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Investing Strategies

How Do I Know Which Short Sale Deals to Go After?

shaun and jpAs a seasoned short sale real estate investor in St. Louis, Shaun McCloskey is in the trenches daily in this market. He knows what’s working, what’s not and why.  If my Mom wanted to learn how to crush it in short sales, Shaun’s the guy I’d call for her.

In other Mogul lessons, Shaun’s shared some really strong information with us – negotiating strategies and cool, Jedi mind tricks – all about helping you really demolish your competition, regardless of your investing niche.

In this one, I’m asking Shaun to dig into his short sales specialty specifically, and help you see if the short sale opportunity you have in front of you is actually worth pursuing.  Short sales are present an immense opportunity right now, but they also require a certain investment of time and energy. There’s nothing worse than wasting your time, money and effort going after the wrong deals.

So let’s go to Shaun…

From Shaun McCloskey, Short Sales Advisor...

The last thing that you want to do is to go after prospective deals that are never going to close. This not only wastes your valuable time, it also wastes the homeowners’ time and energy as well.

What I want to do in this lesson is give you some guidelines and important things to consider in helping you quickly differentiate between a potential deal worth investing time and energy into, and a time-waster you should pass on sooner rather than later.

I'll explain each guideline for you in detail to make sure you really get it. Then at the end I'll give you a quick summary in bullets of what to be mindful of. I recomend you copy and paste the summary bullets at the end onto a quick checklist for yourself - something you can use as a quick litmus test for any short sale deal that comes across your desk.

A Few Things to Bear in Mind First...

  • Desire does not a deal make. In other words, just because someone is willing to give you the deed to his or her house, doesn’t mean it’s worth your time to take it!!
  • The seller MUST be motivated. You cannot help someone who’s not willing to allow you to help in the way that you need to. If they are absolutely dead set on staying in the house, they’re not for you.
  • You can’t help everyone. You can only help the people that your solutions will work for.
  • You’re not the one with the problem. Nor did you put the homeowner in their situation, so all you can do is try to help them. If for any reason the short sale does not work, the homeowner is in no worse of a situation than before you came into the picture, therefore, it is not your obligation to help. It is their privilege for you to help them.
  • Do they deserve your help? There is a difference between those that need help and those that deserve your help. The seller MUST be ready, willing, and able to provide you with what is necessary to get the short sale approved. If you have problems with a seller up front, chances are you’re going to have problems with them later on.
  • Are things really that tough? The seller must have some type of legitimate hardship. If you’re trying to help people that just don’t feel like paying their mortgage because they don’t like the house any more, you’re going to get very frustrated in the short sale business.
  • Don't waste time. If you’re spending time on the people that are not good candidates, you’re ROBBING the other people that you CAN help of the time that you’re wasting on the wrong people. Remember, there are a lot of people that need you!! Don’t take away from the people that you can help by going after the ones that you can’t. 

The Loan Balances Can’t Solve the House Problem for the Lender

  • The debt on the property is $100,000. The house is worth $200,000. Is this a good candidate for a short sale? NO!! The lender’s not an idiot and can easily see there’s a high chance they’ll actually make a profit one way or another if they foreclose. They’ve got no motivation to consider a discount.
  • If the house is worth $100K and $90K is owed, can the house solve its own problem? NO. Therefore, a short sale is a good candidate here. 

You Must Have Enough Time to Work the Short Sale

  • 12-10 short sale timeIf there’s not at least 10 days left to the foreclosure sale date, chances are it’s not going to be 
a good short sale candidate. (This is not a RULE, but a guideline.)
  • For example, if you have a house where there’s a $200K first mortgage and a $50K 2nd mortgage, and you only need to get a discount from the 2nd lender, the 2nd lender may be willing to work with you up until the day before the foreclosure sale date since they may be wiped out at the sale anyway.
  • If you’re in a QUICK SALE state, (where the notices come out and then 21 days later there’s a foreclosure sale date,) you better be prepared. You need to have a very timely marketing process lined up. And/or you need to try to get the leads before they get to this point. 

You Must Be Able to Sell the Property Later

It doesn't do you any good to get a great deal on a property that you can’t sell later on. If a 
property is in a complete and total war zone, can you get a huge discount on it with a short sale? Most likely, yes. 

Can you sell the same property once you've bought it? That might be a different story... 

Make sure that the neighborhoods that you’re working in are "sellable" neighborhoods. If you get to a property and every other house is boarded up, chances are it’s going to be a tough sell later on. The only way that I would work in this area is if I already had a wholesale buyer lined up that loves war zones. (Believe it or not, some investors love these areas).

Your deal must have one of these three acquisition strategies to be a viable short sale deal…

Strategy #1 – Buy with Cash

In this case, you use the typical MAO formula, (or something close to it depending on what your market value determines - see below), as well as the amount of repairs the house needs. Sometimes you'll need to offer less; sometimes you can afford to offer more.

Realize that just because we say “buy with cash” doesn’t mean you’re going to use your own cash here. In my opinion, you should never use any of your own money if you don’t have to. You could utilize a loan from a private lender, a hard money lender, or even a traditional lender to close these “cash” transactions.

Frankly this is my least favorite way to buy properties because it requires the most financial risk. Regardless of whether it’s your cash or someone else’s, it’s still a pile of cash, which is inherently riskier.

NOTE: MAO (Maximum allowable offer) = after repaired value (ARV) minus repairs times 70%. MAO = ARV – Repairs × .70

Strategy #2 – Reinstate the 1st loan, payoff the discounted 2nd loan

mortgage paidIn this scenario, you would get the 2nd lender to take a discount, and then take over the 1st mortgage “subject to” the existing financing. You could then either turn around and sell the property just like you normally would, or get a tenant buyer in there to buy the house on a lease option or owner financing.

In either scenario, your risk is considerably less than buying with cash, since the only money you’re out is limited to the amount of the discounted 2nd mortgage plus the reinstatement amount of the 1st mortgage.

This method is a little creative, but extremely powerful when the deal permits it.

Strategy #3 – Simultaneous closing

12-10 twoIf you have a buyer lined up before you actually have to close your purchase, you can sometimes afford to pay more than the MAO formula suggests.

Your risk is next to nothing because you no longer have to fund the transaction yourself. The entire deal is funded by your buyer’s cash or financing. You buy the property today and sell it the same day.

Of course, having time to find and qualify a solid buyer before you have to close is the critical piece of this puzzle. This is how a “simultaneous closing” occurs. 70% of our deals are done using this method.

Are the Comps All Over the Board?

The lender is going to evaluate your offer based on how comparable properties in the same area as the subject property are selling. So it’s of paramount importance that you’re about to not only view good, recent comps for the property, but that you can make heads or tails of them, and that they legitimately help support a valid case for a short sale on the subject property.

Are the comps in the area all over the place? In other words, are there properties selling for both $75,000 and $350,000 all within 1⁄4 mile? This can be troublesome to your deal.

Or are all the comps in the neighborhood selling for between 125,000 and $130,000? If this is the case, it may be fairly tough to convince a lender they should allow you buy the property for $50K unless the house needs some serious repairs.

Is There a 2nd Mortgage on the Property?

2nd mortgageWhat happens to a 2nd lender when the 1st is foreclosing? Chances are it’s going bye-bye!

That is, typically the 2nd lender will be wiped at the foreclosure sale. (Again, a guideline, not an absolute rule...)

This is very important to remember about second mortgages:

  • A 2nd mortgage isn’t necessarily a smaller mortgage. It really only means that it is 2nd place in line, or JUNIOR to the 1st mortgage.
  • When the first mortgage forecloses, it typically wipes out any other liens that are “junior” to it (like 2nd mortgages, etc.)
  • When the 2nd mortgage forecloses, it wipes out other junior liens (like 3rd mortgages, judgments, etc.) but must typically pay off the first mortgage in full. That’s why you don’t see too many second mortgages actually foreclosing. 

Is the House Really Ugly?

  • Does the house need significant repairs to bring back to sellable condition?
  • Are there areas of the house that don’t fit code requirements?
  • Was any work done at the house by the homeowner or someone else that didn’t know what they were doing?
  • Is the house in need of repairs that affect the safety of other people? (Lenders don’t like to foreclose on houses that could be a liability...)
  • Is a house that needs paint and carpet an ugly house? NO. Banks can handle paint and carpet. They don’t want to hear about minor cosmetic issues. They assume that these things are going to be needed.

Is the House Just Weird?

  • 12-10 weird house

    When you walk into the house, do you say, “Man, this is weird...”?
  • Do you have to walk through a bedroom to get to the kitchen?
  • Did the homeowner do a really bad job at their attempt to make their house just like the one they saw on “Trading Spaces?”
  • Are there some strange do it yourself type rehab jobs? (You wouldn't believe what I've 
seen here...).
  • Are there strange facades on the house?
  • Was there an addition/extra room added onto the house that doesn't look right with the house, etc.
  • Is it a goofy looking house in the middle of a bunch of mansions? Is that why the appraisal 
came in so high when the homeowner refi'd it and renovated it to make it look as weird as it does right now? 

Does the House Just Seem to Have Plain Old Bad Luck? 

  • “Bad Luck” refers to the things around the house that affect its value – although these are things that don’t actually TOUCH the house.
  • Was it once a beautiful home that overlooked a gorgeous creek and wooded area, but now they’re building a Walmart in the back yard?
  • Did the house not used to be in a flood zone but now it is? (Wonder why it is now when it didn't used to be?)
  • Is the house directly in front of an airport, railroad tracks, racetrack, power plant, highway, commercial strip center, new drainage problems in the area, etc.?
  • Did a horrible incident occur in or around the house? (Mr. Lender, everyone in this area knows that there was a murder or a death in this house, and because of this we’re having a hard time selling it!) This will affect the value of the property. 

Do You Only Need a Small Discount?

If the house has none of the above issues with it, does that mean you're not going to get a short sale approved?

Not necessarily, just don’t count on getting a big discount. 
We typically see discounts of less than 15% of the loan balance with these types of properties.

Moral of the story:  Don’t expect to get an offer approved for $150,000 on a house that’s in a neighborhood where every house is selling for $500,000, that needs nothing but paint and carpet, that is in a highly desirable neighborhood where most houses sell in less than 30 days, and is in only two years old. Why would the bank take your offer? It doesn’t make sense. (Believe it or not, new investors make this mistake daily).

These are the types of deals where being a realtor leaves you with a huge advantage. You can make a ton of money on deals like this if you can double dip for commissions.

So How Do You Know Which Deals to Go After?

Let’s recap.  What’s important to remember is that no matter how desperate the homeowner is for you to help him or her and how desperate you are to do a deal, there are just some deals not worth doing.  Remember these guidelines when you are deciding which deal to go after:

  • The Loan Balances Can’t Solve the House Problem for the Lender
  • You Must Have Enough Time to Work the Short Sale
  • You Must Be Able to Sell the Property Later
  • The deal must fit one of 3 viable short sale acquisition strategies
    • Buy with Cash
    • Reinstate the 1st loan, payoff the discounted 2nd loan
    • Simultaneous closing
  • Are the Comps All Over the Board? If they are it might be hard to get a discount.
  • Is There a 2nd Mortgage on the Property?
  • Is the House Really Ugly?
  • Is the House Just Weird?
  • Does the House Just Seem to Have Plain Old Bad Luck?
  • Do You Only Need a Small Discount?

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