While potentially tricky, short sales are some of best ways to find new deals to fix & flip. Let’s talk about how.
Competitive real estate markets require investors to get creative with their inventory. When dealing with a non-stop stream of bidding wars, you realize you’ve got to expand your pool of potential properties to find a better deal. One of these expansions might include looking at short sales. But what is a short sale, and is it actually a profitable way to invest in real estate?
A short sale is a real estate transaction where the original homeowner gets their lender to agree to a property sale for less than what’s originally owed. Short sales mitigate the chance of foreclosure and can be an excellent way for real estate investors to get good deals on well-maintained homes.
But, as with all things that come with real estate, short sales have some caveats. So let’s talk more about what a short sale is, why it’s better than a foreclosure, and the things you need to keep in mind before making an offer on that potential investment property. Let’s dive in.
A “short sale” is the term used for when a property owner sells their house before they are foreclosed on. Typically it’s because the home is now worth less than what the homeowner paid, but it can also be due to things like job loss or other financial issues. Successfully creating a short sale involves an agreement between the homeowner, the lender, and the new buyer.
The process for a short sale doesn’t vary much based on location or market conditions; it generally goes like this:
The homeowner realizes they can no longer make ends meet and stay up to date with their mortgage. It might also happen that the market has tanked, and the homeowner realizes they’re paying on a mortgage that’s more than the property is now worth. Rather than getting foreclosed on, they and their real estate agent list the house for sale on the MLS as a short sale.
A potential buyer sees the house for sale and makes an offer. The offer is less than what the homeowner owes the bank but is competitive enough that the lender might agree to the offer anyhow.
The homeowner approaches the lender with a request to sell the house for less than what they owe and show proof of a new buyer ready and willing to transfer ownership ASAP. The lender then crunches the numbers and either agrees and accepts less than the original loan amount or denies the request and moves ahead with the original homeowner.
If the bank agrees, the short sale releases the original homeowner from any further obligation on the mortgage so long as they receive a Payoff Letter. If no Payoff Letter is offered, the original homeowner is still on the hook for the balance owed.
If you’re not savvy to real estate lingo, then you’ve probably mixed up “short sale” and “foreclosure” at some point, and it’s understandable why. Both short sales and foreclosures happen during a similar milestone in homeownership: the inability to keep up with your mortgage payments. They both also cause your credit score to take a hit. But short sales are still better than foreclosures when you’re the homeowner.
First, short sales put a smaller ding on your credit score. Yes, your score will still go down, but the penalty will be less severe than a foreclosure. It’s like the difference between getting a payment plan with a credit card company to pay off your debt versus declaring bankruptcy. Bankruptcy is like setting a bomb off on your credit report, while a payment plan is more like an “Oops! My bad. Won’t happen again, I promise.” The same goes for short sales and foreclosures. Having a short sale on your credit history might make lenders wary of working with you, but you’ll most likely still find one who will give you a mortgage within a few years (possibly at a higher interest rate than if you didn’t have that ding on your report). Foreclosures, however, get very tricky to navigate when you’re trying to buy a home, lease a car, or even cosign for your kid’s student loans. They’ll fall off your report eventually, but those eight or so years will be hard times for loan approvals.
Next, short sales are much faster than a foreclosure. Foreclosures are both an event and a process (just to confuse you a little further) and can get drawn out for years in court. Consequently, a short sale will most likely end up being cheaper for everyone, including the lender, since they’re removing all the legal fees and carrying costs that go along with assuming ownership of the property.
It seems counterintuitive that a bank would accept less than what’s owed, right? Shouldn’t they just say “no” and force the homeowner to keep paying? The answer is: it depends. Those lenders are smart and know a lot when it comes to probability, statistics, and what’s the better bet for their money.
Investing in short sales as a real estate investor seems like a great idea on the surface. You’re able to get a deal on a home that most likely has low competition since retail buyers typically don’t know what to do with a short sale and get intimidated quickly. There are a few reasons that short sales can be great investment properties, including:
However, there are a few factors you should consider first before going all-in on short sale properties.
While short sales are faster than foreclosures, that doesn’t mean they’re fast. To give you an idea of the timeline you’ll be up against, here are the average times it takes to successfully flip a house, depending on how you acquired it.
Fix & Flip – 24 weeks
Short Sale – 18.6 weeks to close + 24 weeks to rehab and flip
Foreclosure – 101.85 weeks to close + 24 weeks to rehab and flip
Homes bought off the MLS or off-market typically take 24 weeks or six months to sell successfully. Short sales and foreclosures have their own timelines for closing that add to the six-month holding period, so if you need to unload your properties quickly, short sales won’t work for your business model.
Just because retail buyers (buyers looking for a home of their own) get intimidated by the paperwork involved in a short sale doesn’t mean your competition level is zero. Experienced real estate investors seek short sales out when they’ve got other things going on that bring in revenue and have the luxury to wait for the deal. If you’re new to investing or aren’t yet turning a profit, your situation might be too risky to focus your attention on short sales. Look for off-market properties instead.
Putting an offer on a short sale never comes with a guarantee that you’ll be successful. Lenders have all the power in a short sale and can trigger any number of problems that mean you’re not getting the deal you imagined.
Real estate is emotional; there’s no way around it. Even in the best of conditions, selling a house means losing tangible pieces of memories forever. Often these properties will be where families have grown, where holiday parties took place, and where significant milestones (“our first home!”) were made. That’s a lot of baggage to contend with as the buyer. Now toss in the feelings associated with losing that home because the owner has no choice but to sell due to their financial situation. Needless to say, it’s a lot to deal with. If you’re an empathetic person, it can be difficult to take those feelings on while balancing the need to run a successful business. The truth is, it doesn’t get easier since every situation is unique; you just get used to knowing what you’ll be up against. My advice is to find ways to cope through self-care and never let yourself feel guilty. You didn’t put them in this situation where their back is against a wall. If anything, you’re solving a massive problem for them that not only lets them walk away from their financial obligations but saves them from foreclosure and possible bankruptcy.
Working with short sales as a real estate investor has its positives and negatives. While you’ll be able to get a hefty discount on a well-maintained property, that doesn’t mean the process is easy. As long as you can navigate the extended timeline and stress of working with the whims of the lender, you’ll come through okay. Just go in with your eyes open and know what to expect before you send that offer over.
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