhood may use this as a comp and adjust down their valuation accordingly, which will trickle down further. In ‘lower income’ housing areas foreclosure proceedings and thus short selling is, as a matter of fact, much more prominent, which accelerates depreciation. Investors, specifically inexperienced ones, hop on these loan amounts/ property sizes first since they are financially easier to acquire. This is nothing new to these areas…although ‘flipping’ these types of properties has taken the practice to a sinister extreme.

Now we have the pending ARM adjustment and subsequent payment shock. All those people who took an Option ARM or other short-term loan as the only way they could squeeze into a home payment are staring foreclosure right in the face. A 4.5% interest only payment is a fraction of 7% Amortized.

Was it the brokers fault for not properly advising their client of the risk in buying under such tight circumstances during times of historic lows? How about the borrower’s foolish financial mindset or the bank allowing them to state their income, affording them the unsubstantiated opportunity to purchase the home?

Regardless, the next 18 months are going to be ‘interesting’…rate adjustment shock, the short sale, foreclosure, and economic repercussions are coming to ‘suburbia’. Alas, more Bubble talk…