Short sales
“upside down”
The short sale has become so commonplace in some Virginia markets that we’re already able to draw on substantial experience with these critters. Not all of what follows will apply in all markets, or in all sales within a market, or even in all sales with the same lender in a given market. As the Romans used to say, though, “Experiencia docet” — and experience really can be the best teacher in short sales, perhaps the most taxing transaction a residential Realtor® will have to deal with.
LENDER
REALTOR®, know thy
by VAR Special Counsel Lem Marshall
Finding the upside in
Lenders today, especially those holding a snootfull of bad loans, are facing unique pressures. A 2002 Tower Group study found that the average cost to a lender of foreclosing, holding, and disposing of a property was almost $60,000, and I suspect that number is a good bit higher today. Adding to lender woes is the simple reality that the market still has a way to go before we see home prices back into historical balance with household incomes. (See “The subprime meltdown”, page 19.) A lender might not be anxious to take a property and try to sell it 12-18 months from now, when prices might well be lower. Lenders are no fans of foreclosures. Taking ownership of a home means it has to add to its reserves, which reduces money available for lending and other income-producing investments. That damages its balance sheet even before considering the cost of maintenance, repairs, and real estate taxes. May/June 2008 11
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Your first decision is pricing, where you’ll run into the first counter-intuitive reality: Your pricing needs to meet your client’s urgencies, but you must be relatively aggressive, at least if you have any time at all to do so. Why? Consider the lender’s reaction if you present a low offer shortly after putting the house on the market. If the lender is not confident that the offer is reasonable, your change of approval is slim. And most lenders will want to see that you’re making a reasonable marketing effort, especially if there are few other distressed sales in the area. In fact, you might want to approach the lender as soon as you know you’re facing a possible short sale. Some lenders won’t talk to you if your seller isn’t well behind in his payments, and it’s important to know that up front. And lenders are increasingly willing to discuss strategy and, in some cases, even pricing, early on. There are other benefits to early contact with the lender. You can find out who your point of contact is, what the lender’s list of requirements for approval are, and, possibly, how long the lender anticipates it will take to approve a request once submitted. (Knowing how long a wait to expect can smooth things over with buyers, too. They’re more likely to show patience if they know how long they will have to wait.) Some lenders will want to deal with the seller directly as well; they may have specific forms and requirements only he can provide. Once you know what the lender needs, start putting it together. At a minimum that will mean a seller’s W-2 or proof of unemployment, the last two tax returns, financial statements, the last couple of years of bank statements, and a hardship letter. You will almost certainly have to give the lender your CMA or obtain an appraisal of the property as well. Needless to say, be careful. If the seller obtained a stated-income or no-documentation loan, compare the information on the loan application with the what you are preparing to submit with the request for the short sale. Be especially alert to evidence that the seller falsified or overestimated income and/or assets, or lowballed or
REALTOR®, know thy
REALTOR®, know thy
seller
Your first task is to get all the information you can about your seller and the property, and determine whether you’re likely to be dealing with a short sale. That might mean making some probing questions during your initial interview with the seller. You will have done a CMA, of course, but now you’ll need to know how much it will take to clear existing liens and deliver good title. Often your seller will know, and be willing to speak candidly with you about the facts. Sometimes, however, the seller won’t know all the facts (whether there’s a judgment lien, the amount of late fees, penalties and accrued interest, the amounts owing on credit lines, etc.). Sometimes the seller will know these things, but will not want to give you a candid response to your questions, either because of embarrassment or out of concern that if you know the facts you’ll urge a strategy that leaves the seller well short of the net needed to clear the title. You’ll also want to know whether he’s current in his payments, and if not, how far behind is he? Has he received default notice? Has foreclosure begun? If you are not 100 percent satisfied with the answers, consider doing your own lien search, or at least asking the seller to dig out his payment records. You’ll want to know the seller’s motives for selling, and as much as possible about the seller’s financial condition. Is he unable to make his payments because his ARM has reset? Is he able to make his payments, but just doesn’t want to continue to throw good money after bad? And don’t forget to ask your seller for a copy of his loan application and any other financial information he gave the lender when applying for the loan. (You’ll see why in a moment.) You should also get as complete a picture of the condition of the property as possible. You’ll likely have to structure the purchase agreement differently from the more common resale, and surprises about property
condition will not be helpful. It will also be helpful to know the area. Has it been classified “declining”? Are there nearby short sales? How many foreclosures have occurred in the last six months? With most or all of this information I hand, you can begin to prepare a marketing strategy.
marketing strategy
Trying to offload REO into a saturated market can further depress values, starting a vicious cycle of decreased worth and further defaults by borrowers. So if we do our homework and give the lender a deal it can’t refuse, it will have every incentive to take it. (There is one thing to be prepared for: Short sales take a long time — anywhere from 30 to 90 days more than a typical resale. With lenders and loan servicers already overworked, it might even be longer. With short sales, patience is not just a virtue, it’s a necessity.)
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ethical obligations
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The Virginia Code requires you to
buyer
REALTOR®, know thy
Whether you are certain you are dealing with a short sale or just suspect it will take a stroke of good fortune to avoid one, you might be tempted to note in the MLS that this is a short sale. In fact, some MLSs have a field for this information. You can’t make this decision by yourself, regardless of what you hear from other Realtors®. The Virginia Code requires you to “maintain the confidentiality of all personal and financial information received from the client during the brokerage relationship … unless otherwise provided by law or the seller consents in writing to the release of such information.” This certainly includes the fact that the seller cannot pay off his mortgage(s) from the anticipated proceeds of the sale.
When you get an offer on the property, you’ll have to approach things somewhat differently from how you would with a more routine resale. In the first place, the lender is not going to waste time on a deal that can’t close. This means that your buyer will have to qualify to not one but two lenders — his own and the seller’s. The seller’s lender is unlikely to be satisfied with just approval from the buyer’s lender, let alone a “prequalification” letter. Many payoff lenders will actually require the buyer to make a full-fledge loan application with it — not to borrow money, but to prove he’s actually able to get the loan he’s seeking. Obviously, the better your buyer’s loan profile, the better the chance of approval. Whomever your buyer is, he must be able to close and convince the payoff lender of that fact. You might as well make that clear from the start of your dealings. On the other side, if you’re a buyer agent, you’ll want to know your client’s tolerance for a short sale. And, of course, you’ll want to know when you’re about to enter one. If the listing agent has not made that clear in the MLS or otherwise, ask. If you don’t get a satisfactory answer, at least conduct a down-and-dirty lien search to find out if a short sale is in the cards. But don’t blame the listing agent for not telling you up front: he might not be able to.
REALTOR®, know thy
underestimated debt. Serving up to the lender evidence of seller’s loan fraud is probably outside the scope of your authority. Along the same lines, be alert for evidence that the seller has frittered away his earnings or assets on a lavish lifestyle. Lenders respond favorably to legitimate hardship, but frown upon profligacy when they are being asked to take a haircut and forgive debt.
‘maintain the confidentiality of all personal and financial information received from the client during the brokerage relationship.’”
Your seller will need your professional guidance here. There might be an imperative that he get the best offer he can quickly (if he is already under the gun of foreclosure, or behind in his payments) even if it is well below what he owes. In such a situation, it might make sense to let participants in the MLS know how things stand. On the other hand, he might insist on trying the market without letting prospective buyers know of his distress. This might be the case if he has hopes of avoiding a short sale, or is hopeful of securing a workout with his lender — if he is moving to take a better job, for instance, and offering the lender an unsecured note for the deficiency. If you do agree to notify the world of a possible short sale, be sure to get the seller’s consent in writing. Volume 15 ● Issue 3
May/June 2008 13
get approved, get inspected, and put all necessary credits and seller concessions in the price.”
A short-sale contract is going to have a contingency for third-party approval. But how should it read? Most contain a provision along the lines of, “This contract is contingent on approval by seller’s lender.” What does such language mean? It could mean that there is a ratified contract but that seller’s obligations are contingent on lender approval. In this case, the earnest money deposit must be placed in escrow (with all that means), and the buyer will find it difficult to back out of the deal while approval is awaited. Or it could mean that there is no contract until the lender approves. In this case, either buyer or seller can back out before approval arrives. It also means that the earnest money should not be deposited until approval is received. So which is it? It’s worth considering whether to be crystal clear on this point. The contract might say: “Seller’s obligations under this contract are contingent on approval of seller’s lender” or words to that effect. Or “Acceptance of this offer and creation of a binding agreement is subject to written approval of seller’s lender.” It’s especially important to consider the language if more than one contract/offer is being presented to the lender. I have heard of several instances recently where seller has received multiple offers, signed all of them, provided that “This contract is contingent on lender 14 May/June 2008
Now we come to perhaps the most contentious issue of all: commissions. Some lenders will require, as a condition of approval, that the listing agent reduce his commission. Let’s say the seller has agreed to pay the listing firm 600 chickens and that the listing firm has made an offer in the MLS of 300 chickens to the firm that procures the buyer. What happens if the lender requires the listing firm to accept only 400 chickens? First, let’s dispose of the ethical issue here. Is the listing agent ethically obligated to accept the reduced fee to make his client’s deal happen? After all, the lender is offering to accept a deal that allows the seller to avoid foreclosure and possible bankruptcy, and to salvage something of his credit, if the listing agent will only concur. The answer here is simple: A Realtor® is never obligated to reduce the fee he has been promised to make his client’s deal work. You might find it in your interest — compelled by your conscience or your moral compass — but you have no legal or ethical duty, under the Code of Virginia or the Code of Ethics, to do so. And if you agree to a reduction? Most of the time you’ll want to approach the buyer’s agent and request that she reduce her co-broke fee to 200 chickens from the 300 that were offered in the MLS. Is she ethically obligated to do so? May you even ask her, within the strictures of the Code of Ethics, to accept less than was promised in the MLS? It comes as a surprise to most Realtors®, but the Code of Ethics does not prohibit a listing agent from using an purchase offer to renegotiate the terms of what’s in the MLS. Standard of Practice 16-16 prohibits the buyer agent from using the terms of an offer to renegotiate the listing company’s offer in the MLS, but it does not
REALTOR®, protect thy
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Do as much up front as you can:
approval” and sent them to the lender for consideration. This can create a great deal of ambiguity as to where the parties stand. In the first place, are all the contracts “ratified” or not? Does each escrow agent have to keep the deposit and await the lender decision and approval of the seller to release the deposit if the contract is not approved? Does the listing agent have to note in the MLS that a contract is pending with contingency? If you don’t know the answers, you should.
commissions
REALTOR®, know thy
contracts
A well-drafted is always central to a successful transaction, but this truth is magnified in a short sale. A contract with contingencies and full of seller concessions and credits will probably grate on the payoff lender’s last nerve. Do as much up front as you can: get approved, get inspected, and put all necessary credits and seller concessions in the price. A contract that comes to the payoff lender clean stands a much better chance of success. A leaky roof should be your seller’s problem, not the lender’s.
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work the other way around. But does the buyer agent have a duty to her client to accept the reduction to make the deal happen? Again, the answer is no. No Realtor® ever has to accept a reduction in the promised fee to achieve a client’s objectives. It’s entirely your decision as to whether to do so. So if the buyer agent rejects the offer and even refuses to ask his buyer to pay the difference — or if the buyer refuses to pay the difference when asked — what happens to the listing agent? With the lender requiring the reduction, and the buyer and buyer agent refusing to cooperate, can the listing agent count on the seller to support her? Remember that at this point, the listing agent has agreed to accept 400 chickens but finds herself having to pay out 300 to the recalcitrant selling agent, leaving only enough to make a couple of omelets.
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No Realtor® ever has to accept a reduction in the promised fee to achieve a client’s objectives.” Who do you think the seller, seeing only 100 stinkin’ chickens standing between him and foreclosure, is going to support? No, I’m afraid the listing agent is at the mercy of the buyer agent here, and that’s a shame for both. The problem has not gone unnoticed. Some listing agents have taken to putting conditional offers of compensation in the MLS. They will offer something along the lines of, “300 chickens or one-half of the fee approved by the third-party lender.” Let me be clear: Such offers do not belong in the MLS and probably violate NAR multiple listing policy, which has long required that a selling agent be able to calculate, from the offer, the amount of compensation she will receive upon procuring a buyer. When the offer of compensation is essentially “one-half of what I agree to accept” the selling agent has no idea what the compensation, if any, will be. What principle dictates and what reality dictates can be two different things. The NAR legal staff agrees that NAR policy does not permit this kind of offer. But the market is roiled and many agents are framing offers this way because they’ve been burned by uncooperative buyer agents. Virtually all MLSs are accepting them, so — are you ready for this? —we’ll just have to rely on the Volume 15 ● Issue 3
Money Matters Why you should get what’s coming to you When it comes to MLS listings that tie a buyer agent’s commission to what the seller receives (e.g., “one-half of what I agree to accept”), the NAR MLS policy that prohibits it is right, and, more to the point, it is essential. Already the signs are clear that it is discouraging buyer agents from bringing their buyers to these deals. Furthermore, it has led to contentious relations among Realtors® and to a completely unpredictable outcome when we try to determine what the actual contract between the Realtors® is. At the end of the day, it requires us to subsume the certainties we look for in the MLS to a belief that we can impose a finding that acceptance of an offer exists when the offer is not even articulated. It turns the underpinning of the MLS on its head. I am not alone in believing the condition would not be enforceable under basic principles of contract law. Further, it is unnecessary. Lenders are now figuring out that to pit Realtors® against one another and their clients, and to discourage them from taking listings and bringing their clients to the deals that offer lenders so many advantages, makes no sense. This is why we are seeing more and more lenders agree to permit the listing agent to receive the bargained-for commission. I understand that Chase, Bank of America, Washington Mutual, Wells Fargo and many others are now leaving commissions alone. Furthermore, many of the lenders that still condition approval on fee reduction relent when the listing agent just says no and insists on the promised fee. In the end, this is the strategy that Realtors® should consider. Instead of working twice as hard for less than promised — perverting the MLS, breaking faith with selling agents, and throwing a possible deal killer into the mix at the eleventh hour — why shouldn’t we consider just saying “No, I demand my fee”? I performed. I have brought you a deal that offers you many benefits, and you should not stand in the way of my receiving the fee I was promised. Finally, I would remind you that when we agree to work for less than the market says our services are worth, the only beneficiary is the buyer, because our fee is the only settlement service fee that finds its way into the value of the property. May/June 2008 15
In the world of the short sale, the buyer is already getting a good deal, and we should feel no compunction about saying to the lender that, if it insists on netting an additional 200 chickens, that’s fine with us, but it must come from the buyer. Very few buyers will lose a deal at a typically steep discount over a stinkin’ 200 chickens. Why not give that alternative to the lender, if the lender absolutely insists? We can work for less than we’re worth, demand selling agents take what they get, pervert the workings of the MLS, give up in frustration on the whole idea of involvement in short sales, and give buyers a better deal than they are already getting — or we can just say no. Experience increasingly shows we’re better off holding firm than succumbing to the pathologies that result from sacrificing first principles. I expect to be paid what I’m worth. A pretty basic first principle. — Lem Marshall
arbitration panels to sort it out. There’s much more I could discuss about short sales — how you deal with second mortgages or other junior lien holders, for example — but then there’d be nothing for you discover on your own. So I’ll just say that the short sale requires us to know a lot — about lenders, the economic environment, our clients, the property, the neighborhood, the other party, the contract, the Code of Ethics, Virginia law, and ultimately, ourselves. Do we have the stomach for this unique opportunity to show expertise our clients desperately need? I’m confident we do. I’m also confident they won’t last forever, so if you don’t want to miss the fun, you’d better get hopping. l
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webcast house ad here, to come
16 May/June 2008
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