investing strategies

Short Sale Secrets

Dwan Bent-Twyford at the REIC of LA, September 12, 2006

I had mixed feelings about attending Dwan Bent-Twyford’s seminar at the Real Estate Investors’ Club of Los Angeles.

Dwan practices and teaches an investment technique called short-selling. Essentially, she is a master at getting banks to agree to discounted payoffs on the properties she purchases…thereby, creating an instant equity position. She’s been doing it with a great deal of success, for over 17 years. It’s a strategy that is especially effective when the housing market softens, and we see a lot of homeowners going into default.

Now, my hesitation wasn’t because of some ethical qualm about taking advantage of people in trouble. “You’re never wrong making a profit.” My problem was that I was beginning to wonder if my forecast of the coming real estate market was wrong. Clients, fellow investors and friends have been asking me, “When are the foreclosures going to start?” I’ve been telling them, “This isn’t 1992.”

The last time people in California found themselves upside-down in their mortgages was at the end of the cold war. Congress had cut defense spending, and suddenly we had 20% unemployment in California. Our economy was heavy with defense and aerospace contractors. This drop in real estate price was caused by a fundamental change in the real economy.

The media has been warning that the mortgage industry has been heavily selling interest-only, adjustable and balloon payment loans, and that millions of borrowers will suddenly be unable to pay their mortgages. If they sell at once, they’ll cause a collapse in prices and a flood of foreclosures.

Well, I work in the mortgage industry, and I don’t know any reputable lender that wants borrowers to fail. We don’t want your house. Underwriters are painstaking in their analysis of a borrower’s financial profile, and they don’t make a practice of lending money to masses of people who are destine to default.

No, we will not have a rash of foreclosures because of the practices of the mortgage industry. If homeowners start to fail on their mortgages it would have be as a result of some fundamental change in the real economy…like in the 1990’s. So, I’ve been telling people, “Don’t expect a real estate fire-sale anytime soon.”

Now, I’m beginning to wonder if I’m wrong.

John Talbott, a former Goldman Sachs investment banker, published his take on the subject earlier this year, in his book “Sell Now! The End of the Housing Bubble.” He estimates that the artificially low interest rates of the last few years have caused a global overvaluation of real estate, to the tune of $30 trillion dollars. That’s an eye-catching number. I wondered, “Maybe he’s just trying to sell books.” I wondered, “Maybe he has an agenda to cool the market down.” I wondered, “Maybe he’s trying to create a panic.” $30 trillion overvalued! Then, I wondered, “What if he’s right?”

If he’s right, we are about to come into a biggest buyer’s market of our lifetime. If he’s right, you should be in cash…not real estate. You’ll need to be ready to buy when the prices drop, and you need to be thinking about the strategies that are most effective in a collapsing market. You should be listening to Dwan Bent-Twyford.

So, I decided to keep an open mind, and off I went to see what she had to say.

In a short-sale, the investor saves a distressed borrower from foreclosure and bankruptcy by getting the mortgage-holder to agree to a reduced payoff. For instance, if the home is worth $300,000, and the loan is for $295,000, the short-sale investor would get the bank to agree to accept $160,000 to payoff the loan. That’s a $140,000 profit for helping the bank get a problem property off of its books.

Dwan makes three points: 1) understand how a banker thinks, 2) plan your offers & counter-offer strategy in advance, and 3) have an exit strategy.

Bankers don’t want foreclosed houses on their books. 1) They cost money to carry, rehab and to sell, 2) they mess-up the banker’s quarterly statements (red flags to investors, regulators and other banks), and 3) they force the bank to keep up to ten times their value, in cash reserves. Banks don’t want to own a bunch of houses generating no cash-flow. It costs them a fortune to hold and dispose of them.

She recommends that short-sale investors avoid the novice’s mistake of making your best offer upfront. The bank is more likely to accept your offer if you plan on making up to three offers from the very beginning.

Offer #1: Distressed Borrower – Distressed Property

You offer 40% – 60% of the after-repair/full-retail value of the property. In this offer, you include a distress letter from the sellers. It explains why the sellers will never be able to continue servicing the loan, and that their attorney has advised them that bankruptcy would tie-up the property for more than two years. The letter goes on to explain that the investor’s offer is the best offer they could get, and urges the bank to accept it. Include documentation of all of the borrower’s hardships.  

This offer also stresses the property’s level of disrepair. Include photos, mold samples, code violations, etc..

Include the sales & purchase agreement.

Offer #2: Distressed Community

When the bank counter-offers, you counter with your second offer, and you back it up with documentation explaining why this property would be impossible to sell. Send a list of local registered sex offenders, newspaper articles about fires, crime statistics, and anything else you can find on the internet that makes the neighborhood seem unmarketable. The bank’s loss-mitigation office may have no first hand information about the community, and they may rely on the information that you provide.

Offer #3: Cash Analysis

Hopefully, your previous offers have been accepted already. If you have to make a third offer, include with it a cost breakdown of 6 months with no debt service during foreclosure, 2 years of no debt service during bankruptcy, tax & insurance expenses, trustee expenses, rehab costs, carrying cost and selling expense. At this point, they should come to realize that your offer today is better than what they’ll be getting 30 months from now.

Here are some of her tips for getting data for your analysis. Use Zillow.com for comps. They tend to give low-ball value estimates, and the site is free. Use EasyHud.com for estimates of regional closing cost and use HomeDepot.com for repair estimates. Home Depot’s estimated repair costs tend to be higher than what you can pay a handyman for the job. Remember, it’s like trying qualify for a home loan, but in reverse. Instead of presenting the bank with the best appraised value and borrower profile, you present them with the worst perspective on the situation.

Once the bank has accepted your offer, and you have the property under contract for substantially less than market value, you need to cash out. So, you need to have an exit strategy in place before you buy the property. Dwan gave some examples of exit strategies: rehab the property yourself and sell it retail, rehab the property and become a landlord, or assign your purchase contract to a professional rehabber for an assignment fee. She prefers the last technique. It has the advantages of requiring no real estate license, no rehabbing experience and no cash.

Finally, Dwan reminds the investors in the audience to always refer to the sellers by their first names, while speaking with the bank’s loss-mitigation manager. It humanizes them in the mind of the banker, and they are more likely to want to help them. Ultimately, that is why this technique works. It works because it helps people. It helps the borrower escape excessive debt obligations without destroying their credit, and it helps the bank maintain a healthy balance sheet, and if we are really headed into a hot buyers’ market, you might be able to use these techniques to help yourself.