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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   February 2013

Is a Steal for Real?

Look at the pros and cons of distressed-property purchases

Commercial mortgage brokers of- ten may work with clients looking for bargains in distressed properties. With these deals, it is important to remember that distressed purchases create business opportunities for almost everyone involved — from the buyer to the lender to the mortgage broker. Because buyers often purchase distressed properties with cash to meet fast closing deadlines, they frequently look for refinancing facilities shortly thereafter — and a seasoned commercial mortgage broker may be invaluable when evaluating the merits of a distressed-property deal.

To be in position to advise clients on whether a distressed deal is a real steal or not, commercial mortgage brokers should keep in mind the borrower’s risks and rewards in each of the following four types of distressed purchases.

1. Short sales

A short sale occurs when the seller tries to sell a property for less than the amount owed to the lender or mortgage-note holder. There are several benefits to buying short-sale properties, including that potential buyers will have a chance to inspect the property before purchase. In addition, the title typically transfers via a warranty deed, and it often is clean and free of liens. Finally, any outstanding taxes are the responsibilities of the seller, who also is responsible for curing other liens.

Commercial mortgage brokers also must bring the risks that accompany these purchases to their clients’ attention. These risks include:

  • The sale requires a lender’s consent, even though the purchase is between the buyer and the seller.
  • The lender’s consent may be unreasonably withheld because the lender is not obligated to approve the sale.
  • It is typically a lengthy process that may take anywhere from three months to 12 months.

2. Foreclosure auction

In this scenario, buyers typically purchase the property directly from the courthouse as the final step of a judicial foreclosure. The property is awarded to the winning bidder in an auction. The main benefit of foreclosure purchases is buying a property at a low price. Because the lender does not take possession of the property, or invest in cleaning or repairing the property, the lender typically can pass these savings along to the buyer. There are a number of risks, however, including:

  • There is no opportunity to inspect the property. After the purchase, a buyer may find that the property has significant damage or that tenants remain and must be evicted.
  • There is a possibility of title irregularities if all the steps in the legal process have not been carefully followed.
  • The buyer is responsible for outstanding property taxes, any condominium or association fees, and any other liens.
  • Many states, like Florida, now hold foreclosure auctions online only, providing case numbers for each foreclosure. This places the burden on the buyer to conduct the required due diligence.

3. REOs

Real estate owned properties (REOs) also may offer opportunities for bargains. The buyer purchases the property directly from the lender that reclaimed the property in foreclosure. In this case, the buyer has an opportunity to inspect the property, and the title normally transfers by warranty deed, although some lenders may require a special warranty deed. The buyer doesn’t have to worry about outstanding taxes and liens, because these will be paid by the seller, which is the lender.

Although there are several benefits to these transactions, there still are risks, including:

  • Lenders may require all-cash purchases.
  • Lenders may require the use of their form contracts.
  • The property could be damaged or in need of improvements.
  • The competition to purchase these properties is typically intense and therefore increases prices.

4. Note purchase

In a note purchase, the buyer steps into the shoes of the lender that holds the promissory note and buys it rather than the real property itself. There are several risks to keep in mind:

  • The buyer only buys a lien right — not a right to possess property.
  • The buyer therefore has no right to inspect property.
  • The buyer buys a piece of paper, which is only as valuable as the borrower’s ability to repay the note.
  • The borrower may continue to default and force the buyer to go through a lengthy and expensive foreclosure.

There still are some advantages to this type of purchase, however. These deals allow the buyer to purchase the note at a discount. That, in turn, may enable the buyer to reduce the borrower’s monthly payments and still make a return on the investment. In addition, the buyer may be able to convince the borrower to deliver a deed in lieu of foreclosure if the borrower  cannot repay the note.

• • •

The rise of interest in distressed properties means the demand for experienced and knowledgeable advice on these deals is increasing. By offering sincere and balanced advice to clients, commercial mortgage brokers may find themselves with a wealth of business in the distressed-properties niche. Brokers with an understanding of the risks and rewards that accompany these properties may explain the nuances of distressed- property purchases to their clients. Then these potential buyers may make informed decisions on the best route to take with each type of purchase — without being carried away by the idea of having a steal within reach.

Disclaimer: The above is for informational purposes only and does not constitute legal advice.


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