There has been lots of talk lately about short sale fraud. Understandably an appealing topic, most of the recent discussion centers around a recent Corelogic report suggesting one in every two hundred short sales across the United States are "very suspicious."
Although discouraging we remain in economic turmoil on the housing front and distressing that despicable individuals continue prey upon the misfortunes of others, it's misleading to categorically label an investor driven back to back transaction, known as "flopping," as fraud. Though a noble cause, focusing efforts on how to stop bad people from doing bad things is not only a losing battle in this instance it completely ignores the root problem of the short sale process and prevents us from finding a relevant and lasting solution.
Phenomenon of the Short Sale
Short sales occur when a homeowner (borrower) attempts to sell his or her home at a price that is less than the full amount owed to the bank (the lender). Most often a short sale occurs as a last ditch effort by a homeowner proactively trying to avoid a full foreclosure proceeding, which results in losing their home to the bank, being forced to move, and like a bankruptcy, becoming locked out of the financing market for a period of seven to ten years.
Banks prefer short sales to foreclosure because they (in theory) resolve the outstanding debt faster and result in the bank losing less money in the settlement of the bad debt. Before the emergence of our current housing crisis, banks reluctantly agreed to a short sale unless the homeowner displayed one of five generally understood "hardships." Those included, loss of job or income, forced relocation (typically due to a job), death of a spouse or income provider, divorce, or an increase of interest rate that made the monthly mortgage unaffordable.
This all changed after the collapse of Lehman Brothers, and the shifting political winds created amid bank bailouts, job losses, and precipitous drops in home values. American tax payers and politicians demanded something be done to help "Main Street America."
The result of this perfect storm included the largest federal infusion of tax payer capital into the banking system since FDR was in the White House and a myriad of federally mandated programs aimed at helping banks remain solvent (on paper) as they work through bad loans. For Main Street, the programs give unfortunate and honest homeowners relief until they get back on their feet (HAMP) and allow other homeowners a graceful exit from the stress and burden of unsustainable mortgage debt.
Short Sales, once rare, have become more prevalent and outnumber both traditional sales and REO sales in some of our hardest hit markets. For example in Stanislaus County, dubbed the mortgage fraud capital of the country, two of every three home sales occurring last year (ending June 2010) were short sales.
Mechanics of a Short Sale
A short sale does not occur unless the current homeowner decides he or she wants to sell. Further, the homeowner alone decides to whom they will or will not sell the property. This bares repeating; In a short sale the borrower, not the bank, markets and sells their home to a willing buyer.
Banks do not enter into the short sale process until the homeowner finds a suitable buyer for the home, enters a binding contract, and submits the required financial and hardship documents to the lender.
Although reported as a simple transaction, the short sale is anything but a "straightforward transaction." I tell my clients the short sale actually involves two transactions. One the primary real estate transaction between the owner of the home and the potential buyer, and two the debt settlement transaction between the owner of the property and the lender holding the mortgage(s) in default.
With the exception Wells Fargo (only applying to securitized loans initiated by Wachovia, Golden West Financial, and World Savings all failed banks previously absorbed by Wells Fargo) a bank will not begin negotiating the debt settlement portion of a short sale transaction until a seller has submitted a valid offer from a ready, willing and able buyer. In other words, they will not discuss accepting less money on the outstanding debt until someone steps up to buy the property. If this does not happen soon enough, the bank will foreclose on the home. This is the crux of the problem.
Most buyers making their housing decisions have real life issues to contend with. Children entering the school year, coordinated moves from one home to the other, obtaining financing for the new purchase all require the buyer to spend money and meet deadlines. In a traditional sale, the buyer makes an offer and the seller responds within 3-5 business days of receiving the offer. This is not the case in a short sale.
Although the seller may respond within the same time periods outlined above, neither party is contractually bound to deliver on the agreement until the bank decides what price and terms they will accept. To make matters more complicated, most banks can take from 30-60 days (sometimes longer) before responding to an offer. Adding insult to injury, most banks leave little to no margin for error, all the while reminding sellers and their agents that they may pursue the unpaid debt after the short sale (deficiency judgement), and oh by the way, the clock is ticking, so...
The result of this mess is fewer buyers willing to wait around for a short sale to close unless they have a reason to do so (translation: cheap enough to wait it out). Another result, buyer agents refuse to expose their buyers to such nonsense or, on the listing side seek innovative and creative ways to prevent their clients from losing the home to foreclosure.
This is key factor in the process. The real estate agent represents and is bound by a fiduciary duty to the seller of the property. In no way is the real estate broker/agent representing the bank in a short sale transaction, and in no way are the banks looking out for the seller's best interest. It's also important to note the seller, with few exceptions outlined in the HAFA program, is expressly prohibited from benefiting financially as the result of a short sale transaction. Therefore the primary goal of the seller in a short sale is to avoid a foreclosure; real estate agents are bound by their fiduciary duty to the seller to work diligently and obediently towards that end.
Motivating Factors of a Short Sale
In light of all this why does anyone attempt to complete a short sale? This answer is different for all parties to the transaction.
Banks and/or lenders are primarily driven by profits or the mitigation of a loss. Simply put they are attempting to collect as much as possible on a bad debt. In a recent article at thestreet.com John Gittelsohn writes, "the average loss in principal for prime loans that went into foreclosure was 42 percent, compared with a 33 percent loss for short sales, according to Amherst Securities Group LP, an Austin, Texas-based company that analyzes home-loan assets." Banks lose less and recover faster by allowing and encouraging sellers to pursue short sales.
Sellers are seeking closure. Coming to grips with the financial loss or loss of a family home is devastating to everyone who faces the situation. However the most excruciating part of this process more often than not is the wait; waiting for the phone calls from creditors, waiting for the mailed letters demanding payment, waiting and wondering if the Sheriff will show up one day and lock them out of the house and throw all their belongings to the front lawn.
Many sellers are motivated to complete a short sale to once and for all put an end to the ordeal. Unfortunately the process welcomes them with more waiting; waiting for a real buyer, waiting for the bank to respond to that offer, waiting for the bank to process paperwork, the list goes on.
Of course there are other very valid reasons why a borrower would pursue a short sale. For example a short sale is far less devastating to your credit rating compared to a foreclosure. After a short sale, a defaulted homeowner can re-enter the housing market and obtain financing on a new home in two years or less as compared to the seven to ten years they wait after a foreclosure. In a short sale you are proactively advocating for the best possible debt settlement from the lender, in a foreclosure you are leaving the outcome to chance and the lender will not be kind as they seek to remedy their loss (of course this does not begin to address the reasons associated with strategic defaults, another topic all together).
Buyers too come with their own set of motivations - most clearly seeking a bargin. This is not a bad thing, nor is it surprising; Finding a deal is as American as Apple Pie. If you need examples visit a going out of business sale, the wholesale district of your local central business district, or a Ross Dress for Less on a Sunday afternoon. However, as most of these retailers will tell you, there is no brand loyalty in the bargain basement. Translation, buyers are fickle and unreliable more often than not in a short sale, and most will leave the transaction in a heartbeat if a better deal comes along, leaving a seller vulnerable to missing a short sale opportunity and again facing a foreclosure.
Enter the Investor...
Some Investors are Their Own Worst Enemy
Type "short sale wholesaling" into Google and you'll know what I mean. They market themselves as ninjas, guru's, money making maniacs, and often times resemble Family Guy's Al Harrington more than a trusted financial adviser or capable real estate expert. Many of these so called investors present themselves surrounded by piles or cash, expensive homes or cars and expound the virtues of making huge profits with no money and little effort. In a nutshell they are out for themselves and work at the expense of all other parties to the transaction.
They make promises they cannot keep and suggest outcomes that are unlikely to occur. They proliferate because distressed homeowners are desperate for financial salvation, want to believe anything that sounds like a solution, and have lost faith in government programs that fall short of expectation and benefit some while neglecting others. This opportunistic group, gives sound capable real estate investors a bad name.
Crazy as this sounds, this "speculator" has his or her place in the current market and a seller is still better served by this group "flopping" a short sale compared to going through a complete foreclosure. Unfortunately, left unchecked or unregulated, these groups edge out real investors or home-buyers who add value back to a distressed asset through renovation or deliver a once dilapidated property back to the rental market after moving through a distressed sale. Their actions also cause banks and government agencies to take sweeping actions that harm the overall housing recovery (eg. initiating the 90 day no flip rule).
There is no place for fraud, misrepresentation, or lack of compassion. Those acting with such reckless abandon should have no place in a short sale transaction and won't when banks begin expediting the short sale approval process. A faster process will attract better buyers willing to pay more and intent on sticking with the transaction to the end. With the risk of losing a buyer over time mitigated, sellers will also be more willing to continue with a buyer willing to pay more for the property. This will effectively edge out the "floppers" all together.
The Same Goes for Many Real Estate Agents
The sad fact is that for a few hundred bucks, an Internet connection, and a few hours over the weekend any agent can become a Certified HAFA Specialist. Equally, by paying a few bucks to the local Association of Realtors and attending a half day seminar any agent can become SFR (Short Sale and Foreclosure Resource) Certified by the National Association of Realtors. Conspicuously missing from the list of requirements in obtaining these "expert" designations is actual real world application. Yes you read that correctly, you can become a certified expert without completing a single short sale transaction!
Yet this new market along with new and innovative technology provide for a new paradigm for real estate professionals. As Chris Brogan and Julien Smith reference in their book Trust Agents, today's influencers are those who trade in trust, reputation, and relationships. Author Seth Godin describes the indispensable business leader of today as a Linchpin, the artist who inspires change by connecting with people in a positive way, changing people by connecting with them in a way they want you to connect with them. He goes on to suggest it's all about adding value.
It's no longer good enough to plant your face on the bench at a bus stop, at least nor more than it's about hanging as many for sale signs as possible in a particular neighborhood and waiting for the calls to roll in. It's no longer about gathering a litany of acronyms to follow your name, at least no more so than it is about controlling the flow of information on the local MLS.
It's time to become less of a salesperson, and more of a trusted and capable adviser.
Finding a Solution by Shifting the Focus
So what is the point of all this? This is an opportunity for all of us affected by this housing crisis to step up and become indispensable by allowing ourselves to shift the focus from prevention to solution. It's a call to action for all of us working towards a greater good. One of my little league coaches taught me that there is a very big difference between playing to win vs. playing not to lose. I believe the same applies to the current housing crisis.
We've been in prevention mode long enough - preventing the meltdown of the financial crisis, preventing foreclosure for homeowners who are upside down on their mortgage, preventing fraud, preventing strategic defaults...
Bad people do bad things, we're not going to change that. However, it's a heck of a lot harder for bad people to do those bad things when everyone else is actively participating in making things better.
If banks don't want to get short changed on a short sale flop, make it faster and easier for everyone to get a short sale completed. The "flop" in and of itself is not illegal and banks do not have the right to force an owner to sell to anyone. They do have the choice to foreclose or allow sellers to settle their debts for less.
If you want to make money as a short sale investor, become part of the solution for everyone. Don't turn a buck at the expense of someone else, make your spread by adding value to the transaction.
If the government wants to fairly help Americans resolve their mortgage issues, stop unfairly dictating who is and who isn't justified in walking away from their mortgage debt, and once and for all let the market correct itself. As David Streitfeld of the New York Times alluded to last Saturday, there is a growing sense of exhaustion with mortgage intervention. It was a valiant effort to save homes and help new buyers enter the market, yet our free market economy seems reluctant to prop up an over-leveraged market.
Finally if you want to become a more successful short sale agent, become a Trust Agent, trading on reputation and relationships. Know your client, continue to learn and always serve your client's best interest in the transaction.
After all, the ultimate fraud prevention is a viable solution.