Every investor in rental property wants to find cheap real estate. The truth is, there are some great real estate deals out there if one knows where to look. One type of below market value real estate opportunity is buying a short sale property. Purchasing a short sale property is a bit different from buying a typical investment property. And because of this, we’d like to overview the benefits of buying a short sale. And while there are three clear benefits of a short sale, there are also three drawbacks that any real estate investor must be aware of and prepare for when buying one. Here’s what you need to know when shopping for a short sale investment property.
Background: What Is a Short Sale?
A short sale is a property that has outstanding debt greater than its sale value. More specifically, a short sale is one in which the owner works with a bank to sell a property for less than the value of the debt. The bank allows for this type of transaction because they realize that the owner will otherwise default on the loans and the property will then be bank-owned and move to foreclosure. Lenders prefer not to have a property go to foreclosure. Also, underwater owners who wish to preserve their credit can often sell a property and move on without bankruptcy this way. There may be more than one mortgage on a short sale and all lenders generally need to be in agreement on the terms of sale.
3 Benefits of a Short Sale for the Property Buyer
Benefit #1: A Below Market Price Purchase
Short sale investment opportunities provide buyers with a great deal. Like foreclosures, short sales are never offered at market value, but at a deep discount. An important part of the short sale process for any real estate investor is to benchmark the property’s value with comparable properties. Mashvisor can be a very valuable tool in this regard as any short sale property in the Mashvisor Property Marketplace is accompanied by a list of comps.
Once one knows the property’s true value, shoot for a deep discount of ten to twenty percent at a minimum. Be sure to include your expected repairs and legal costs.
Benefit #2: Quick, Easy Equity
Unlike a traditional sale in which rising market value will be a key way for equity to be added, a short sale is a fast way to equity. Almost to a fault. You will need to do major repairs to most short sale properties and that equity can come from you if you are able to do some of the work yourself. A properly planned short sale will result in a healthy equity spike once the deal is finalized and the repairs completed.
Benefit #3: An Empty Rental Unit
With any property that has a pre-existing tenant, the plan after ownership transfer should be crystal clear and legal. With a short sale, insist that the seller is out of the property on the closing date. Don’t even consider then renting the property back to that party. They have already proven to be a bad credit risk and a clean break is a must. Furthermore, short sales involve significant repairs and maintenance after a sale. An empty unit is a blessing in disguise here. No tenant will want to tolerate the amount of construction likely to be needed. Work with your realtor or develop your own marketing plan for the new unit and show representative images with a “Ready by” date to gather interest before showing it. It is unwise to ever show a unit one plans to repair. It can only work to turn off buyers or renters. Look at the empty unit as a benefit and start fresh with a new tenant once you have brought it up to standards.
3 Drawbacks of Buying Short Sale Properties (and How to Prepare for Them)
Drawback #1: Unusual Sales Practices
Short sales are a bit odd. The selling agent is actually working for both the owner and the bank. The commission terms are often custom, and the seller may be getting a flat fee rather than a commission on the sale price. Buyers can (and should) attempt to negotiate with the seller to get the price down as low as practical. However, be aware that short sales attract cash buyers in many cases and money talks. Know what leverage you have. A pre-approval is a must if one is not planning to pay cash. Since the bank or banks get to decide on the sale price, the seller is in effect the bank. And oddly, the selling real estate agent will sometimes help to convince the banks to take an offer.
The actual owner will be getting no revenue from the sale. For this reason, be aware that the banks hold the cards and they are just professionals at their daily job. They have no sense of urgency to reply back to a buyer’s offer. Real estate investors should have patience and a pleasant professional tone in all communications. Short sales can take months to be agreed upon and months more to close. To get that below-market property, one needs to play the long game with short sales.
Drawback #2: Repairs and Maintenance
The next big difference between a conventional sale and a short sale is the level of repair and deferred maintenance to expect. Document thoroughly the condition of the investment property at the time of the deal’s acceptance and ensure that you protect yourself with language in your purchase and sale agreement that the property will not be damaged beyond that level.
Sellers of short sales are often in dire straits. They don’t have the resources to do things like grounds keeping and general repairs. Never mind big repairs like new roofs and heating system replacements. Get a proper home inspection and be prepared for some major repairs. Prepare both mentally and financially. Carefully factor in the repairs you know about and add in a bit of padding so that things that turn up later don’t cut too deeply into your equity.
Drawback #3: You Need Legal Help
Truthfully, real estate short sales are not a type of sale one can do alone. Get a lawyer who is skilled and experienced in short sales to assist you with the offer, purchase and sale, and closing. Budget for this expert help. Short sales are more complicated than traditional sales but can be well worth the effort. Your legal help should include verifying all prior loans and any municipal and contractor liens are closed and cleared and the title successfully transferred. Title insurance would be a wise investment in any short sale property.
Conclusion – Short Sales Can Work Great
Any real estate investor asking themselves, “Should I invest in a short sale?” should know that there are many benefits of a short sale. Your author has successfully purchased two short sale rental properties. Both added 50% equity within five years, and one re-sold quickly and easily at that new higher price point. There is work to do with a short sale investment. However, the benefits of a short sale are substantial.
To get more help finding and learning about short sales, start your free Mashvisor trial today.