Distressed Sellers, Short Sales, and the Coronavirus Pandemic
Starting with Short Sales
Although short sales are significantly less common today than they were in decades past, especially during the 2008 mortgage crisis, they remain an important characteristic of the United States housing market. With the coronavirus pandemic still running its course and upending the United States economy, it is quite possible that short sales begin to rise again.
Victor Khosla, founder of Strategic Value Partners Global (SVP), has predicted a 10% default rate on high-yield and leveraged loans throughout both the United States and Europe. What this means for distressed sellers remains unclear. Yet, Khosla has suggested that the impact will not be as severe as during the 2008 crisis: The market will not be as deep nor will the prices be as low.
This, however, has not stopped major investors from preparing for major opportunities to open up. In fact, several major investors have already begun preparing for such a possibility following the 2008 crisis. Combined, Blackstone Group, Starwood Capital Group, and Kayne Anderson Capital Advisors are now sitting on over $300 billion of capital. That is over half of the total value of home sales in 2019 ($570.6 billion) according to Real Capital Analytics.
These investors are preparing to take advantage of short sales. Real estate law allows for mortgage lenders to forgive a portion of an outstanding loan balance for distressed home sellers. For the distressed sellers, this allows them to avoid foreclosure and perhaps other property law issues.
As per usual, there are numerous pros and cons to home selling and home buying during the short sale process. Every state has their own guidelines for handling short sales. Robert Good Lohman III and Lohman Law Group, LLC are prepared to handle any challenges that the Illinois and Chicagoland real estate laws present to prospective home buyers and home sellers.
What Are Short Sales?
A short sale occurs when a distressed seller intends to sell his or her home for less than what he or she owes to the lender. This can only occur with the consent of any lenders involved in the home sale. In essence, the lender’s approval means they are forgiving a certain portion of that outstanding balance to avoid any property law issues.
In Illinois, if this occurs without the lender’s approval, the seller, i.e. the homeowner, will likely get hit with a bill for the outstanding balance known as a deficiency judgment. This can put a distressed seller already in financial disarray into even deeper hardship. When opting for a short sale in Illinois, homeowners need to ensure that their lender cannot still issue a deficiency judgment. Illinois real estate law grants lenders the right to do just that if they are unsatisfied with the short sale and their contract with the homeowner does not include a clause that waives their right.
Here is an example. Let us say you own a house in Des Plaines, Illinois. The total cost of your outstanding balance is $250,000. You have fallen into financial hardship and have missed several payments. You want to sell your house to avoid foreclosure, but the market value of the home does not even cover the remainder of your mortgage.
At this point, you have become a distressed seller. You are on the brink of foreclosure, so you have little leverage when it comes to the home selling process. Chicagoland home buyers are looking to take advantage of these exact situations. Your Des Plaines, Illinois real estate team, Lohman Law Group, LLC, or your agent, might suggest attempting a short sale.
If your lenders are on board, you may proceed through the home selling process by listing your home for less than the outstanding balance. When the house then sells for $225,000, the remaining $25,000 balance will be wiped away by your lender.
Benefits of Short Sales
This can be a win-win situation for everyone involved - the home seller, home buyer, the Des Plaines real estate agent, and your Lohman Law Group, LLC real estate law team.
For the home seller, the benefits are obvious. For one, the seller avoids foreclosure and other major property law issues. Their credit score does not take as big of a hit. However, most sellers in such a situation have likely missed payments in the past, so this is not to say that their credit score will improve or even remain the same. Simply, the effects of foreclosure on credit can be disastrous. This is important to the seller because it will help them eventually find and close on a new home sale.
Additionally, the seller will avoid any fees and commissions associated with the home sale. Instead, the bank will be forced to handle those fees. Ultimately, a short sale provides emotional relief to the seller and his or her family. Foreclosure is the worst-case scenario, and anyone facing such a threat knows how rewarding it is to avoid.
For the home buyer, some of the benefits are obvious as well. The reduced price of the house makes it a much more attractive option than it otherwise may have been. And, in most cases the lenders, seller, and agent will want to sell the house as quickly as possible. This makes for less competition and less commitment to increase the sale price. So low-ball offers may have a better chance of being accepted and may even reduce the price further.
Robert Good Lohman III and the Lohman Law Group, LLC would successfully help a distressed seller navigate Illinois real estate law. And for the agent, a short sale is important because they would otherwise lose out on commission and marketing. In Illinois real estate law, when a house goes to foreclosure, the agent loses out on any fees and commissions. During a short sale, the agent may receive less in commissions, but it will still be greater than nothing. Plus, during a short sale, the agent will also benefit from preparing, listing, and marketing the house.
Risk Associated with Short Sales
However, these situations are still relatively uncommon. It takes a bit of patience, will, and luck to execute a short sale successfully. Just think, the outstanding balance of $250,000 should be less than what the home sold for originally. So, if the original price was close to $300,000 or $350,000, the $225,000 price tag is a bit suspicious.
This is the most glaring risk associated with short sales. What is dragging that price down so low? Are there major problems with the property? What is the neighborhood like? What is the overall market like in that area?
Just because the house had sold for $300,000 a few years ago but is now selling for $225,000 does not mean that the home buyer would be picking up $75,000 in equity instantaneously. Banks and other lenders are not naive. They will do their due diligence to get as close to market value for the property as possible.
Even if the property does sell below market value, even significantly below market value by $15,000 or $20,000, that does not mean that a major deal exists either. Many short sales are ‘as is’. Lenders want to sell the property quickly so they will sell it with the problems as is. These problems can add up to more than the $20,000 in savings for investors. There may be some major issues with the house.
Pest or insect infestation
Roofing repairs
Electrical or HVAC issues
Poor foundation
Damaged walls, ceilings, windows
Combination of other minor problems
There are other potential risks associated with the short sale process as well:
The closing process on short sales is typically longer than most. Illinois real estate law requires extra paperwork to be filed and approved. When more than one lender is involved, even further complications can arise.
Lenders usually include stipulations in the terms of a short sale that allow them to make last-minute changes. For example, if new property laws are passed in Des Plaines, Chicago, or Illinois as a whole, a lender may shift their position. Changes in market conditions may also spark change as well.
There are also higher closing costs associated with short sales. Lenders will be hard-pressed to include any ‘extras’ in the sale. They may even refuse to pay some of the seller’s closing fees or taxes.
You have a distressed seller. A motivated seller is engaged with the real estate transaction and seeks to maximize the value of his or her house. However, with short sales, the seller is essentially removed from the equation. There is no longer an incentive for him or her to upkeep the property, pay for any fixes, or offer any deals. The lender has full control over the transaction.
This is not to say that short sales are bad investments. There are many cases where everyone involved wins and the home buyer stumbles upon a great deal. However, real estate law makes short sales a complicated avenue. For that reason, any investor or home buyer seeking to get started with short sales would benefit from an experienced legal professional. Robert Good Lohman III and his team at Lohman Law Group, LLC are experienced in the Chicagoland real estate market. Their support will ensure that your short sale is a successful one.
Coronavirus and Distressed Sellers
During the 2008 mortgage crisis, short sales were in high demand. The total number of distressed sales peaked between 2009 and 2011 averaging over 1.1 million sales each year. During that time, the average home sale price dropped by over 35%. Since then, the total number of distressed sales has nearly halved and prices have more than doubled. However, the ongoing coronavirus pandemic has many economists and investment firms predicting a major uptick in distressed sales.
COVID-19 has affected every aspect of the United States economy, especially the real estate market. Businesses forced to shut down have lost significant, if not complete, sources of revenue. Eventually these businesses will default on mortgages. Homeowners displaced from a job will eventually struggle to pay for their property once their lender’s alleviations have passed.
Intertrust Group recently conducted a poll and found that 92% of private equity professionals see the number of distressed real estate transactions rising because of the coronavirus pandemic. And, 83% of them also believe there will be increased investor demand for the distressed assets because of COVID-19.
So far though, the response has been pretty mild. Many firms such as Blackstone Group and Starwood Capital Group have large reserves of equity ready to splurge on distressed real estate assets. Yet, they have yet to make the leap.
Trevor Hoffman, a director at Goulston & Storrs law firm, attributes this to a variety of factors. For one, the coronavirus pandemic is still a relatively new development. The U.S. economy only began to shut down about 4 months ago. And unlike the 2008 mortgage crisis, there have been several accommodations made for homeowners and tenants. Lenders and landlords have relaxed certain policies and have offered forbearances and deferrals among other things. Additionally, the government continues to respond to COVID-19 with various policies aimed at reducing the effects on the real estate market, at least in part.
For these reasons, homeowners and tenants have been able to make it this far. Investors seeking to take advantage of distressed assets have had to remain on the sidelines. Where this goes in the future remains unclear.
Victor Khosla sees the real estate market moving through three unique stages as it relates to investors and the coronavirus.
Coronavirus Impact on the Real Estate Market: Phase 1
Phase 1 is this period of idleness. It is not necessarily a great time to begin investing. Instead he sees investors remaining on the sidelines and assessing different opportunities such as distressed sellers and short sales.
Think of this as the period of “wait and see”.
Coronavirus Impact on the Real Estate Market: Phase 2
Phase 2 will see some of the most vulnerable companies and individuals beginning to file for bankruptcy or foreclosure, and starting to sell their assets.
Whereas bankruptcies stay on your credit report for ten years, foreclosures stay on for seven years. Unfortunately, neither reflects positively in the eyes of lenders.
While short sales also stay on for seven years, in certain circumstances, prospective home buyers may be able to gain another home mortgage in as few as two years! This is because of the way a short sale is reported, as well as because it is different than a foreclosure.
The goal for many of these businesses will be to drive revenue via their real estate collateral. For many others, this could mean a complete liquidation.
Coronavirus Impact on the Real Estate Market: Phase 3
Phase 3 will see larger companies attempt to restructure or default as well. When it comes to investing in some of these struggling companies, Khosla sees investors avoiding risky industries already struggling before COVID-19 such as airlines, oil, and gas.
He sees there being potential investment opportunities into real estate as well. However, he does not see COVID-19 having the same effect on real estate law as did with the 2008 mortgage crisis.
Changing the Real Estate Market
Additionally, COVID-19 is likely to change the real estate market in a more fundamental way. The coronavirus pandemic has exposed some of the major side effects of living or owning a business in a large city. Larger cities have had some of the most restrictive policies due to COVID-19. With their own personal liberty at jeopardy in larger cities, many Americans have already indicated that they would move out of the city into the suburbs or further into the countryside as soon as possible.
Many economists see this mass exodus coming as well. What does this mean for potential short sales on real estate in large cities? Investors might find plentiful distressed sales in Des Plaines and the greater Chicagoland area, but there may be no one available when it comes time to turn that property around and find a buyer or a leasee. And, if that trend continues, the price of the property is likely to fall as well.
Only time will tell how things shape up. For now, most investors are remaining on the sideline and waiting until a prosperous opportunity presents itself.
For homeowners and business owners facing the threat of foreclosure or bankruptcy, investors are needed for them to avoid the worst-case scenario. With the coronavirus still sweeping its way through the United States economy, these will remain uncertain and challenging times for those facing such a threat.
Robert Good Lohman III and the Lohman Law Group, LLC have focused on foreclosure defense and short sales in Des Plaines, Illinois for over 20 years. The Lohman Law Group, LLC is especially prepared today to help those most affected by the COVID-19 pandemic maintain order and navigate the ins and outs of Illinois real estate law.
For help completing a short sale transaction or navigating the real estate market as a distressed home seller, please contact Robert Good Lohman III and Lohman Law Group, LLC today.