REOs or Short Sales, Which Are Better For Mammoth??

Upon my return from vacation I found the most recent issue of the “trade” magazine from the National Association of Realtors®. For years I have always tried to glean something of value out of these publications, and I often used the best information for some discussion at sales meetings (over the years I noticed most of the company’s agents simply tossed theirs’ in the trash). On a back page under the banner of “Commentary” I found some very interesting discussion from a broker from Carlsbad by the name Jim Klinge. The crux of the discussion was weighing which have a less damaging effect on the real estate market; REOs or short sales?? The column made me think about this question on a local/Mammoth level.

Mr. Klinge’s brief resume shows he is a very active agent in the North County San Diego area. He sells REOs and short sales and traditional sales too but he is not married to any particular segment of the market. So he should be unbiased. The subtitle of this column is “Foreclosures blight neighborhoods and depress home values. But short sales could be more damaging.” His first sentences beg the question; “It’s widely agreed that foreclosures and REO properties devastate nearby home values and impede the housing recovery. But we don’t hear similar complaints about short sales.”

So he moves to his first bullet point, Seller Motivation Issues. “Properties listed as short sales are often occupied by homeowners who aren’t concerned with getting top dollar. Instead, their motivation may be to extend their “free rent” program or get out of their financial obligation to pay off a mortgage. Consequently, they often don’t fix up their house to sell it and may be less than cooperative about showings. On the other hand, REO listings are vacant properties and have a lockbox for easy showings.”

In Mammoth, seller motivation can be a bit different. While there are owner occupied short sales happening and what Mr. Klinge says is true about them, Mammoth is far more second home oriented. And more and more underwater second homeowners are jumping on the short sale bandwagon. Like I said in a recent newsletter, it has almost become fashionable. These short selling second homeowners come in many flavors. Many remain on their nightly rental programs generating revenue. Many aggressively use or let others use the property for vacation time (I guess this is the “free rent” equivalent). And yes, maintenance can lag. Some actually act more responsibly and vacate to make the property “show” better and allow for easier agent showings. Some want the short sale to happen quickly because they want relief from the HOA fees (which are a personal obligation) and the lender will want current/paid at the close of escrow. What is consistent is the “aren’t concerned with getting top dollar.”  More on that in a minute…

Mr. Klinge’s second bullet point is Delays. “Short sales require that the home owners submit their financials to the bank every month––and if they don’t, the sale stalls. The delays and uncertainties make these listings very difficult to sell. In contrast, it takes a week or two to get a REO listing into escrow, with deals closing in about 30-45 days, whereas short-sale approvals these days take 30-60 days.”

This is all true but again the Mammoth market is a bit different. As Mammoth buyers see the REO inventory decline they are warming up to the “delays and uncertainties” part of the short sale. Admittedly, the process has become more time efficient, but delays of many months are still common. But the real difference is that most Mammoth buyers aren’t overly anxious to move in because this is a second home purchase (unless it is the week before Christmas). They are a little more patient and they will watch the inventory for something better while they are waiting for short sale approval. I have referred to this as the “option” part of this purchasing environment. I’ve actually seen people buy here in Mammoth and not really move-in for many months and sometimes years. And of course they just might want to do some remodeling before moving in. So for many, the delay part of short sales isn’t such a big issue.

But Mr. Klinge’s next bullet point is where the rubber meets the road: Pricing. “Short-sale agents often price their listings aggressively low to compensate for the difficulty in selling. They hope that a lower price will draw buyers interested in a bargain. REO listings on the other hand are appraised by neutral third parties and priced for retail sale by asset managers who have a fiduciary duty to their investors to maximize return…And if they do inadvertently price a property too low their selling strategy enables every buyer to make an offer within the first few days. When that happens the sales price can be bid up to retail––or even higher.”

Short selling sellers really don’t care what the property ultimately sells for as long as they get the lender’s approval and get the property liquidated. Most agents care even less, but the property will be appraised by the lender considering the short sale. They may even have one or more agent BPOs (broker price opinions) completed. Each lender has different criteria for what they will allow for short sale pricing. Some buyers walk away if they don’t get their price. In Mammoth there is some underpricing to entice buyers. This past winter we saw it in 2 bedroom units in the Westin; there were several priced in the mid-$300K and they ended up closing over $400K (and they weren’t overbid).

REOs on the other hand go through the process described. Most REO asset managers will “fish” with a higher price to see what the market will bear. In Mammoth that is a smart strategy because there are definitely buyers who will pay for something special or desirable. REO properties will go through “price discovery” or regularly scheduled price reductions to find the market value. And REO properties do get into overbids in Mammoth, and sometimes after they have been on the market for a couple of weeks. But ultimately the pricing of REO properties is much more positively supporting of the market than short sales. While most lenders may think their “net” on a property is higher with a short sale, the current environment doesn’t display any true price stabilization because of them. They could be shooting themselves in the foot.

The article’s next bullet point is Buyer Preference. “Buyers shy away from short sales because of their uncertain, murky reputations. Because of lower demand, they sell for a lower price. But there is high demand for REOs because bank owned properties enjoy the reputation of being underpriced, even though they have been selling well for years.” I’m not so sure the current pool of Mammoth buyers have a true preference. They want good properties at good prices. Or they want something in particular. They are more patient. They watch the market closely via the Internet.

And lastly, the article discusses Fraud Potential. “Short sales are fertile ground for fraud. These properties, priced to sell by the listing agents, are sometimes shopped around exclusively to a small group of buyers already known by those agents. Deals are made “prior to listing input” and sold at an untested price without open market exposure…By comparison, REO asset managers insist upon open-market exposure to ensure the best possible sales price.”

Well, I can assure that this is all true. Maybe half of all short sale sellers are using third-party attorney/negotiators. There is less hanky-panky on those transactions because the attorneys are trying to protect themselves too; better valuation methods, true exposure to the market, etc. There definitely are “inside” deals going on in the short sale market. But the lenders really need to perform their own due diligence. REOs on the other hand are almost militaristic. The detail and extent of documentation is like no other real estate transactions I have ever seen. And the files are often audited a year or two later. There is little room for slop. For buyers, REO transactions are demanding; timelines are shortened and performance is required, but there is far less uncertainty.

Mr. Klinge ends with, “As an industry, we should acknowledge that REOs offer a better way to sell homes and improve the housing market than short sales––for consumers and practitioners. Vacating houses, sprucing them up, putting a lockbox on them, and exposing them to the market for a period of time is how you can sell distressed properties for the best price.”

So it depends what side of the fence you are on. If you are a buyer looking for a great deal, a short sale might work great and continued short sales may drive values lower. If you’re an owner interested in keeping values up, then REOs maybe be your friend. The investors need to look at their net and the potential future of the market based on their actions today.

Meanwhile, in the second half of 2012, short sales will have a dominant position in the Mammoth market. Only time will tell if that will be better for the market.

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