Would you like to know how to create equity out of thin air?

Would you like a guaranteed method to “recession proof” your income?

If you are a property owner who’s been hit by the falling real estate market, how’d you like a way to climb back on top?

Out of chaos comes opportunity. If you have been paying attention to the real estate market (and, really, how could you not?), you know that in most parts of the country foreclosures are through the roof. But don’t be scared off by other people’s real estate failures. I have found a way for everyone to win. Even you. And even if you are not currently involved in real estate. Let me explain…

I have been in the real estate business – both residential and commercial – for over 25 years. I am a licensed real estate broker in Florida, just outside of Orlando. And I can tell you from experience that when the market is cranking along and credit is easy to get, you could just about train a chimp to make money with real estate. But when times get tough, you need to try an unconventional approach. The one I recommend is learning how to work “short sales.”

Buying Short Sale Homes
The short sale has been around for many years. It’s nothing more than the lender/bank agreeing to take less than what is currently owed on the property. They do it because they are not in the business of owning real estate. They just want to get the property sold and off their books before they have to go through foreclosure.

Here’s how it works: A property owner, real estate agent, or investor informs the lender that they would like to short sale the property they are involved with. After they submit the appropriate paperwork, the lender’s Loss Mitigation Department (a department that can actually help the property owner) will negotiate an acceptable price lower than the current mortgage balance.

Many times, the Loss Mitigation Department will use their own internal formula to determine the discount they will take. But when the market is so slow that most houses are selling below asking price and even below “market” price – like right now – lenders will often agree to take bigger discounts.

The short sale enables property owners to get out from under properties that have either declined in value or were simply overleveraged to begin with. And it enables investors to make below-market deals on properties that they can quickly turn around for a profit. Everybody wins!

As an investor, the lower you can negotiate the debt, the greater your potential profit upon re-sale. And it’s even easier if there are multiple mortgages on the property.

Here’s what I mean…

Let’s say you start doing research, and one fine day you find a soon-to-be foreclosed property with an 80 percent first mortgage held by Acme Primary Bank and a 20 percent second mortgage held by Secondary Lender Corp. You have struck gold!

While Acme Primary Bank may not be interested in discounting the balance of their 80 percent first mortgage a whole lot, you will probably be able to get it down somewhat. Meanwhile, Secondary Lender Corp. will almost certainly be willing to discount their 20 percent second mortgage. You see, when a first mortgage is foreclosed, the second mortgage is usually wiped out along with any other junior liens on the property. So the only way for Secondary Lender Corp. to get anything out of the property is to work the short sale and accept a much smaller amount for their payoff.

When you are dealing with properties in the $500,000 range, a 20 percent second mortgage is $100,000. This is where equity is created out of thin air for the short sale investor.

I keep my eyes peeled for this type of situation. If I know the second mortgage holder will discount their loan to mere pennies on the dollar, then I know I can walk into the property with equity. In most cases, the first mortgage holder will discount their loan to some degree. Combined with a major reduction in the second mortgage… that’s a windfall for the savvy short sale investor.

There are many reasons to invest in short sale properties:

  • There are currently so darn many of them to choose from.
  • You can create equity in properties where none existed before.
  • You can work these deals in the comfort of your home. No office necessary.
  • You don’t need money to profit from short sale deals.
  • If you buy them right, you don’t need credit either.
  • Short sales will be a hot market for at least the next 18-24 months.

Here’s one example of how I used a short sale to turn a profit…

I found a property with an “asking” price of $105,000. This included the $74,000 first mortgage and a $28,000 second mortgage, plus late fees and costs. The owners could not sell it for that price because of the condition it was in. It needed some rehab work, but they didn’t have the money to do it. Using my short sale techniques, I successfully negotiated a purchase price of under $50,000 and immediately sold it for $78,000. That netted me a profit of over $28,000.

My buyer bought the property from me the same day I bought it. I didn’t bring a dime to the closing table, because the money to fund my agreement with the bank came from my buyer. The deals were closed simultaneously… and here is the result:

In another recent deal, the asking price on the property was the total debt balance plus commission/closing costs of $253,000. In this case, the property had a true market value of just over $212,000. I was able to get the first mortgage balance of $162,000 down to just $145,000. The second mortgage of $74,000 was negotiated down to just $3,000. I ended up buying the property for $148,000 and selling it the same day for $210,000 – making a $62,000 profit on the deal.

Another deal had just one mortgage. The property had a true market value of just over $190,000. But in order for the property owners to pay off their $203,000 mortgage balance, their back payments, and their commissions/closing costs, they had to list it at $234,800. And there was no way they could sell it for that. I negotiated the debt down to under $155,000 and sold the property for about $180,000 – a $25,000 profit.

Even if a property is 100 percent financed, the lender will usually discount the payoff amount to around 82 percent of what’s called the “Broker Price Opinion” (BPO) – an estimated value, determined by a real estate broker or other qualified appraiser – that is frequently below market value. That makes doing everything you can to influence the BPO one of the most critical aspects of successful short sale investing. And when banks/lenders contract with a licensed appraiser to come up with the BPO, you have just one opportunity to do that.

That’s why I always insist on being present during the BPO inspection. I then produce comparables that reinforce and justify my contract price. I “help” the appraiser by handing him information on other properties for sale in the neighborhood. If repairs are needed, I hand him a copy of all the repair estimates. I also research the average number of days properties in that area are on the market, according to the local Multiple Listing Service, and hand that to him.

I do all this for one reason and one reason only: to legally and ethically influence the property’s BPO. This estimate becomes the starting point for negotiations with the bank/lender. So the lower, the better. If the bank/lender knows that the house may need some repairs and has copies of my repair estimates, it will affect their decision. If the bank/lender knows that the days on the market (DOM) for this property is reaching – or exceeding – the average, they know there’s a good chance they will have additional holding costs to pay before they can sell the property. All this information is designed to get the bank/lender to accept my offer and not take the property through the full foreclosure process.

All indications are that we are in for another two years or so of a soft real estate market. Learning about – and knowing how to make money with – short sales will get you through it.

[Ed. Note: Clyde R. Goulet is a real estate broker and author of The Survival Guide to Foreclosure.]