(This is Part 1 of a two-part series. Read Part 2.)

Have you ever closed a short sale?

(This is Part 1 of a two-part series. Read Part 2.)

Have you ever closed a short sale? If you’ve been in the business for fewer than 10 years, this may be an entirely new term for you. It’s also one of your worst nightmares as both a listing and selling agent.

A “short sale” refers to a situation where the seller lacks sufficient equity to close the sale. When this occurs, the seller must contribute additional funds or ask the lender to reduce the loan amount in order to close the sale. As you might imagine, earning a full commission under these circumstances can be extraordinarily difficult.

Short sales normally occur in flat or declining markets. It’s also common when large numbers of buyers have purchased with no money down. In 2005, approximately 40 percent of all sales closed with nothing down. Virtually all of these loans are adjustable-rate mortgages. If the loan readjusts and the sellers cannot afford the increase in payments, the loan will become delinquent. Most sellers in this situation will attempt to sell their property. Assuming a 6 percent commission and 2 percent in additional costs, the sellers of a $200,000 property would have to come up with $16,000 in closing costs. If these people were unable to come up with a down payment, the odds are extremely high that they will be unable to come up with enough money to close the sale.

Typically, when a seller is upside down (i.e. he/she owes more than the property is worth), one of the following scenarios results. First, the owner may try to sell the property without representation. In a depressed market where there is a large amount of inventory, chances are slight that the seller will be successful. The second approach is to allow the property to go into foreclosure. Depending on the state, the seller may pick up six to nine months of “free rent” by not paying his/her existing mortgage. Once the lender completes the foreclosure proceedings, it still may have to evict the delinquent seller from the property. This may take an additional 30 to 60 days. The third scenario involves going to the lender and asking the lender to lower the amount that it would have normally required to close the sale.

It’s extremely difficult to persuade lenders to reduce their loan balance to close the transaction or that they should be responsible for paying the closing costs. Their typical reaction is, “We’ll just foreclose on the property.” I had a blatant example of this when I had a short-sale escrow with a property in Malibu, Calif. The day after a large wildfire ravaged this ritzy seaside community, the lender turned down our request for a short sale. Their reasoning was that their comparable sales showed that the property was worth more. I persuaded them to take the short sale by sending them the pictures of the comparable sales; however, these homes had all burned down. Furthermore, the tenant, who moved out the day of the fire, took all the fixtures, including the toilets. Clearly, the property was no longer worth what it was before the tenant trashed it, and 80 percent of the neighborhood burned to the ground.

Persuading the lender to pay the commission is also a challenge. The best approach is to make the following argument:

If you foreclose on the property, you will achieve the highest possible price in the shortest period of time by listing with a top agent. This means that you will pay the commission anyway. Given that sales are declining and that inventory is increasing, it may take a number of months to sell the property. This means that you will have the commission costs, several months of holding costs, and a possible loss in value because of the substantial amount of competing inventory. Selling now may actually net you more money than waiting. Would you prefer to lock in a sale today or would you prefer to wait and perhaps take even less for the property?

Any time you speak with a lender, it’s critical that you have hard statistical data to show them. Your data should include how much inventory is on the market, how much the inventory has increased or decreased in the last six months, as well as whether prices are increasing, decreasing or staying flat.

With almost 9 million loans readjusting to a higher rate in 2007, there will be an increasing number of people who cannot afford to make higher loan payments. Foreclosure rates are continuing to climb. If you want a steady stream of business during a market downturn, learning how to negotiate short sales can be a lucrative source of business. Representing sellers who have little or no equity is not for the faint of heart, however. If you’re ready to tap into a difficult but lucrative market, see next week’s article to learn how.

Bernice Ross, national speaker and CEO of Realestatecoach.com, is the author of “Waging War on Real Estate’s Discounters” and “Who’s the Best Person to Sell My House?” Both are available online. She can be reached at bernice@realestatecoach.com or visit her blog at www.LuxuryClues.com.

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