As May draws to an end, we want to keep a watchful eye on distressed homeowners, short sales, and foreclosures. In a short sale the seller negotiates a price with the buyer and the transaction is submitted to the bank for approval since the seller won’t realize sufficient funds to pay off his loan. In a foreclosure the seller is evicted and the bank’s representative auctions the house to the highest bidder. If the bank bids highest in the foreclosure auction, then the property becomes bank owned and is sold in the real estate market, usually after some months off market following the foreclosure auction. Homeowners owe more than the house is worth in roughly a third of our current transactions - not a scientific estimate - so this process of sellers dealing with a shortfall in paying off their loans is very much part of our current Kitsap County Market, not just some hypothetical situation.

On May 15th National Public Radio’s This American Life featured a report by Chris Arnold about loan modifications entitled, “The Mod Squad,” which highlights some current issues with distressed property sales. This report stated that 15- 20% of American households are now under water (owe more than the house can be sold for). Nationwide, more than 342,038 homes received a foreclosure filing last month, a 32% increase from April 2008. Arnold’s report estimates that about half of the 6 million foreclosures over the next 3 years don’t need to occur, that currently only 5-10% of the people who need help are enabled to stay in the home, that 46% of the people whose loans are modified fall back into default, that only 16% of loan modifications actually reduce the principal owed. The report states that large banks lack the technology to model the costs of short sale vs foreclosure. It said that the rules for banks to account for foreclosure allow them to delay posting the loss, whereas in a short sale, the bank must post the loss when it occurs. Thus it may appear best for the bank to delay sale, even though it continues to lose money every day that the property is not sold. The report said that the existence of 2nd liens often prevents modification of the primary loan to keep the homeowner in the house.

Hundreds of billions of dollars in legislation and Treasury initiatives have had little effect to speed loan modifications or speed the sale of troubled assets so that bank balance sheets can be repaired. From our perspective, property market values in short sales should not be any different than values in foreclosure, though desperate sellers may agree to short sale prices that banks are currently unwilling to accept. While banks ponder how to improve their loss mitigation software to predict the costs of sale, we wonder why they don’t just hire a Realtor. Perhaps legal procedures could be modified to level the accounting rules and allow sellers to authorize the bank to act directly for the seller in short sales in lieu of foreclosure, with provisions for certain guarantees such as allowing the seller sufficient time to vacate the premises following sale, etc. Realtors already can estimate sale price and costs of sale, do the legwork to effect necessary repairs, and otherwise fill in the decision making gaps currently lacking in the banking industry. The bank’s decision process would be simplified to whether the bank would lose less by restructuring the loan or by selling the house. We don’t know all the legalities that drive the current system - only that the end result is a system that isn’t working. With unemployment continuing to rise and with pressure on interest rates to rise, we expect that the number of home owners underwater will continue to increase and that prices will continue to fall until the excess inventory of homes is worked off.