At the beginning of December, the Treasury Department unleashed some pretty powerful initiatives to expedite and encourage the influx of short sales.  As many as 33% of pending sales reported by the National Association of Realtors, are short sales.  Unfortunately many of these sales fail to close.

This trend has caused the Treasury Department to take a hard look at the process.  The most glairing breakdown in the system is the prolonged amount of time these transactions take.  Investors get discouraged and move on.  There are plentiful supplies of short sale housing.  With each failed short sale, the existing inventory of homes for sale continues to grow and lowers values of other properties.

The Treasury realizes the need to strengthen the real estate market and cut into the over-abundance of existing inventory.  In 2009, 500,000 short sales have been completed.  More than twice that number of short sales has failed to close.

The new plan is designed to assist homeowners who do not have the income or debt levels to capitalize on the government-backed $75 billion loan modification program called the Making Home Affordable.

To qualify for short sales assistance, the subject property must:

·                     Be the homeowners principal residence

·                     The mortgage must be delinquent or default must be in the offing

·                     The original loan had to be issued prior to January 1, 2009

·                     The homeowners total monthly mortgage payment must exceed 31% of their before-tax income

The short sale seller will receive $1500 to help offset moving costs.

Short sales are preferable to foreclosure because while they will affect the borrower’s credit rating, the negative effect on lasts about two years.  Meanwhile, neighborhood property values are not as negatively impacted as if a foreclosure had taken place. 

Lenders are finding short sales save them money as they do not have to go through the expensive foreclosure process.  While not the chosen result, the new short sale program should benefit all parties.   

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During the recession, credit markets and especially those dazzling home equity lines of credit were called, limited and not for sale.  The home-equity line of credit business was on hold.  There are signs that this credit tool may be opening the doors again.  The word is out that the consumer should beware.  Terms are very different than in the real estate heydays.

Millions of homeowners watched as their home equity lines were shut down.  However, as the market has stabilized, lenders are slowly getting back in the home equity game.  The volume of new home equity lines is still less than 50% of the real estate boom days, but the trend is encouraging. 

In the home equity golden days, the loans typically were offered one half point below prime.  Those days appear gone.  The new rates are prime plus one percent.  The floor on new home equity rates is 4%. 

To qualify, the homeowners must have a minimum 20% equity position in the residence.  Overall, the home equity line of credit is a far better source of emergency funds than a credit card. 

The lines of credit also come with revised standards.  The days of 100% financing are gone.  Most lenders now want to keep total credit exposure at 80% of value or less on residential lines.  There are no assurances that the housing market has hit bottom and lenders are cautious.  Credit reviews are strict and must be fully documented and substantiated.

As the credit line rates are likely to rise, homeowners should only view the line of credit as a source of emergency funding.  Right now a $75,000 home equity loan would cost about $344 per month.  If rates increase, that on may soon cost about $469 per month.  Still, in certain situations, the line may be the way to go.

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The lax credit policies during the Bush Administration have come close to sinking the American Dream.  10.7 million Americans live in homes whose mortgage now exceeds the value of the real estate.  Another 2.3% or 2.3 million homeowners are within 5% of going underwater, or having an upside down mortgage.  That constitutes 28% of all American homeowners.

The five states with the most underwater mortgages are no surprise.  The ratio of upside down mortgages in these five states is staggering.

          *        Nevada        65%

*        Arizona        48%

          *        Florida         45%

          *        Michigan      37%

          *        California     35%

In all these states, many of the prime loans have gone bad.  The option-adjustable rate mortgages, where minimum down payments were used to purchase high-end homes, is as high as the lower priced mortgage failures.  In states where home values have begun to stabilize, the number of upside down mortgages is dramatically lower. 

If home equity credit lines are factored into the equation, it is estimated that 33.8% of mortgages would have been underwater in the third quarter compared to 32.2% in the second quarter.

Careful real estate investors read these trends and see opportunity.  Supply definitely outweighs demand.  Many investors have become familiar with foreclosure sales and short sales.

In fact the National Association of Realtors has begun to instruct agents in the procedures to transact short sales.  Thus far, in 2009, short sales account for approximately one-third of all the NAR’s pending sales.  Unfortunately, many of these transactions fail to close, a fact the NAR guards closely. 

By learning all the necessary steps, investors are able to capitalize on bulk transactions at a fraction of the value.  Banks do not like to take over real estate.  They often will take a loss rather than bear the expense of carrying costs, but investors must present a viable, convincing argument.  Sharpen up your short sales presentations and negotiate your way to profits.

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There are rules of the 1031 exchange transaction laid down by the US tax code and treasury transactions. If these are met, the owner can avail deferment taxes as well. The first part says that the properties involved should be of the same kind in terms of value and should be used for business, trade or investments. The second part of this law stipulates that the proceeds of the sale should go to buying a new property which should be similar in kind. If not used for buying the same value of property, the net savings that are made will qualify for the taxes.

This option should be looked at as a replacement method when one is selling the primary dwelling and taking a replacement which is almost equivalent in value. Otherwise, any net gains from the transaction would be liable to be taxed under the head of capital taxation.

There are some timelines associated with the 1031 transactions as well. Specifically, there are two timelines that one has to be aware of. One is the identification period and the other is the exchange period. The identification period refers to the period of identifying the right property for replacement and is around 45 days. The exchange period is the time between relinquishing the property and getting the replacement. This period should be within 180 days.

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The mortgage industry has undergone regulatory reform.  The recession took a heavy toll on the creative lending practices.  Subprime lending and exotic subprime mortgage products are a thing of the past.  Here are some of the reforms that have been implemented by the Mortgage Reform Act of 2009 and subsequent legislation.

·                     More documentation – The low documentation loans and no documentation loans that characterized the subprime lending practices are no longer permissible.  Today’s mortgage applications require more paperwork than ever before.  Lenders must substantiate and verify all income and debt.  Borrowers should expect to provide lenders with pay stubs, bank statements, retirement account information, income tax returns and brokerage accounts and debt statements.

·                     Refinancing delays – The banking industry, like many recession industries, has undergone massive layoffs.  Requests for refinancing can now take up to 60 days to process.

·                     New appraisal practices – The new Home Valuation Code of Conduct has overhauled the appraisal profession.  The new code discourages contact between real estate sales people and appraisers.  Only lenders can work directly with appraisers and even that practice is diminishing.  Most appraisers are retained through the use of an independent third party.  These changes have led to some confusion but Realtors have asked Congress to suspend the new rules.

·                     Credit evaluation – In the past a Fair Isaac Company (FICO) score of 740 would entitle the borrower to lower interest rates.  The new favored credit standard is 760.  If your credit score is 760, you may want to consider refinancing.

·                     More Truth in Lending – As of July 2009, lenders must disclose earlier in the application process how much a loan will actually cost.  The purpose of this early disclosure is to allow the prospective borrower more time to consider the mortgage offer.  After the borrower receives the new disclosure, the borrower has even days to confirm the selection.

·                     Longer Closing Dates – It now takes more time to close mortgages.  Part of delay is caused by the extended decision time and part of the delay is caused by the simple fact that foreclosure departments are busier than lending departments.

The most aggressive mortgage lender is now the FHA.  More than 60% of mortgages issued by the FHA in 2009 have been issued to first time homebuyers.  The Federal Housing Administration has lowered their down payment requirement to 3.5% and has increased the acceptable debt to income ratios.

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The most distressed real estate markets in the country are located in Nevada, Florida and California.  Sunbelt cities, Las Vegas, Cape Coral- Fort Myers and Stockton, California, are posting the largest number of foreclosures. 

Real estate investors from around the country are retaining real estate agents in these areas to keep them abreast of local activity.  One seasoned agent in Cape Coral-Fort Myers reports attending 8 foreclosure auctions a month.  In Lee County, Florida, 2009 foreclosures are expected to top 40,000. 

The real estate agent reports that today his typical sale is under $200,000.  During the market’s peak in 2006-2007, the same agent said that his average sale price was $600,000.  Initially, the majority of foreclosures were from subprime loans.  As unemployment has jumped in the Sunbelt, foreclosure activity is affecting all levels of housing and prime real estate loans as well as subprime loans.

Investors in these markets will find very active markets.  2009 has been a record year for closed transactions.  In August, 2009, foreclosures accounted for 37% of all closed real estate transactions.  Foreclosures in the Sunbelt account for close to 50% of all real estate activity.

Investors expecting a quick turnaround are likely to be disappointed.  However, for investors who can find tenants or who are willing to wait for employment to gear up, the medium to long-term returns should be outstanding.  Residential housing in these areas is down as much as 50% from June 2007 highs.

Investors from other areas have learned to perform extensive due diligence before considering short sales or foreclosure purchases.  Many of the Sunbelt properties have preemptive liens from homeowner’s association dues and various tax liens.  Real estate agents in these areas can arrange for structural inspections in advance of foreclosure auctions as well suggest an attorney to search the title.

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Foreclosure gauges are beginning to sound a lot like those ominous unemployment statistics.  They are exhausting.  They are emotional.  In an era where 514,000 new applications for unemployment benefits is considered good news, the fact that 343,838 homes entered the foreclosure market in September 2009, is somehow seen as an improvement in the rate of decline.

Believe it or not, it is!  But like all numbers reported in this recession, it deserves a closer look.  While the September foreclosure activity is less than August, which was less than July, it is still the third highest number of monthly foreclosures on record with RealtyTrac. 

“Bank repossessions, or REOs, jumped 21 percent from the second quarter to the third quarter, corresponding to jumps in defaults and scheduled auctions in the previous two quarters,” said James Saccacio of RealtyTrac.

For today’s qualified real estate investors, the game is on.  Dispelling the adage that real estate investors cannot make money in a down market, buyers with cash can go a long way as banks get creative when looking to get out for under REOs.  Florida investors are buying large blocks of homes from banks and at public auctions.

These investors are banking on their ability to lease properties to “snowbirds” and other displaced homeowners until the market turns.  Residential real estate prices are down as much as 50-60 percent in some Florida markets and the weather has not changed, so rental appeal remains strong.  While seasonal visitors are pulling back from purchases, they are still looking to rent.

“REO activity increased from the previous quarter in all but two states and the District of Columbia, indicating that lenders may be starting to work through some sort of the pent-up foreclosure inventory caused by legislative delays, loan modifications efforts and high volumes of distressed properties,” added Saccacio.

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Buying that Real Estate Owned (REO) property represents a real investment opportunity for profit.  Sounds easy, doesn’t it?  The lender does not really want to hold the property.  The previous owner has gone a separate route and there is a very real possibility that this property can be purchased well under market value.  Like all marketplaces, the REO marketplace is competitive so develop your strategy and stick to it.

The experienced investor can win in this market, but it takes preparation, discipline, a solid investment plan and a coordinated team effort.  Once the bank owns the piece of property, their goal is to turn it over.  Usually banks retain the services of a familiar real estate agency to manage the property and handle the sale.

The investor should ask the agent to research the performance of the REO real estate firm.  Often these companies price properties according to a specific formula.  The investor can learn much about the asking and selling price by knowing the asking and selling prices of other REO’s handled by the listing agency.

The selling agent should contribute to the information gathering process by constructing the property’s history.  Research the Trustee’s Deed or Sheriff’s Deed to find the Bank’s purchase price.  This information may also be on the tax rolls or listed with the title company.  Compare that purchase price with the listing price.

Analyze the loan amounts that secured the property. Somewhere between the original mortgage amount and the foreclosure sale price is the amount the bank is willing to accept.

These figures may have no correlation to the market value.  The investor needs to know the fair market value.  In many REO purchase situations, there may be multiple offers.  The investor must use the fair market value to determine the profit potential.

As we have discussed before, the investor takes an unemotional view of the REO.  This is about profit.  Use the historical data to build an understanding of the bank’s position and use the fair market value analysis prepared by the real estate agent to set your purchase limit.  Present a well-qualified offer and be comfortable with the offering price.  Peace of mind has value too.          

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Opportunities are out there.  Great ones.  Are you ready?  When the short sale knocks, will you be ready to open the door?  Like all investors, real estate investors are thinking ahead and are in a position to move at lightning speed.  Building a savvy, experienced short sale team of experts is a wise decision that can reap big profits and facilitate the short sale process. 

The ideal short sale team consists of the investor, a financial backer, an accountant, an attorney, a certified home inspector and, of course, a licensed real estate agent.  Short sales can have legal and tax repercussions.  Avoid any surprises and engage the accountant and attorney in the process early.  A half hour of advice can facilitate the whole transaction.  In any case, every short sale purchase agreement should contain a one week period for attorney review.

Before you move on any short sale, the buyer should always insist upon a home inspection.  Check all vital systems such as plumbing, electrical, roofing, heating and cooling, foundation, paving and siding as well as termite and/or infestation inspections.  Every seller, including the mortgage holder, will respect the buyer’s right to a physical inspection.  A one week contingency can prevent a lot of hardship down the road.

The real estate agent is the critical component on your short sale team.  Spend some time with the agent and understand the agent’s responsibilities.  The investor should detail the overall investment plan, specific property criteria and property types that are not of interest.  Meet with the agent periodically.  These sessions will serve as the agent’s marching orders.

Increase the real estate agent’s effectiveness by creating a letter of authorization permitting the agent to discuss properties and investments on your behalf.  The letter should contain the date, investor’s name and address and any contact information and all the same information for the agent. 

When the agent finds the ideal short sale opportunities, authorize the agent to contact the lender and procure all financial information about the property.  While the attorney, accountant, agent, home inspector and financial representative are on your team, remember that it is your investment.  Check all reports relative to the short sale.

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Even the most experienced real estate investor can get excited when opportunity knocks and pressures their investment plan.  Sometimes good real estate opportunities arise quickly and require immediate attention.  Ideally, the investor has time to involve the team of professionals, but sometimes the pieces are hard to pull together.

One of the mistakes investors make is to act without doing the necessary legwork and before performing responsible due diligence.  A good investor always finds a way to get the homework done on time.  Many times contingencies are the investor’s best friend.  Whatever it takes, protect yourself and your plan.  Use contingencies to assure enough time to perform due diligence and get your estimates.

Another tricky forecast that can get the investor in trouble is the inability to properly project cash flow and carrying costs.  If the strategy is to buy, hold, rent and manage until certain profit levels are achieved, cash flow is critical.  In today’s market management fess for single-family rentals can run as much as 7 – 10% per year.

Real estate investing is about addressing your plan.  Determine if you are a part-time investor or if you are a serious, volume investor.  If you are in it to win it, establish a steady pipeline of possible investments.  Keep the possibilities coming and sweet profits will follow.

Just as important as building that never-ending pipeline is to develop multiple exit strategies.  If you invest in a property and only have one way to exit, you should reconsider the investment.  The real estate market is like any investment market.  There are swings in supply and swings in demand.  Cover all your bases.

Another area where investors must keep their eye on the ball is checking estimates for rehab and repair.  Many times these proposals are a best guess estimate.  Danger lies in those muddy waters.  Get on top of your estimates, allow for increase and proceed accordingly.

Happy real estate investing!

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