Often, in bad economic times (like the past few years), companies need to reduce their asset load due to decreases in property values. In essence, the properties that were once assets are now burdens and foreclosure is a very real possibility.

However, for an investor with a focus on what will happen down the road – not how the next mortgage payment will be made – this can be an opportunity. And a commercial short sale may be the best avenue for an investor to help a company or individual facing commercial foreclosure.

In today’s tough credit market, it’s not easy to get credit and often commercial loans require a personal guarantee, so Mr. Business Owner may be in more than a tough spot company-wise; he may be looking at taking a personal hit if the bank forecloses.

When the bank allows a short sale, the bank may come out better than if it did foreclose. According to an article from Forbes, the trend of foreclosures on commercial properties has increased exponentially since 2006.

Additionally, a 2010 report from the Congressional Oversight Panel called Commercial Real Estate Losses and the Risk of Financial Stability estimates that commercial loans made over the past 10 years total will require refinancing between now and 2014. The estimated $1.4 trillion in at-risk loans includes properties such as retail space, office buildings, industrial plants, hotels and apartment buildings.”

The Congressional report said, “A significant wave of commercial mortgage defaults would trigger economic damage that could touch the lives of nearly every American.” It points to the aftermath of a commercial property takeover – loss of jobs, loss of community value (abandoned store fronts, office buildings and apartments) and even the failure of banks in the community.

The Forbes article said that “a further spike in delinquencies would strain banks and then dry up funds for future commercial borrowers.”

So, are commercial short sales the answer to this dilemma? Maybe, maybe not. However, these sales could ease the burden on banks and struggling companies.

As we’ve seen from the two previous sources, banks are already struggling with too many foreclosures. The market is flooded with properties that were sold at the top of the real estate bubble Mark Bergen makes a very good point in the Forbes article, “Loan restructuring and credit easing and interest rate guarantees won’t go all that far if people just aren’t buying your stuff.”

Investors have an opportunity to help the commercial market through short sales but it’s important to follow the rules, to ensure it’s a good investment and to have an attitude of helping the situation.

Short Sale Defined

A short sale is basically selling a property at the current market rate without adding in the debt owed to the owner or lender. This sale has to be approved by the mortgage holder in order to make the transaction happen, so that’s where the work starts.

The Process

The first step to beginning a short sale is to get a market price for the property. A real estate agent or appraiser can help determine the property’s current value. If there’s a big difference in the current value and the amount owed on the property, it may be a good idea to involve a loss mitigation specialist. This person can also help in complicated situations or in the event the seller is in unfamiliar territory. Short sales have a lot of steps and regulations, and a specialist can help the process along.

After determining the property value and deciding whether to involve a loss mitigation expert, the seller (or loss specialist) will develop a proposal for the lender. The proposal will break out the financial risk a lender will take in the event of a foreclosure and compare it to how the lender comes out in the event of a short sale.

The property you’re looking at or trying to short sell probably needs improvements and that needs to be factored into the proposal for the short sale. Don’t just give a lump sum on the amount of repairs needed. Get contractors to give estimates and include those with the proposal.

Finally, you’ll need to craft a letter of hardship. This letter should explain the current financial situation and the projected situation for the underwater mortgage payer.

The idea is that you’ll have to do all of the legwork (told you this was boot camp) to create a solid proposal.

The lender will work through the proposal and give an approval or denial of the short sale.

What’s In It for Investors?

You can specialize in short sales and build a network of rentals or flip short sale properties. In order to specialize in this area, you need to understand how to structure the proposal or have a loss mitigation specialist on your team. You’ll also need to do thorough market research to ensure the deal is a good one.

Stay tuned for more lessons this month on commercial loan modifications and workouts.

The additional paperwork is said to help all parties with an interest in the short sale to “have more information to identify potential mortgage fraud and a clearer understanding of the intent of all parties involved in the real estate transaction.”

Of the most concern is the practice of “flopping.” HousingWire’s Jon Prior describes this process as real estate agents on the buyer side of the short sale not disclosing other bids on the property. The result is that they are said to “rig” the sale at a lower price.

“The fraudsters can then flip it, sometimes the same day, and pocket the difference,” Prior writes in a Tuesday report. And Freddie considers the knowledge of a buyer willing to pay a higher price for the property “unscrupulous.”

What are your thoughts? Do you think a real estate investor with a target buyer willing to pay a higher price for a property to not deal with the short sale process is taking a fraudulent approach? How do you think the changes will affect investing in short sales?

And, if you’re a real estate investor, it’s important to help protect consumers from scams. As an investor you must negotiate short sales appropriately under the new MARS ruling from the FTC.

FTC Chairman Jon Leibowitz says, “At a time when many Americans are struggling to pay their mortgages, peddlers of so-called mortgage relief services have taken hundreds of millions of dollars from hundreds of thousands of homeowners without ever delivering results. By banning providers of these services from collecting fees until the customer is satisfied with the results, this rule will protect consumers from being victimized by these scams.”

Who are the scammers?

The FTC calls them bogus operations that in exchange for an upfront fee will negotiate with a homeowner’s mortgage lender to get one of the following – a loan modification, a short sale or other relief from foreclosure.

These groups often claim to be affiliated with a government agency or the government housing assistance programs.

What does this mean to real estate investors?

Some of the work you do to get deals requires that you negotiate with a homeowner to do a loan modification or short sale. The easiest way to be in compliance is to know what you can and can’t do in negotiations.

The biggie is that you can’t charge an up-front fee. That’s fairly simple, don’t you think? I think it is. I mean you’re trying to get a deal, not $100 quick bucks.

Here’s what that quick money could turn into – mega fines in the ballpark of $11,000 per occurrence and $11,000 per day that you are in violation.

Here’s the breakdown of the rules.

Advance Fee Ban

• You can’t collect fees until you have provided the homeowner a written offer from their lender or servicer that the consumer deems acceptable.
• The mortgage holder must provide a written document describing the consequences of accepting the offer.
• You must also remind consumers that they have the right to refuse the offer – without any fees.

Disclosures
In all of your communications, your company must disclose the following:

1.     You are not associated with the government or endorsed by the government.

2.     The lender can refuse to modify the homeowner’s loan.

3.     If a homeowner stops paying their mortgage, they could lose their home and damage their credit.

4.     The homeowner can walk away from the deal at any time before accepting the lender or servicer’s offer AND that they are not required to pay your negotiation fee.

5.     Your fees for negotiating the terms of the short sale or loan modification.

What You Can’t Claim

• the likelihood of consumers getting the results they seek;
• the company’s affiliation with government or private entities;
• the consumer’s payment and other mortgage obligations;
• the company’s refund and cancellation policies;
• whether the company has performed the services it promised;
• whether the company will provide legal representation to consumers;
• the availability or cost of any alternative to for-profit mortgage assistance relief services;
• the amount of money a consumer will save by using their services; or
• the cost of the services.

A Big No-No
If you tell your prospective homeowner customer to stop communicating with their lenders or servicers, you’re in violation.

Your Pitch

If you claim that you can help a homeowner, the FTC says you have to have “reliable evidence” of your claims about the benefits, performance or effectiveness of how you negotiate.

Where Do These Rules Apply Most?

There are two scenarios where these rules apply most – subject to and carry back loans. In both cases, you are either taking over financing or making a loan modification. You need to follow the rules and you’ll be fine.

Check out the entire FTC ruling here. Stay informed with the Investor Insights by signing up for email notifications.

This is great news for sellers, buyers and investors. There are a lot of good investment opportunities buying short sales. The biggest obstacle has been how long it takes to get them approved.

Under the HAFA program, the loan servicer or lender has 10 days in which to respond to the seller whether or not they are approving the short sale offer. This is a huge difference in the way the short sale process has been handled up to now. It has been taking lenders anywhere from three months to six months and even up to a year in some cases to approval a short sale.

The program is voluntary so both the lender and the seller must agree to participate in the short sale and close the transaction. The government is offering the lender and the homeowner incentives to close the deal.

Here are highlights from the HAFA program:

The borrower’s financial information and hardship letter that was submitted with their loan modification request is used in connection with the short sale determination.

The borrower can obtain the pre-approved short sale terms the lender is willing to accept for the sale of the home before they list the home. This way, there is no guessing as to what price the lender will accept for the property. It lets the buyer/investor know the exact price they must pay for the home.

Releases borrowers from any future liability or deficiency judgment against them by the lender. So basically, the short sale proceeds are applied to the loan and the bank writes off the rest of the debt. The seller owes nothing more on their loan.

Provides the following financial incentives:

$3,000 for borrower relocation assistance;
$1,500 for servicers to cover administrative and processing costs;
Up to $2,000 for investors who allow a total of up to $6,000 in short sale proceeds to be distributed to subordinate lien holders, on a one-for-three matching basis.
Each individual lender has to create their own process and policies concerning their own HAFA.

Hopefully, Bank of America, Chase, Wells Fargo and others will implement these changes quickly and stream line the process making it easier for all parties to close a short sale transaction.