There is no such thing as a free lunch. If you are a fix and flipper planning to find a deal with enough juice to buy it, fix it, and flip it for a profit, you better buy it right. There may be no better way to score a below-market price on your fix and flip than by buying a distressed property. No, that doesn’t mean the house is stressed out, but rather the owner has fallen behind on mortgage payments, and the home’s lender has found itself in a pickle. There are three main ways out of this predicament. The first, and easiest, is the owner catching up on the mortgage payments. The second and third are often confused for each other, and represent a key source of deal flow for fix and flippers. They are a foreclosure and a short sale.
What is a short sale and why is it different from a foreclosure? For starters, a short sale prevents a foreclosure from happening. What happens in a short sale, is the lender makes an exception to allow the house to sell for less than what is owed on the mortgage. In other words, the lender is taking a loss on the loan to get a problematic property off its books. Why would a bank do this, you ask? Well, the alternative is heading to foreclosure. As a general rule, lenders don’t want to be in the business of owning and selling houses. A short sale lets the mortgage lender wipe its hands clean of the house and move on. As for the former owner of the house, a short sale is preferable because it is less damaging to your credit than a foreclosure.
What happens when the bank is not amenable to a short sale? The house goes into foreclosure. In a foreclosure, the lender has taken possession of the home, it has clear title and the house should have no liens or claims on it. Often, foreclosures are sold via auction, and to all-cash buyers. Since the house has already been foreclosed upon, the lender wants to sell it as soon as possible, and the timeline will be much quicker than a short sale. Of course, a foreclosure is utterly damaging to the credit of the former owner.
So, should fix and flippers and real estate investors prefer a short sale or a foreclosure? Both have their pros and cons. The key drawback to a short sale is time. A short sale takes significantly longer for multiple reasons. First, the lender is under no pressure to agree to a price, because they can always foreclose. Second, there may be multiple liens or claims on the house that the bank needs to sort through before closing. Third, the lender typically requires the buyer to take on many of the fees that a seller would normally pay for. Overall, the process can take anywhere from 90-180 days from start to finish. On the flip side, the sale more closely resembles a traditional sale. This means that the buyer can often view or tour the house, the house is generally in better condition, and the buyer can seek more traditional financing.
In a foreclosure, the buyer will typically have to close ASAP. A buyer will generally not be able to see or view the home before purchase. They will also almost always have to close all cash, and the house is typically in poor condition. However, a foreclosure often offers buyers the opportunity to take advantage of a well-below-market investment, and to avoid much of the competition that comes with a short sale. Buyers who can close quickly and with cash, have a huge leg up on the market, and can really cash in via foreclosures.
It’s clear that both short sales and foreclosures offer the benefit of below market investment properties to fix and flippers, rehabbers and other real estate investors. However, there is no clear answer as to which is the preferred method. Both have their pros and cons, and they need to be approached with eyes wide open as it relates to their advantages and disadvantages. Experienced fix and flippers and investors utilize both of these methods to build their real estate investment portfolios and shop for bargains. The more familiar an investor is with each process, the easier it will be to take advantage of the opportunities. While neither method is the clearly superior strategy, it’s clear that every fix and flipper and real estate investor needs to have both of them in their playbook.