HOAs are no strangers to foreclosures. The loss of HOA assessment income due to foreclosures is substantial. More and more owners are “underwater” in their lot or condominium unit: the amount they owe far exceeds the value. Lenders are taking longer to foreclose and HOAs are experiencing increased losses as a result. One tool to reduce foreclosures is the short sale. Simply put, a short sale is a sale of the property for less than what is owed.
So, you have an owner who is past due on his assessments. His property has been on the market for months, and he finally found a buyer, but at a price substantially below what he was asking. In the midst of trying to close on the sale, he has learned that the proceeds are not sufficient to payoff all of the liens: the first mortgage, the second mortgage, and the assessments. So, he comes to you and says he wants the HOA to approve a short sale.
A short sale is a way for an owner to avoid a foreclosure, for lenders to recover more from the sale of the property than if a foreclosure took place, and for the HOA to get a new owner who will pay assessments in the future. This kind of situation is facing hundreds of HOAs nationwide. If you or your HOA have not been involved in a short sale yet, chances are you will be within the next year or so and you should have an idea of how to deal with it.
As an example, assume the owner has a potential buyer who is willing to pay $150,000, but when the owner bought the unit two years earlier, he paid $180,000. When he (or she) bought the property, he got a first mortgage, the balance of which is now $135,000. In addition to the first mortgage, the owner has a second mortgage of $15,000, and owes the HOA $4,000 for assessments. If the property is sold for $150,000, there is not enough money to pay all of the secured parties. In addition to that, there are closing costs and real estate broker fees. So, the wner cannot sell the property for $150,000 unless somebody agrees to take less than he is owed.. The owner now comes to you as a representative of the HOA. What should you do?
Well, if he already has a title or escrow company involved with the sale, the first thing you want to see is a preliminary settlement statement. That is a statement prepared by the escrow or title company listing the income and expenses of the sale. It will list the sales price, closing costs, real estate broker commission, and payoff balances to all lien holders. This is important for the HOA. You want to confirm the sales price (yes, I have had owners misrepresent the sales price, although it really is rare). You want to know the payoff amounts to each of the lenders and the real estate commission to the realtor. Lastly, you want to know how short is the owner; that is, how much are the proceeds short from paying everyone in full.
Naturally, owners and real estate agents come first to the HOA, thinking since the HOA is last in line, it should reduce its lien so that the deal can get done. What they usually do not realize is that the HOA’s lien is usually senior to the second mortgage. So, the HOA’s response to the owner or his agent is that the owner needs to be talking to the second mortgage holder, not to the HOA. The HOA certainly is not going to reduce its balance so the second mortgage can get paid; there is little reason to do so.
Let’s assume for a moment that there is no second mortgage, but the proceeds are not sufficient to pay the first mortgage, the expenses of the sale, and the HOA. Look to see how much the real estate agent is being paid. Often, yes often, there will be enough to pay the HOA but for the real estate commission. It is time to tell the real estate agent to take the hit, at least a substantial part, along with the HOA. The HOA is not in the business of subsidizing home sales. If the HOA does not approve the sale, the real estate agent will not get a commission. So, try to strike a balance so the agent gets a reasonable amount and the HOA gets as much as it can.
What else can you do as an HOA? Remember, if the deal closes, you get a new owner who presumably will start paying the new assessments, so closing the deal helps cut off an ongoing problem and continual shortage in assessment payments. You really do want a new owner in there. Consider allowing the owner to close by paying the HOA less than the amount owed from the sale, but have the owner sign a promissory note for the difference and let him make payments. Make sure the note has a provision for attorney fees. If he balks at that, remind him that if the first mortgage is foreclosed and the property sold, he will still be liable for the full amount of assessments and attorney fees, and repayment terms will not be as attractive. Taking a promissory note for the difference is not fool-proof, however, since the note is unsecured. The owner could always file bankruptcy later, resulting in little on no payment on the note.
Negotiating a short sale is not easy. Often the owner does not approach the HOA until late in the sales process or with a foreclosure sale set to take place soon, creating time pressure. Sometimes the HOA will need to play chicken and be willing to risk a failed sale to get what it wants. A short sale may fall through because the HOA and the owner (or the agent) cannot come to terms, but do not let that discourage you. Remember, if the first mortgage holder forecloses, the owner will still usually be personally liable for the unpaid assessments as well as any second mortgage. Thus, the owner will want to do his best to get the short sale done if it likely will bring more money than a foreclosure. The HOA will need to decide when to hold tough to make sure it gets its fair share, but it will need to be reasonable to get a deal done.
A short sale can be a useful tool for HOAs to recover assessments which may otherwise be lost. You may win some, you may lose some. But, in our current economic environment, boards should be willing to consider short sales as an opportunity to reduce losses and improve future cash flow.