Foreclosures in the Shadows: Surprise Discounts Emerge For Forclosed Homes

There’s something new in the foreclosure marketplace, not just the “deep discounts” described by the National Association of Realtors but submarine markdowns which test the limits of financial understanding, deals beneath the surface of the foreclosure system with discounts so large they’re difficult to explain.

Short Sale
The foreclosure process is no longer a straight trip from nonpayment to the auction block. State mandated foreclosure delays and required mediation opportunities slow the system, modification programs can stall foreclosed homes for months, and sloppy paperwork and uncertain loan ownership claims are clogging courts nationwide.

Because of the increased complexity required to foreclose — and because of the huge lender losses a foreclosure can produce — more and more forecloses are candidates for short sales. With such arrangements owners and buyers try to work out a sale subject to approval by the lender. In effect, unless the lender is willing to take a loss on the short sale process there’s no deal.

The lender’s goal is different. It wants to get as much as possible for the property and avoid adding another home to its inventory of unsold short sale houses. In this environment the only attraction of a short sale to a lender is that it may be less awful then a foreclosure. Because the goals of lenders, owners and buyers differ, the short sale process has become a sticky, angry, often lengthy process where the lender takes every step to assure that the property is not being sold for anything less than fair market value.

Meanwhile, while short sale rambles on the loan is delinquent and the lender has every right to foreclose. Thus while the lender’s Ms. Smith is trying to work out a short sale, Mr. Jones in another lender office is independently trying to schedule a foreclosure auction at the nearest courthouse or orchestrate a foreclosure listing.

Foreclosed Homes: Conflict
So far we have a system which makes sense in theory: The lender will take the option that produces the best result, whether it’s a short sale or a foreclosure. In practice, the situation is sometimes very different.

What happens is that while the lender, owner and buyer are talking about a short sale the property is foreclosed. The curiosity here — and the opportunity — is that sometimes the final price is substantially less than what the lender might otherwise have gotten.

Consider these foreclosed homes for sale:

Catherine Myers, with Windermere Bay Area Properties in Walnut Creek, Cailf., tells of a sale where a home was bought for $520,000 and as a short sale received an offer of $420,000. The property was foreclosed and the winning bid was $400,000 — $20,000 less than the short sale offer.

Ronnie Evans, with Florida Executive Realty in Tampa Bay, Fla., says she had a $200,000 cash offer for a short sale. The bank came back with a $205,000 counter-offer. The deal didn’t go through, the property was foreclosed, the bank took ownership and the home was again made available as a foreclosure listing — this time for $175,000.

Ruth Gabbard, with Gabbard Hawaii Properties in Honolulu, said she had one case where a property had an auction value of roughly $150,000. There was an offer — one offer — for $135,000. The bank bid $250,000 to retain the property. Ten months later the home was available as a foreclosed home for sale (REO) — real estate owned by the lender — for $35,000.

Why do such things happen with foreclosures? That’s unclear. One possible answer is that the volume of distressed properties is now so great that lender blunders and bungles are simply inevitable.

Single Point of Contact
Federal regulators have been trying for some time to assure that borrowers facing foreclosure will be able to deal with a single point-of-contact. Now, under the $25 billion robo-signing settlement worked out in February, participating lenders will be required to have “a single-point-of-contact for borrowers seeking information about their loans and maintain adequate staff to handle calls.” The idea is to prevent surprise foreclosures while a borrower is in a loan modification program during pre foreclosure.

The problem with this proposal is that it applies to borrowers in loan modification programs, not borrowers negotiating short sales. With short sales the door to confusion, surprise foreclosures and big discounts remains wide open.

Foreclosure: Winners & Losers
Who benefits — and who suffers — with submarine discounts is fairly complex.

Homeowners. Owner-occupants face the loss of their property plus financial damage. In some cases the homeowner may also face a deficiency claim from the bank, a suit to get back the unpaid mortgage balance.

Real estate investors. If the property is investment real estate then the investor faces the loss of the property, the possibility of a deficiency judgment and perhaps a big tax bill from Uncle Sam for any unpaid mortgage balance. This can happen because while the Mortgage Forgiveness Debt Relief Act of 2007 protects homeowners against federal tax claims when a mortgage is not fully repaid, the same protection has not been extended to real estate investors.

Mortgage investors. Denver real estate broker Alisa Hagner with Your Choice Real Estate suggests there should be “an online listing history of failed short sales turned foreclosures.” You can bet the first people who would want to see such a list are mortgage investors, the insurance companies, pensions and sovereign funds that make much of the home loan system possible by purchasing mortgage-backed securities. In situations where properties sell below available offers mortgage investors lose because their loss is bigger than might have been the case had a prior offer been accepted.

So who wins? The only clear winners are distressed property buyers. Whether the buyers are homeowners or investors they win if they can acquire a short sale with a below-market price and they win bigger if they can buy the same house for even less at a foreclosure auction or a foreclosure listing.

Finding Submarine Discounts
“There doesn’t seem to be any pattern or policy to account for submarine discount sales,” said Daren Blomquist, vice president at RealtyTrac. “Given that we have millions of distressed mortgages it’s apparent that sale values are not being maximized in every case. That’s good news for buyers who may be able to pick up bargains from overwhelmed lenders.”

If there’s a secret to finding submarine discounts it has to be information. Buyers negotiating a short sale need to track local foreclosures daily. This is necessary because while short sale negotiations drag on with one lender representative it may be that another lender official is busily setting up a foreclosure where the very same property will be available at auction — and at a lower price.

Do submarine discounts make a lot of sense for lenders? Not at all. But if lenders are going to insist on submerged pricing why should buyers object?
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Peter G. Miller is syndicated in more than 100 newspapers and operates the consumer real estate site, OurBroker.com.

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