Recently I had a borrower inquire about doing a short sale, and they said they had a buyer lined up. I told them I would accept the offer they proposed if they could make the sale happen. I was speaking with someone who isn’t as familiar with the non-performing loan business, and they were curious why I would accept less than what I was owed, especially when the BPO value of the home suggests I could sell it for more than what the borrower has an offer for already. In this newsletter I’ll go through my rationale on why I would be willing to accept a short payoff.
I’ll give some example numbers to work with. These aren’t the actual numbers from this deal but hopefully they help in the process of thinking through the various scenarios without adding confusion. I’m leaving out the total cost basis because in theory that shouldn’t affect the decision too much, you should be optimizing the return vs risk.
- Payoff amount: $50K
- Short payoff offer: $42K
- BPO value: $63K
- Total cost basis to date: ???
The first thing to remember when considering a short offer is that in non-performing loans the face value of assets isn’t always relevant. Remember that when you buy non-performing loans you are getting them at some discount. I might be owed $50,000 in this example, but the borrowers aren’t paying anyway. So its really a question of looking at the alternatives and figuring out if there are better ones.
One of my options is to tell the borrower that I would require a full payoff, and that I think the home is worth $63K so they should be able to get more for it. This is reasonable. But it could also drag out the deal, and/or it could turn out that the borrower can’t sell it at that price. When I have a borrower who is ready to pay me off I prefer not add extra moving parts to the deal. I could potentially get more value, but I could also potentially get nothing and be back to square one with a non-performing loan.
It would also be reasonable to request a payoff that is somewhere in between what they offered and the full payoff. I would just advise that borrowers tend to take the path of least resistance. If you try to grind them down too much there is a good chance that they just give up and go silent on you.
I can also just proceed with the foreclosure. That could add several thousand dollars to my cost basis and potentially drag out my timeline several months. Plus my return could be lower. The property is not likely to sell for BPO value at a foreclosure auction. And if it doesn’t sell at auction and I sell it myself it still probably won’t sell for BPO value quickly and then I will have additional selling costs. When its all said and done I might net 75% of the BPO value, which in this example would be ~$47K. That may or may not be better than the short sale option depending on the increase in time and expenses. But remember that my BPO value is based on an assessment of the exterior condition only. There could be other issues lurking on the inside of the home that lower that value. The borrower could also leave a lot of junk behind that results in an expensive cleanout. Or they could do damage on the way out. Or the copper goblins could show up once the home is vacant. So if I take the short sale there are a lot of risks that go away. Fewer risks and shorter timelines are things that I like.
Hopefully this helps explain some of my thought processes in these scenarios. Remember to focus not just on the absolute $ amounts, but the amount of risk and time it will take you to realize those $’s along with borrower behavior.