Bank Owned Properties (REOs) vs. Short Sales

These days it happens all the time.  Either a client hears about short sales and bank owned properties and asks me what they are, or they are browsing around on our website and find a house that looks a lot better than everything else in the price range in the neighborhood and say, "Wow, gotta see this one right away."  When I see that it's a short sale I have to warn them that it may not be as good as it looks, at least in terms of bringing home the keys.

First let me state the most basic:  whereas I warn them that short sales can be at best problematic and take a long time, and at worst get us off track and a disappointing waste of time, bank owned properties are usually extremely well priced and represent a good bargain that is worth exploring.

What is the difference?  A Bank Owned property has been repossesed by the bank, which is now the owner.  In this situation, you are dealing with the owner when you negotiate, so besides being well priced, you have every hope of getting a quick answer. 

A Short Sale is still in the possession of the private owner, who is trying to sell it before the bank repossesses it and this has a negative impact on their credit.  The reason it's "short" is that the owner owes the bank more money than the house can be sold for in this market.  This could be because it was one of those "0 down" loans with a variable interest rate that took place a couple years ago, leaving the homeowner no margin when prices dropped during our recent mini-crash (looking to be recovering nicely, there was appreciation in parts of Seattle and Seattle overall last month).  Or maybe the homeowner owned the home for a few years but needed some cash and took out a second mortgage or refinanced at a higher value.  Whatever the reason, they now owe the bank (for example) $400,000 but the market value of the home is $365,000.  What happens if they have to sell the house?

If they have a lot of cash in the bank, they can just "eat it."  In other words, they can sell the house for $365,000, give that money to the bank, and then pay all their expenses for the sale, and also withdraw the extra $35,000 they owe the bank from their savings and pay it.  We call that being "underwater" or losing money on the sale of your home.  We say the seller has to "bring money to the table" to get the house sold.

If they don't have the funds to cover the shortfall, then they either have to keep the house and keep paying the mortgage, or stop paying the mortgage and let the bank reposses the home.  This really crashes their credit, besides the fact that a lot of people don't want to fail on their obligations.  But there is another possibility, which is the short sale.

If they are behind on their mortgage, the bank will sometimes allow them to apply to accept a lower offer than what is owed.  We real estate agents see the notation "subject to third party approval" or "subject to lender approval" on the listing.  It means that the bank will have to approve the lower offer.  Once in a while a good listing agent who really understands short sales will get the bank's approval beforehand.  These are "preapproved short sales."  If I see one of those I never hesitate to advise my client to try it if they like the house, as it's bound to be a favorable price and there are not the usual barriers to success.  These are pretty rare, though.

Usually the agent has followed the more common path of listing the house as a short sale "subject to bank approval" and then waiting for an offer.  Until they get an offer in hand it is hard to get the bank to negotiate, but with an offer the approval process can get started.  The bad news for my buyer is that approval process can take up to six months or more and has very little chance of success.  We used to tell our clients that about 30% of short sales actually succeeded, now the figure we quote is around 10%.  Why do something like 90% of these offers never result in getting handed the keys to your new house?  (It's kind of like buying a lottery ticket at that rate of success!)

To keep it simple, sometimes the bank just says no.  Even if the bank will consider approving it, "the bank" consists of quite a few offices and staff that the approval has to pass.  And if the loan has been sold to private investors, which is a common practice (most are) then potentially there could be as many as 100+ investors with an interest in that loan, who would have to agree to take the loss.  And that is before considering properties which have a second mortgage, very common.  The first mortgage holder gets paid off before the second one, so they might get nothing.  Or the bank might have to negotiate with the second mortage holder to take a part of what they are owed.  Or the seller's agent might be in that position of negotiating.  A friend of mine who represents a lot of sellers doing short sales told me that during the negotiation process on one my clients offered on, the bank changed who was in charge of the negotiation several times and he had to start from scratch.  It took over six months.  More bad news for the buyers... even after the process is started the bank will often continue to entertain new (potentially higher) offers during the whole time till it's signed off, making your chances even lower if it's a good house which is attractively priced.  Luckily for my buyers while our offer was sitting on the table on that short sale, we discoverd a great house at a great price that wasn't a short sale, and they closed on that house four months before the short sale one resolved... to another buyer at $35,000 over their offer price!

If there is a moral to this story, it's that it certainly doesn't hurt to shop them, but be very aware of what you are looking at and know that the "cost" of getting that great deal is a whole different game with different rules.  You need lots of time, patience, and a philosophical attitude if you want to try short sales.  On the other hand, my advice is to be sure and check out the Bank Owned properties, they are usually priced low.  Also, it's still possible to negotiate.  The downside will be they are 1.  sometimes "as is" with needed repairs and 2. usually not fixed up "to sell" so you need to do some imagining and usually some painting once you get the keys!  Often they are also "winterized' which means the electricity and water might be turned off and it's harder to get a sense of the house.  But if you are willing to work with these parameters, take a look, you might find a gem!