Distressed Properties

1. Distressed Properties Understanding Short Sales, Foreclosures, Bankruptcy, and Lender REO

2. Agenda: Why Are You Here? • Why become knowledgeable about distressed properties? • Capture more business? • Help existing transactions close? • Develop strategy to work with lenders? • Minimize headaches?

3. Objectives • Recognize different stages • Suggest workout solutions • Talk about tax and credit impact • Learn about new forms as of April 2008 • Discuss new California laws impacting lenders as of July 2008

4. What to Expect • Increased paperwork • Increased time • Buyers may withdraw offers • Overall lower closing rates • Special forms and addenda • Tax and legal advisors are involved • Distressed property sales (w/ or w/out NOD) usually slower and more difficult than other sales

5. New July ’08 Foreclosure Timeline • Borrower doesn’t make payments (several months) • Lender contacts homeowner (30-day notice) • Lender files Notice of Default (3 months) • Trustee files Notice of Sale (20 days) • Trustee’s Sale soon after • TOTAL TIME AT LEAST 5 MONTHS

6. V. The Foreclosure Process • A. Promissory Note and Deed of Trust • Borrower = Trustor • Lender = Beneficiary • Holder of Deed = Trustee • Reconveyance Deed • Forecloses and issues Trustee’s Deed • Typically title company or bank

7. B. Default by a Borrower • Failure to Pay as Agreed • Commits waste on the property

8. C. Power of Sale Provision • First step (non-judicial foreclosure) is lender signs and records a Notice of Default in county of property. • July 2008 California law requires lender to give the homeowner a 30-day notice before filing the Notice of Default.

9. D. The Notice of Sale (NOS) • Three months after filing NOD, Beneficiary directs Trustee to file a NOS. • Published for 20 days in general circulation newspaper, and posted on the property and in a public place. • Indicates time and place for Trustee’s Sale, defaulting property address, as well as amount due.

10. E. Right of Reinstatement • Make the beneficiary “whole” by bringing the loan current • Can be done up to 5 days before the Trustee’s Sale

11. F. Right of Redemption • Borrower may “redeem” the property by paying off the Beneficiary in FULL. • Can redeem at any time prior to the actual Trustee’s Sale • Borrower can do NOTHING once the Trustee’s Sale takes place • Called Equity of Redemption

12. G. The Trustee’s Sale • Public auction situated in the county where the property is located. • Sold to the bidder offering the highest price. “AS IS” • Bidder must have cash/cashier’s check for FULL amount. • Only the foreclosing lender is allowed to “credit bid”. (continued…)

13. Trustee Sale, cont. • Conduct at Sale • Cash or cash equivalent • Lender may credit bid amount owing (debt + interest + late fees + costs of foreclosure) • High bidder gets title free of liens junior to foreclosing lender but subject to liens senior to foreclosing lender • High bidder takes subject to any rights of redemption

14. Trustee’s Sale • Lender publishes minimum bid. Usually, value of the debt, including principal, interest, late charges, advances, and costs of foreclosure. • If there are NO other bidders, the Trustee’s Deed is executed and given to the foreclosing lender. Now the property is REO. • If there ARE other bidders, title passes to the highest bidder and the lender is paid off in full. (continued…)

15. Trustee’s Sale • Trustee’s Deed conveys title to the purchaser free and clear of all JUNIOR liens, but subject to all senior liens and property tax liens. • IRS liens MAY NOT be extinguished by the sale unless the IRS receives notice at least 25 days prior to the sale date. • Title insurance may not be available due to possibility of “set aside” issues with the Trustee’s Sale.

16. Trustee’s Sale • Even after the foreclosure process has begun, other options are available to the property owner until the foreclosure is complete

17. Trustee’s Sale Tip: Over 97% go back to the lender and become REO • Question: If you have the listing, can you work for a seller who is being foreclosed, and also cultivate the future listing from the foreclosing lender?

18. Judicial Foreclosure • Time frame • Generally, lengthy • Court time varies from county to county • Post-sale right of redemption • 30 days (no deficiency or deficiency waived) • 1 year if deficiency permitted • Lender preference • Generally, trustee sale better than judicial foreclosure • Faster, less costly, no redemption

19. Deficiency Judgments • Meaning – The right to pursue to borrower for the difference between the amount received at the sale and the amount owed on the debt • security first rule: recourse loan (refinance; heloc) • No Deficiency Judgment (non-recourse loans) • Purchase money (acquisition, 1-4, owner-occ.) • Seller carry back (any property type) • Following a trustee sale • Exceptions • Sold-out junior ( to security first rule only) • Fraud • Bad faith waste

20. II. Working with Short Sales A. Contacting the Borrower’s Lender Workout options: • Suspend payment • Renegotiate interest rate • Change payment • Extend maturity • Waive late payment charges • Delay filing a Notice of Default

21. B. Alternatives to Lender Workout • Refinancing • Deed in Lieu of Foreclosure • Short payoff • Bankruptcy

22. C. Incentives of Lender Workout • Foreclosure time • Costs to foreclose • Ultimate condition of property • Property’s carrying costs • Lender still has to sell • New mandated maintenance laws for lenders as of July 2008 (Animal care, property maintenance) • Lender often prefer because a foreclosure is costly, time consuming and financial results uncertain

23. D. Listing a Short Sale Property: What You’ll Need • Seller’s Property Questionnaire • Preliminary Title Report • General Index: Checks seller’s personal debts, child support issues, IRS liens, etc. • Seller’s Net Estimated Proceeds (CAR ESP)

24. The Tough Part: Communication • Who is the lender? • Where is the lender? • What are they thinking? • When will they respond?

25. Does the Lender want to Cooperate? • Start process when listing is taken • Provide PTR showing liens • Get relevant financial information from homeowner • Assemble CMA and current market statistics • Communicate with the lender • May want to use outside service to help

26. E. Steps of a Short Sale • 1. Property is listed using SSL • 2. Buyer’s offer comes in, including SSA • 3. Seller verifies hardship • 4. Seller submits documentation to lender • 5. Lender evaluates property • 6. Lender makes decision to reduce debt • 7. Buyer goes through escrow • 8. Lender may consider more offers • Offer to Closing longer than a non-distr. (typical) transaction

27. F. Lender Requirements • Hardship letter • 1003 loan application • Purchase agreement • TDS • Buyer’s pre-approval letter • Certified escrow instructions • Preliminary title report (continued)

28. More Lender Documents… • Estimated closing statement • Seller’s signed IRS form 4506 • Personal financial worksheet • Previous 2 years’ tax returns • Employment paycheck stubs – 2 months • If self-employed, P&L statement • Bank statements – 3 months • Other paperwork – possibly BPO

29. Lender Requirements • Lender numerous requirements must be satisfied before a lender will consent to a short sale • Lender not obligated to agree to a short sale request even if all documentation submitted

30. Seller Interests • Lender’s written consent to a short sale should include a commitment not only to release the property from the lien but also to reduce the loan balance (and, for junior lien holders, cancel the debt) • Short sale contract should be contingent upon lender consent to reduce the balance of the loan

31. G. Earning Your Fee • Lenders may be antagonistic • Secure the lender’s approval on the listing so they know what you expect to be paid • Work with a Buyer’s Representation Agreement – lenders or sellers cannot modify this • Neither agent has a fiduciary obligation to the lender or lenders (unless the lender owns the property as REO).

32. H. Marketing Short Sales on MLS • Listing must indicate commission and sale is subject to lender approval • Listing agent must indicate how commission to selling agent may be reduced if lender reduces gross compensation • Without these items, Listing broker is at risk for payment of commission to cooperating broker as published

33. I. Pricing Strategies for Short Sales • Fast sale, but highest dollar • Use a CMA for aggressive pricing • Check for details on pending sales • Did SOLD statistics include any credits?

34. J. Agents Who Promote Short Sales • Represents an opportunity to prospect for sellers • Must not claim that seller will have “no costs” • No false or misleading claims • Lenders may require alternative payback at a future point

35. K. Using Standard Forms • If no NOD is filed, only a Short Sale Addendum is required. Use regular forms. • If Notice of Default is in place, property is owner-occupied 1-4 units, and an investor/purchaser makes an offer, special forms allowing for cancellation will apply.

36. Agents are not Accountants Agents should not provide advice; we just let clients know what questions to ask their tax advisors. Federal tax laws and California tax laws often do not agree! Seller must consider both tax and credit consequences

37. III. Tax and Credit Impact • A. Comparison of Distressed Sales • Foreclosure • Short Sale • Deed in Lieu of Foreclosure • Bankruptcy

38. B. Credit Considerations - Foreclosure • Late payments reported • Default on loan payments reported • Foreclosure reported • FICO score lowered 200 basis points • Credit impact on file for 7 years

39. C. Credit Considerations – Short Sale • Shows as “failure to pay” or “charge off” • FICO score impacted 75-100 basis points • Stays on record 2 years, then diminishes • Can likely repair credit after 2 years

40. D. Taxation Issues - Foreclosure • There may be Capital Gain • Difference between market value (at Trustee’s Sale) and adjusted basis of borrower • Don’t overlook depreciation/cost recovery • Borrower can have gain even if no equity and no proceeds! • Foreclosure is treated as a “sale” • IRS allows $250,000/$500,000 CG exclusion if principal residence & owned/occ. 2 out of 5 years • Wiped out junior liens may issue 1099’s – ouch!

41. Taxation Issues – Foreclosure Borrower may have no Capital Gain if: • It is discharged with bankruptcy • The borrower is proven insolvent • The loan is non-recourse (purchase money or seller financing)

42. Example of Tax Calculation - Foreclosure Homeowner paid (2005) $170,000 Current Market Value $200,000 Capital Gain: $ 30,000 Homeowner refi’d & owes $220,000 Lender forecloses for $220,000 Fair Market Value of Property $200,000 Debt Relief: $ 20,000

43. In this example, Homeowner may avoid taxation: • No taxes from Capital Gain if principal residence and lived in totaling 2/5 years • No ordinary income taxes from debt relief if insolvent OR • No ordinary income taxes from debt relief if non-recourse loan, or if the lender used a Trustee’s Sale to satisfy the debt

44. If Principal Residence is Foreclosed • Any recourse loan debt relief is taxed as ordinary income, although possibly not collectible • No debt relief (taxes) on non-recourse loans • “Wiped out” loans may be 1099’ed • Can’t deduct a capital loss on principal residence • Double whammy: no loss recognized, but possible debt relief income • This is why we don’t give tax advice!

45. What happens to the junior loans? • Second loan $15,000 HELOC for boat • Third loan $20,000 for son’s college • First loan $500,000 purchase money If the lender for the first loan forecloses, wiping out the second and third loans, what are potential debt relief tax issues for homeowner?

46. E. Taxation Issues – Short Sales • Relief of debt is taxed as Ordinary Income • Exception: HR 3648 (2007-2009) • Qualified principal residence indebtedness (acquire, construct or substantially improve or refinancing of same) • Savings added to capital gain (reduces basis) • Federal law relief of debt 2007-2012 • State law relief of debt 2007-2008 • Amounts higher for fed than state

47. F. Bankruptcy Issues • Debts discharged in bankruptcy might not be taxed if the borrower proves insolvency • All assets are tallied and publicly reported • Credit impact is according to which chapter of bankruptcy, length of time, and resolution • Typical 7 years to clear credit • Credit impacts whether only filing to get delay through relief of stay or get a discharge

48. Here’s Why We Don’t Give Advice • Federal law mandates that if the debtor makes more AGI than the median income threshold for the county of residence, a debtor may have to file under Chapter 13 bankruptcy, not a Chapter 7 straight discharge. • The debtor might end up under control of the bankruptcy trustee for 5 years!

49. G. Deed in Lieu of Foreclosure • May have debt relief (taxed) unless loan is non-recourse or seller financing • Lender (grantee) must accept deed • Rarely used method: no existing liens are wiped out

50. H. Don’t give Legal or Tax Advice Use accountants, attorneys, legal aid clinics, government programs. IRS has set up Low Income Taxpayers Clinics (LITC) to assist taxpayers with IRS tax disputes (using $8 million in grants!) www.irs.gov.contact Don’t give Legal or Tax Advice!