Why Short Sales are Still Good to Invest in!

Investors should buy short sales

With all the negative press surrounding real estate investors and short sales these days, it’s refreshing to read a clear, concise explanation of what we as investors really ad to equation of boosting the weak housing market by purchasing properties that require the “buy down” or short sale of the lender’s loan amount.

I don’t usually post articles written by others that often, but the following exerts from an open letter written by Ben Pargman to Freddie Mac, is a real summation of what we bring to the table as investors and how detrimental it can and will be if government organizations like FreddiMac  falsely mislead the public into believing that investors who buy short sale properties at a lower price than market with CASH and then flip them (after all the liens and other issues have been resolved) for a profit are somehow breaking the law; then the housing market will definitely feel the pinch.

Mr. Pargman begins his letter to Freddie Mac by stating: Last week you published an article on your website “Emerging Fraud Trends: Short Payoff Fraud.”  Absent further clarification, your letter could cause serious damage to the already struggling housing market, compromise the Administration’s goals of reducing foreclosures, and increase losses to lenders and investors such as Freddie Mac.  I’m sure that was not your intent, so the following is offered to assist in a clarification that must be forthcoming.

You expand the definition of mortgage fraud to include misrepresentations or omissions by the borrower or buyer made to a lender in the context of a short sale.  You then specifically mention ‘a subsequent transaction at a higher price’ as one such misrepresentation.

Here’s what I think you’re missing: A property with debts that exceed its value does not have clear and marketable title and cannot be sold until such time as a short sale approval is obtained.  Obtaining a successful short sale approval is a complicated, frustrating, and lengthy process.  This reality is reflected in market pricing: properties that do not have clear and marketable title command less from the market than those that have clear and marketable title the same way that a house with structural foundation issues will command less than the same house without the defect.

Accordingly, a potential short sale property commands a lower-than-retail price which may be attractive to a wholesale investor looking to purchase a property at a discount and later reselling for a profit.  You recognized this appropriately in your October Sellers & Servicers Bulletin:

Property flips are not inherently illegal and not all transactions involving a rapid purchase and resale are improper. Legitimate property flips are acceptable transactions in connection with loans purchased by Freddie Mac. Some indications of property flip transactions that may be legitimate include: . . . Sales of properties that the property seller acquired at below market value after purchasing as a result of a distress sale (i.e . . . . short sale . . .), where any increase in the sales price over the property seller’s acquisition cost can be clearly shown to be a result of the difference (if any) in the market’s reaction to distress sales and typical arms-length market sales.

Best Practices for Loans Involving Possible Property Flips, Freddie Mac Bulletin, NUMBER: 2009-24, Attachment A (October 9, 2009)

There you got it right and recognize the legitimacy of a flip from a lower distress short sale value to a higher typical market sale.  Your October Bulletin recognizes that opportunities to buy low, add value, and resell for a profit are the very foundation of our market economy.

The wholesale investor invests the time, energy, and expertise to obtain the short sale approval from the seller’s lender together with other short sale agreements and lien releases as may be necessary.  (Most short sales transactions involve multiple mortgages, liens, homeowner association dues, back taxes and other title exceptions that must be cleared – it’s not easy stuff and often involves a significant amount of work.)

Completing this non-physical repair work to create clear and marketable title increases the value of the property from the prior “non marketable title/distress sale” value.  The increase in value is not a product of a fraud or misrepresentation.

Here’s where your recent article causes some troubling confusion.  The increase in property value from repairing clear and marketable title by securing a short sale takes place between the time of the buyer’s original contract (at the lower value) and the eve-of a closing usually several months later at which point the wholesale investor, through the efforts of clearing title including obtaining the short sale, has created an asset that can now be re-sold at a higher price.

If by the statement “misrepresentations in these schemes may include…a subsequent transaction at a higher price” you are suggesting that it is fraudulent for a short sale buyer to resell properties for increased prices resulting from their efforts to clear title through short sales, then you are attempting to create new law of an affirmative duty that does not otherwise exist while simultaneously bringing about a dramatic decrease in the number of short sales that are successfully closed.

Realize that every lender currently has the ability (absent your newly fabricated duty) to control their short sales and shut out investors.  The short sale is entirely at the discretion of the lender to approve or deny.  If the short sale lender does not like the offer from the investor (because it is too low), it is entirely within the lender’s prerogative to reject the offer, counter at a higher price, request other offers, or simply foreclose.  The entire process is always within the complete control of the lender.

The lender has always been able to make requests for information from their borrowers, require a signed statement from a buyer at closing, or put restricting language in a short sale approval that would prohibit subsequent transactions.  (Such efforts foolishly disregard the value the wholesale investor brings to the lender in advancing a product that does not have clear and marketable title but for the investor’s involvement and compromises the Administration’s goals of promoting short sales to reduce the foreclosure rate; however, it is certainly within the lender’s prerogative to take such actions should they choose to.)

However, above and beyond any such requests or restrictions by the short selling lender, if you are asserting that once a lender has accepted a short sale offer and the buyer then attempts to resell at a higher price, that the buyer has an affirmative duty to reveal its sales price of a subsequent transaction and that the difference between the short sale approved price and the subsequent sales price is somehow a fraudulently obtained unjust enrichment, then . . . geez . . . will the last Gd fearing American grab the flag on the way out!

If that is really what you mean, you will further damage the housing market, dramatically increase foreclosures, vastly reduce the number of successful short sales, and impose a chilling effect on the free market that will likely have serious ramification beyond the housing market.  You would be setting a precedent that wholesalers, anyone who owns stocks, equities or commodities, sales persons, importers, and any other entrepreneur who buys, creates value and sells products or services somehow has an affirmative duty (even if not asked) to get permission from their seller to resell an asset at a higher price prior to completing their purchase?

You can’t really mean that?  You would have:

• Car dealers get permission from new car buyers to resell their trade at a higher price before closing the deal?
• Anyone who buys a stock or commodity having to get the approval of the stock seller before reselling the asset at a higher price?
• Fruit wholesalers required to obtain the permission from the farmer to resell their crop to a grocery store at higher price?
• Importers getting permission from China before Wal-Mart could sell a t-shirt?

No.  You can’t possibly mean that!

You had it right in your October Bulletin when you recognized the legitimacy of these transactions.   In addition, the FBI makes it very clear what current law considers mortgage fraud involving a short sale:

In a typical short sale scheme, the perpetrator uses a straw buyer to purchase a home for the purpose of defaulting on the mortgage. The mortgage is secured with fraudulent documentation and information regarding the straw buyer. Payments are not made on the property loan causing the mortgage to default. Prior to the foreclosure sale, the perpetrator offers to purchase the property from the lender in a short-sale agreement. The lender agrees without knowing that the short sale was premeditated.

Mortgage Fraud Report “Year in Review”, Federal Bureau of Investigation (2008).  Yes, now that’s mortgage fraud!

Yet the policy suggested in your article goes well beyond this clear example to potentially include any resell of a property where a buyer does not go above and beyond to reveal the subsequent resale of a property at a higher price.

I believe in my heart of hearts that the work that I do together with thousands of hard working, honest, proud American entrepreneurs creates win-win-win transactions that add value to the U.S. economy, the housing market, sellers, and Freddie Mac while supporting the Administration’s objective of promoting short sales and reducing foreclosures.  I offer these thoughts to further these mutual objectives.

Together with other real estate investors, educators, and entrepreneurs, I would be eager to contribute to a dialogue to help distinguish truly fraudulent actions from what is good honest entrepreneurial work essential to the Administration’s objectives of healing our troubled housing market.

Reference: “Open Letter to Freddie Mac” by Ben Pargman. Published April 19, 2010.

Tags: investing, real estate, Short Sales