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In my last post I explained my experience and understanding of short sale spreads I have encountered in the Twin Cities area. In this post I would briefly like to explain my experience while representing a buyer in a prominent south suburb of Minneapolis.

There were some issues.

I went out with a family friend helping her find her first place. We went through a standout charmer out of a dozen others we saw that day. We decided to write an offer on the property, and began the process of collecting information about the place. This city required a city inspection and a city escrow if issues where present. There were some issues with the inspection. We contacted the listing agent, and asked if the seller would take care of them. Right away we received a “no problem!” from the listing agent.

The listing agent then explained that the property was being sold by a trust, and that repairs would be taken care of. We assumed that the property was an estate, and we moved forward by writing an offer on the home. After submitting our offer the listing agent sent us a wordy short sale disclosure. I was very surprised at this point. As a listing agent of a ton of short sales in Minnesota I am fully aware that many sellers do not have money to make repairs or improvements for a buyer. I asked how the seller would be able to cover the expenses required to satisfy the city. The listing agent said that we should not worry about it.

In the short sale disclosure we received there was wording stating that we must use the seller’s title company. My skepticism rose dramatically. I informed the listing agent know that we would use the title company of the buyer’s choice. The listing agent informed me that the “seller” would not accept our offer if we used our own title company. We withdraw our offer immediately and moved on. We assumed that the listing agent was creating a spread.

If a seller wants a buyer to use the seller’s title company the buyer should be rewarded for it (i.e., title insurance policy for buyer at seller’s expense), and the buyer(s) and agent(s) should fully understand a HUD-1 statement and scrutinize the closing documents.

Controversy is beginning to grow surrounding short sales in Minnesota, and people in the real estate community are taking notice. There is a situation surrounding “investors” who are “purchasing” real estate from lenders who have non-performing real estate loans, and reselling the property before even closing on it.

Confused? Read on.

Here’s the outline. A person or legal entity (such as a trust or LLC) searches through public record and discovers that John Doe hasn’t been making his mortgage payments (let’s call the person or entity “Company XYZ”). In fact, Mr. Doe is facing foreclosure and he is running out of time as the sheriff sale has occurred and the redemption period expiration is approaching (see Minnesota Foreclosure Process for more information). Company XYZ contacts John Doe, and explains that they can save Mr. Doe from foreclosure by completing a short sale. John Doe agrees to work with Company XYZ and discloses information to Company XYZ that will allow them to negotiate the short sale on Mr. Doe’s behalf. So far so good - this is how many short sale transactions are started. Let’s move on.

For illustration purposes, let’s say John Doe has one mortgage with a principal balance of $200,000, and the property is worth $175,000. Company XYZ contacts Mr. Doe’s mortgage company and negotiates with the mortgage company to accept $150,000 for the property. At the same time Company XYZ is marketing the property to buyers, and negotiating the terms of the sale to the end buyer (let’s call the end buyer “Buyer 2″). Buyer 2 agrees to pay $175,000 for the property. At closing Company XYZ collects $175,000 from Buyer 2, and pays John Doe’s mortgage company $150,000 making a profit (or “spread”) of $25,000.

Generally, it is completely normal for investors to buy real estate and sell it at a profit to an end buyer. The issues with the above illustration is what is legal, what is disclosed, and what are the potential consequences to the parties involved. I am not an attorney, so I cannot comment on the legality of this situation. I recommend seeking legal advice if you want to know what is legal.

One of my main concerns here is what is actually disclosed to all parties involved. Is the seller aware that there is a buyer paying $175,000, but his or her mortgage company is only getting $150,000? Is the mortgage company aware that a buyer is willing to pay $175,000 yet they are only receiving an offer of $150,000? For that matter, is the mortgage company even aware that the end buyer is in the picture? And is the buyer aware that the mortgage company would accept $150,000 instead of $175,000? If all terms are disclosed to all parties involved, all parties involved are aware of all parties involved, and everyone is in agreement is there an issue here? Possibly.

Another concern involves the consequences of short selling real estate. If John Doe owes $200,000 and the mortgage company only receives $150,000 there is a deficiency balance of $50,000. The mortgage company may seek a variety of ways to be compensated for that balance (depending on the situation - seek an attorney and/or accountant for legal and tax advice). The issue is that the deficiency balance is $50,000 when it could be $25,000 if the mortgage company received $175,000 instead of $150,000. If all parties involved are aware of all terms and are in agreement - and the mortgage company is not going after the seller at all regardless of the deficiency balance - is there any problem here? Time will tell. The regulatory bodies are paying attention. So should every buyer, seller, and agent.

Please note that we do not participate in and have not participated in “spreads.”