A Crash Course in Pre-foreclosure Sale and Short Sales
Published 6:30 am 11 May 2020
Regardless of the property market conditions in Australia at any given time, 1% of entrepreneurial investors are capitalising on bank repossessed homes for sale.
Savvy investors make their own enquiries and through their due diligence are able to analyse current market conditions. Banks have been greedy and have lent too much with little or no lending criteria or responsible lending practices in place.
This means that since the Global Financial Crisis in 200l8 when banks stopped lending many Australian homeowners have hit the wall. For the first time ever in the Australian housing market a significant number of home loans in good areas are underwater.
We have never had this situation before as house prices have always gone up or, at worst plateau for a little before growing again but we are now experiencing falling values. This is a perfect storm for those wanting to grow a property portfolio quickly for their retirement.
People buy a home then for any number of reasons they stop making payments and the lender has to sell the property. Although there are certainly a few more steps involved in the process, the skill is learning how to make money between the steps.
In this blog, I will take you through a crash course on the repossession process to help you start to identify where real opportunities lie.
What are Mortgagee Repossessions?
For those who are interested legally, the distinction is that with a foreclosure, the lender goes through the legal process of getting the borrower off the title to the property and putting themselves on the title deed as the owner of the property.
With mortgagee repossession, the lender just gets a Court order to take over the property and sell it but the owner still remains on the title deed. In reality lenders do not bother to “foreclose” and get themselves on the title, they take the property as a mortgagee in possession and try and sell it as expediently as possible whilst still achieving the highest possible market price.
By law banks cannot undersell the property or even advertise it as a mortgagee or fire sale. If they foreclose, banks cannot chase the borrower for any shortfall. With repossession, the borrower is still on the hook for the difference between the sale price of the property and the amount owed.
If the homeowner is in arrears on their loan, the bank will prefer to repossess the property, sell it and then chase the borrower for any shortfall.
There are many reasons why foreclosure properties are repossessed. The process can be broken into three basic phases:
- Pre-foreclosure sale
- Short Sale
- Mortgagee Sale
The process has never been taught or practised before in Australia, simply because we have never had market conditions such as these in the past.
Some terms are not known vocabulary in the distressed real estate market. So don’t go quoting to a bank or lender that you want to do a “short sale” or a “pre-foreclosure sale”, the bank won’t know what you are talking about.
I have borrowed the terms from the American market where they have been doing this for decades. (They have seen this market before in the late eighties and early nineties during the savings and loan crisis when this system of property investors buying distressed real estate at huge discounts occurred.)
We will use the terminology I have chosen here as distressed asset specialists for ease of reference in our process of finding suitable foreclosure properties but it will be a case of you having to educate the lenders when you go to buy.
- Pre-foreclosure is the time period between where a home owner misses his or her first mortgage payment and the date when the bank commences legal proceedings to repossess the property.
- During the pre-foreclosure phase is where your efforts will yield the greatest reward.
- Short Sales are a deal that can be cut with the lender to pay out the loan on the property for less than what is owed on it. The lender agrees to accept full payment for the mortgage debt in an amount that is less than the homeowner actually owes.
- During the repossession process the lender will always lose money sometimes a great deal of it. With the advent of creative (low doc and no doc) mortgages over the past several years combined with a cycle of soft or declining real estate markets some homeowners actually become ‘upside down’ on their property.
- ‘Upside down’ means the home owner can’t afford to sell their property as they owe the lender more than what the property will sell for.
- Currently in Australia one in five properties in Queensland and Western Australia is ‘upside down’ or “under water”.
- In these circumstances many homeowners and lenders are faced with the difficult choice of the lesser of two evils. Can they hold out until the market turns or should they sell up now and cut their losses?
- Most homeowners don’t know that short sales are possible or how to structure a short sale transaction. When the circumstances are right you will be in a position to help.
- A lender sells the property with the owner still being registered on the tittle. The lender “possesses” the property. The bank appoints an agent and does what is necessary to sell the property.
How does the Real Estate Rescue property investment training course strategy fit with the repossession phases?
The first phase, pre-foreclosure, is where we will be locating our foreclosure properties in the first instance – we can then follow them down the foreclosure path while trying to acquire the property during each phase.
The earlier you get to a deal the better your chances of paying a good price for the property. Buying at this stage may be both risky and competitive.
During the public auction stage there has been a lot of attention brought to the property and the owners have been beaten up and are worn out.
Are there deals out there? Yes, but they take work and luck to get – and the harder you work the luckier you get.
Properties that are purchased from the lender via a mortgage sale will almost always be bought at auction.
Almost all repossession properties are listed with real estate agents and at regular retail prices. That makes it a little hard to make a profit. Due to the recent rash of repossessions you may come upon advertised “mortgagee auctions” where banks are offering hundreds of foreclosure properties.
Good deals can be found but there may also be savvy people at these things and you are likely to end up losing out as other bidders force the price up.
I would estimate that 50% of properties found at this stage may go above your reserves. It is still worth following every one through though as if you are Johnny on the spot you can bag the deal of the decade.
Banks are required to market repossessed properties through public auction by law and to try to get the highest possible retail value for the asset.
At this point the property may have already been fixed up and the lender has taken their loss. They are under no pressure to wheel and deal and many foreclosure properties end up selling for within 10% of the asking price.
Pre-Foreclosure Sale is the Best Stage to Invest
Purchasing properties at the foreclosure stage offers you several advantages:
- There is less competition since other investors are involved at the public auction stage you will be able to operate and negotiate with the owner in a more comfortable environment.
- It is far easier to work directly with the owner as opposed to a solicitor or the lender and you have more time to put together a successful deal.
- There are more options that you can explore with the homeowner and the costs are generally lower.
Foreclosures and Short Sales – Neither Illegal nor Unethical
Yes, there are people you will meet who are in dire situations. You will be tested emotionally and hear some heartbreaking stories. You did not cause it, nor can you necessarily fix it. And you don’t need to take advantage of it to make a profit.
When you are negotiating foreclosure transactions you should never feel guilty about what you are doing.
If you don’t help the homeowner then someone else will. Worse still, if no-one intervenes the bank will cause untold damage and heartache for them for many months and years to come.
You are their knight-in-shining-armour.
Many investors will become drawn into a situation and will be tempted to take advantage of sellers. These are small minded people with a scarcity mentality who like to create a win – lose deal. Don’t do it, it will end your career quickly.
Always try to help the homeowner.
You are providing a service and should not feel any guilt about doing a deal. In most cases the bank will end up selling the property and you are providing a way for the homeowner to gain stability, preserve their credit rating, gain control and definitely avoid additional heartache.
You are saving the bank time and money and you expect to get paid for your knowledge and experience in solving a problem you did not create.
Nothing I ever suggest or teach in any way should be construed or used for illegal or unethical practices.
Do it the right way and you will build a great reputation and make some good friends along the way.
Pre-Foreclosure Sale Risks
There are risks involved in pre-foreclosure investing. Owners at this stage are usually quite emotional or in a state of denial and only want to sell at market value or more.
Dealing with these types of homeowners can be complicated and stressful and then just as you get a deal negotiated, they can change their mind.
You will also encounter owners who misrepresent or falsify information. That is where doing your homework will come in handy and we will cover this later in the course.
There are also legal issues and liabilities which may face an investor purchasing a foreclosure directly from a homeowner.
Because you will be purchasing properties at less than market value, your actions could be seen as taking advantage of the distressed homeowner. However, for all the risks involved, you still have the chance to help a great number of people and make good profits along the way.
Why Foreclosures Happen
The common causes for mortgage defaults are:
- Health problems
- Job loss
- Predatory lending
- Rising costs of living
Foreclosures Sales Are Increasing
The biggest reason that foreclosures keep increasing is that Australians can’t seem to live on what they earn and keep borrowing money for things they can’t pay for.
Credit card debt keeps spiralling upward every year and the homes people purchase (thanks to creative mortgage products that they don’t understand) can leave them one pay cheque away from disaster in every direction.
When a property is foreclosed on, the bank (or the lender) takes control of the property.
Given that banks are in the lending business, they don’t want to hold onto the property, so they are looking to sell it off as quickly as possible. The banks want to recoup their losses and get the property off their books as fast as they can. This is where foreclosure auctions come in.
A foreclosure auction occurs when the mortgagee takes control of the property and wants to sell the property.
A foreclosure auction is usually the process that the mortgagee will use, for a number of reasons.
- The foreclosure auction process is transparent and the mortgagee can get the market value for the property quickly and easily.
- The foreclosure auction process is also used because it allows banks, for example, to be seen as being open about the process and remove the potential perception they had sold the property under market value to get their money back.
- A private sale treaty might not have that same level of transparency as a foreclosure auction.
That said, the banks do have a legal obligation to get as much as they can for the property.
Understanding Foreclosure Auctions
One of the key points to note about buying at a foreclosure auction is that you generally have to buy the property as-is.
There is often little room to purchase the property subject to any kind of conditions and that makes it difficult to negotiate. The mortgagee is simply looking to get the property off their books as quickly as they can.
So as a buyer in a foreclosure auction you need to be prepared in advance and understand what you are buying. Be sure to inspect the property in closely and do detailed due diligence. Any reports will need to be done prior to the foreclosure auction.
For those looking to buy at a foreclosure auction in Sydney or a foreclosure auction in Melbourne, they might be more familiar with the auction process as it is widely used in those states. For those looking to participate in foreclosure auctions in Brisbane, foreclosure auctions in Perth and foreclosure auctions in Tasmania, it’s important to understand the auction process in those states it is not as common as sale by private treaty.
Another important factor to consider is how you are going to finance the property when you purchase it.
Not all properties purchased via foreclosure auction will be able to be financed by a bank or lender and might need to be settled quickly and even for cash. So be sure to speak with the selling agent and understand the terms. It’s also vital to talk to lenders well in advanced of the foreclosure auction. For example, if a property is badly damaged it might not be ‘livable’ in the eyes of a lender and they won’t lend for the purchase.
Because the foreclosure auction process is highlighted by the fact that the property is unconditional at the time of auction, if you bid for it and win, you are legally obligated to take possession and most importantly pay for it. So you must be organised and well prepared before looking to buy at a foreclosure auction.
Lawyer, Asset Protection Specialist and Property Educator
Dominique Grubisa is a practising legal practitioner with over 22 years of legal and commercial experience. She is a property investor and developer, an entrepreneur with businesses in Australia and Southeast Asia, a speaker, educator, writer and published author. You may contact Dominique at firstname.lastname@example.org
This column has been written for general information purposes only. It is not intended as legal, financial or investment advice and should not be construed or relied on as such.