I just returned from our annual summertime visit to see my sister-in-law in Indianapolis. She and her two children have a lovely lakeside house in the suburbs. We had a great time playing around on her jet skis, barbecuing hamburgers, and watching the Olympics on her giant back-projection television.
One night while we were sipping our evening drinks on her screened-in porch, she told me that she had come into a bit of money and was investing in rental properties in the area.  I asked her why she was putting her new found wealth into real estate when so many others were fearful of getting their toes wet.  She told me that this seemed like her best option at a time when the stock market was faltering and money markets offered such poor returns.

I was surprised to hear that she had recently been able to purchase a nice three bedroom two bathroom single family home for less than $200,000 while being able to get a rental income of $2,000 each month. In Jefferson County it is virtually unheard of to generate this type of gross income except for the most expensive properties, perhaps over $600,000. This one sounded like a great deal to me.

She was now in negotiations on another house. She made an offer that was lower than the amount that the seller owed the bank. This intrigued me. Why would a bank, let alone the owner, want to take a loss on a property? She told me that the bank was willing to take a substantial hit to their bottom line to avoid foreclosing on the house. “No bank wants to get into the landlord business,” she said.

When I got back home I did some research on the deal. It turns out that these types of transactions are called “short -sales,” and they can only take place with the full blessing of the bank involved — typically the loss mitigation department. The bank will take this path only if it believes it will make a smaller loss through a short sale than through a foreclosure.

An owner prefers a short- sale to a foreclosure because the process is quicker, and they normally can avoid the black mark of a foreclosure on their credit history. Another advantage for the seller is that since the Mortgage Forgiveness Debt Relief Act of 2007, borrowers are not taxed for the debt that has been forgiven by the banks — which used to be taxed as income.

But the bank might not choose a short-sale.  If the seller has other savings, the bank will liquidate these to make up their loss. If the seller has a good job and has not been late on payments, the bank will not even proceed to foreclosure. If there are other lien-holders — another bank home-equity loan or a lien from a mechanic — the bank often chooses a foreclosure, which is a more satisfying route.

After some research I did find that most short-sale contracts never make it to closing. Not only do they falter due to the problems outlined above, but frequently short-sales fail due to lack of experience of all those involved. By some measures, as few as one in 20 make it to settlement.

Many realtors advise their clients not to spend any money on such things as appraisals or home inspections on their short-sale properties until the bank approves the contract. A longer than normal settlement period would be wise as well, given the red tape that must often be cut through before closing on one of these deals. The most successful realtors have the short sale package approved by the bank before even listing the properties. Such efficiency is sadly rare, even in this troubled market.

I called my sister-in-law to see how her deal was coming along. The short sale approval was still sitting on somebody’s desk at the bank. But she is in no hurry. If it doesn’t work out she will move onto the next property, maybe a short-sale, maybe not. If the bank says yes, she will have won herself a terrific deal. It’s a win, win situation. 

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Residential sales in Jefferson County took a small upturn in July 2008. The number of homes sold was slightly higher than the year before, as was the number of homes that went under contract. But perhaps most importantly, the number of homes for sale (the inventory) dropped from 703 to 668 since June 2008. This should relieve some pressure on the supply side of the market, and may slow down the decrease in prices the area has seen over the past few months.