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Short Sales: A Sweetening Alternative for Servicers

Daren Blomquist
Dec 23, 2011

Short sales have rarely been the first choice of servicers given the extra complications involved in negotiating a property sale with at least two other parties—more if there are second lien holders and investors involved. Beyond the practical complications lies the belief that short sales flout one of the fundamental principles of mortgage lending: Those who enter into a legally binding contract to pay off a mortgage should, in fact, be required to pay off that entire mortgage. A short sale violates that principle by, in effect, giving the borrower a principal balance reduction. In the interest of keeping both the principal and principle intact, mortgage servicers have typically favored disposing a property through foreclosure rather than short sale. RealtyTrac’s foreclosure sales report shows sales of foreclosed and real estate-owned (REO) properties nationwide have surpassed the sales of pre-foreclosure properties (in default or scheduled for foreclosure auction, these are typically short sales) in every quarter since the first quarter of 2008. Cumulatively over that time period, a total of 2.3 million REO properties have sold compared to 1.5 million pre-foreclosure sales. Short sales spiking But, we noticed a significant shift in the second quarter of this year that indicates short sales may be growing on servicers. Overall, REO sales still outpaced pre-foreclosure sales by a wide margin, approximately 60,000. Nevertheless, pre-foreclosure sales spiked 19 percent from the previous quarter, while REO sales posted a fractional decrease from the previous quarter. In some of the nation’s biggest real estate markets, it appears that lenders, servicers and investors are pushing pre-foreclosure sales as a means to reduce costs and clear non-performing loans. Some of the states with the biggest quarterly increases in pre-foreclosure home sales included Nevada with a 43 percent increase, Washington with a 39 percent increase, California with a 38 percent increase, and Texas with a 34 percent increase (see Fig. 1). If this trend continues, it could be a solid sign that short sales are finally becoming more palatable to servicers, lenders and investors. Another sign of this trend can be found by looking at foreclosure sales data at the metro level. In a few bellwether local markets, pre-foreclosure sales actually topped REO sales in the second quarter. For instance, the RealtyTrac report shows 2,755 pre-foreclosure sales in the San Diego metro area in the second quarter compared to 2,393 REO sales during the same period. Across the country in the Cape Coral-Fort Myers, Fla. metro area, another market hard-hit by foreclosures, a total of 1,358 pre-foreclosure properties sold during the second quarter compared to 1,151 sales of bank-owned properties during the same time period. Deeper discounts Furthermore, the average discount on pre-foreclosure sales increased in the second quarter, indicating servicers may be more willing to authorize lower selling prices for short sales. Pre-foreclosures, which are often sold via short sale, had an average sales price nationwide of $192,129, a discount of 21 percent below the average sales price of non-foreclosure homes. That discount was up from a 17 percent discount in the previous quarter and a 14 percent discount in the second quarter of 2010. Despite the growing discounts on pre-foreclosures, however, the average discount on REO sales continued to be more than double. Nationally, REOs had an average sales price of $145,211 in the second quarter, a discount of nearly 40 percent below the average sales price of non-foreclosure homes. That was up from a 36 percent discount in the previous quarter and a 34 percent discount in the second quarter of 2010. The bigger discount for REO sales offers a clear sign that servicers may often be able to get a better return on a distressed property by selling via short sale rather than selling as REO. The bigger REO discount is undoubtedly impacted to a certain extent by the type of properties and location of properties that tend to make it to REO status, but it’s still reasonable to expect a short sale property to be in better sellable condition simply because it is usually occupied by a homeowner and not vacant. Shrinking time to sell Apologies to all the real estate pundits and prognosticators out there, but the old reliable quip that there is nothing short about short sales may not evoke knowing laughs much longer. That’s because short sales appear to actually be getting shorter, if ever so slowly. Pre-foreclosures sold in the second quarter took an average of 245 days to sell after receiving the initial foreclosure notice, down from an average of 256 days in the first quarter—following three straight quarters of increases in the average time to sell. Nationwide, it still takes longer to sell a short sale than an REO property, but the time to sell those REOs is headed up. REOs that sold in the second quarter took an average of 178 days to sell after being foreclosed on, up from 176 days in the first quarter and up from 164 days in the second quarter of 2010. In some states, however, the average number of days to sell a pre-foreclosure is shorter or virtually equal to the average number of days to sell a bank-owned property. In Texas, pre-foreclosures that sold in the second quarter took an average of 165 days to sell, compared to an average of 195 days to sell REOs. The average number of days to sell a pre-foreclosure was also shorter than the average number of days to sell an REO in Oregon, Washington, Virginia and Georgia. In California, it was a virtual tie, with pre-foreclosures selling in 169 days on average, and REOs selling in 165 days on average (see Fig. 2). The second quarter jump in pre-foreclosure sales, coupled with bigger discounts on pre-foreclosures and a shorter average time to sell pre-foreclosures all point to a housing market that is starting to focus on more efficiently clearing distressed inventory through more streamlined short sales—particularly in some areas. This gives distressed homeowners who do not qualify for loan modification or refinancing—or who are not interested in those options and want to sell—a better chance of completing a short sale to avoid foreclosure. Streamlined short sales give lenders the opportunity to more pre-emptively purge non-performing loans from their portfolios and avoid the long, costly and increasingly messy process of foreclosure and the subsequent sale of an REO—which may end up selling for a lower price than it would have as a short sale and in the meantime further stress already overloaded REO departments. Significant challenges to streamlining the short sale process remain. It’s no easy task to deal with the complications of cutting a deal with secondary lien holders and getting approval from investors. But the added foreclosure documentation and processing requirements now being imposed by regulators, legislators and judges are making the foreclosure process more complex, costly and risky. Even foreclosures done by the book using today’s standards may not measure up to higher standards imposed in the future, and therefore, might be subject to dispute even after the REO has been resold to a third party. Certainly short sales will not completely supplant foreclosure as an alternative to disposing of non-performing loans, but they are starting to look like a much sweeter alternative. Daren Blomquist is director of marketing communications for RealtyTrac. He may be reached by phone at (949) 502-8300, ext.115 or e-mail [email protected]  
Published
Dec 23, 2011
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