This is article four in our ongoing series on formulating a real estate investment business plan
Short sales or pre-foreclosures are also considered distressed properties because the borrowers are about to default on their mortgages and the homes may be heading to foreclosure, or the owners may have already received a foreclosure notice from their lender. With a short sale, the owner must provide you with disclosures about anything that is considered materially and would influence your decision to purchase the home because they still are in possession of the property. However, they are under no obligation to make any repairs.
Short sales require the approval of the borrower’s lender before the transaction can close because the lender has to write off the difference from the sale proceeds and what the borrower owes the lender on their mortgage. Short sales may take a while to close because lenders typically don’t respond quickly. The average short sale transaction may take three to six months or even longer. Keep in mind there is no guarantee that the lender will even accept the offer. You could be waiting and miss other opportunities.
How to protect yourself when making an offer on a short sale
If you do decide to make an offer on a short sale, negotiate an out clause in case a better opportunity comes by and you want out get out of the deal. An example of an out clause might be that the offer is contingent upon your attorney’s approval or your partner’s approval. Give yourself a 45 day out clause so that if you have not heard anything in writing from the seller or their lender in 45 days from the time you and the seller negotiated the short sale contract, you have the right to cancel and get any initial deposit returned.
Short sales are not for everyone, especially if you are in a hurry to close. However, if you have the time, they are good investments because you can purchase them below market value. Many short sales are also in much better condition than foreclosure auction homes or REO’s because generally the owner or a tenant is living there maintaining the property. The home might only need cosmetic fixing or it could even be in move in condition. That is not to say that every auction property or REO is in poor condition because there are also a number of properties that only need cosmetic repairs or are also in move in condition.
Avoid short sales that need lots of work
REO’s and short sales offer less risk to the investor because the new buyer is not responsible for paying off any liens on the properties, title insurance can be obtained and there are no costs that the buyer has to incur for evicting former owners or tenants because the properties are always delivered vacant. However, auction properties can be bought at larger discounts.
You need to do your homework first before you buy a distressed property by checking out the comparable prices and conducting a physical inspection of the property so you know what you are getting for your money. All distressed properties are sold as is so what you see is what you get. Many distressed properties are in bad or poor condition so it is important to budget for repairs.
It’s smart to avoid distressed homes that need major systems replaced because that is expensive and cuts into your profit margins. Cosmetic fixers are better investments, especially if you are handy and can do the work yourself. Either that, or you’ll have members of your team that specialise in those areas and can make light work of it.