Is A Short Sale A Good Idea for a Rental Property?

By: Eveline Brownstein (c)

When considering any rental property for purchase, part of that consideration is how soon you can start generating income, and how much of a return on the money you put into the property are you going to get.  Short sales often appear to be bargains.  The bank or mortgagor is willing to walk away from the property for less than what is owed and the owner of the property needs to get out from under the mortgage.  Besides the bargain price, there are a number of considerations that go into the decision to purchase a short-sale property for a rental income:

How much time do you have?  Typically, short sales can take three to six months from acceptance of the offer price to closing of the sale.  Hiring a realtor who is experienced in short sales is important, because often the mortgagor on the property will have a tendency to move the file on the property through different departments for review.  An experienced realtor who has dealt with short sales knows that it is important to establish at each stage which department the file has been transferred to, and who to contact for a follow up.  Nevertheless, these transactions usually move very slowly and file review takes months.  A buyer cannot expect to own the property for several months and therefore cannot expect to be able to move a tenant in during that time.

Do you want a move-in ready property? Many short sales properties suffer from the reality that not only did the owner not have sufficient money to pay the mortgage, but the owner also did not have any extra money for maintenance, repairs and upkeep on the property.  I once represented a buyer of a short sale property where the owner had begun extensive remodeling of the property and then lost her job.  She was unable to complete the remodeling projects and thus any offer my buyer made had to take into account that the remodeling projects left undone would need to be completed before she could move in.  The same would go for a property one intends to rent to a tenant.  Landlords have a legal obligation to provide a habitable property as defined by local and state ordinances.  Any issues with the property will be the responsibility of the buyer as short sales are generally sold “as is” without a single credit for repairs, nor are any made prior to the closing of the sale, regardless of habitability.  Short sales are typically not move-in ready, so added to the time considerations of how long it will take to own the property, one has to consider the additional time it will take to undertake the repairs to the property, before it can be rented.  Between the time it takes to own the property and the time it takes to undertake necessary repairs, it could be close to twelve months, or more, before a buyer can realize any rental income on the property.

Are you willing to pay the original amount of property taxes? Even though a short sale property sells for less than the market value, most property tax rates are based on the market value of the property.  So, once you close on the property and you have undertaken the necessary repairs to make it habitable, you will pay the market value of the property in property taxes as determined by the local assessor’s agency.  Once you get that first property tax bill, the bargain of the purchase price may not seem like such a bargain if the property is located in a high property tax, or high property value area.

Can you set aside enough money to make necessary repairs? As mentioned above, if the property is not move-in ready (and most short sales are not), you will need to set aside enough money to make necessary repairs.  When considering the cost of the short sale, you must also add in the cost of repairs to the property.  For the purposes of a rental property, adding in the cost of currently necessary repairs may not be sufficient.  A property inspection may reveal future, necessary repairs.  As I have previously stated, I believe that the purchase of real estate for rental income purposes (and many other purposes) should be undertaken with a ten-year plan to hold the property.  So, apart from the immediate repair issues, one should also consider long-term repair projects like roof replacement, furnace and water heater replacements and appliance replacements.  Painting of the exterior should also be considered in this plan.  When calculating what the rental income will be, one should consider what portion of collected rents should be set aside in a capital improvement account for the long-term repairs of the property.  Short sales with deferred maintenance may need sooner capital improvements, due to long-term, general neglect.

Are you willing to defend a legal action? In the current climate, some banks have been accused of acting improperly in their short sales and foreclosures.  This could expose a buyer of these properties to legal action.  A very careful review of all the paperwork in a short sale is critical to protect the buyer from legal action.  It is a good idea to hire an experienced real estate attorney to review the legal paperwork, if an attorney for a real estate transaction is not required in your jurisdiction.  Legal fees charged by such an attorney should be considered in your calculations of the cost of the property.  Nevertheless, even if you do not have legal exposure, this does not mean that you cannot be sued and that you will not be required to defend your purchase.  It may merely mean that you will prevail, but you will still likely have to hire an attorney to defend your position and that can be costly.  The potential for this should be weighed against the savings you will be realizing in the short sale purchase. Purchasing a short-sale from a mortgagor who has a solid and dependable reputation for legally reliable transactions is important.  So, take some time to research the mortgagor’s reputation in these types of transactions, before making your offer.

Some bargains truly are bargains.  Some bargains have the potential to become money pits.  Taking a little time to thoroughly research the parties and the real costs involved in a short sale, before committing to the purchase, can ensure that your purchase choice is the right one for you.

 

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