There are standard terms that are imposed by lenders as conditions to approval of a short sale. Among these, and perhaps the most understandable, is the term that the sale reflect the “highest and best return” available at market. This term is incredibly broad and malleable, and it is meant to evoke in bank’s a cause of action against sellers and brokers for fraud. The basic idea is this; lenders are taking a loss on the sale, but sellers and brokers are warranting that they have done EVERYTHING in their power to mitigate that loss. Suffice to say, lenders and government try to protect against situations where the lender takes too big of a hit in short sales. Where the “highest and best return” clause may be written differently by each individual bank, it exists as a material condition for every short sale. Banks will always include it. And banks will always write related conditions as a means to guaranty the best possible return from the sale. The point of this writing is to introduce some common conditions that bank’s create to enforce the “highest and best return” condition of their approval.

Buyer residency

Many banks require that the buyer actually declare honest intent to make the property his or her primary residence. This requirement is obviously important for bank lending purposes, but some real estate professionals are not immediately aware of why it is relevant for bank selling purposes. Some banks require buyers to declare intent to reside at the property because it helps ensure that the bank is getting the highest and best return on the sale. Banks figure, if a passive investor is simply buying an investment, the investor probably has some undisclosed financial incentive for making the purchase right this moment. Perhaps the investor knows of a potential offer that is higher than the investor’s own, or perhaps the investor knows of additional value in the property that has escaped the bank. If a buyer is willing to make the property his or her home, the buyer is much less likely to be engaged in a quick profit scheme. Instead, the buyer is planning to wait out the market and build equity in the asset over time. As such, by forcing the buyer to live at the property, the bank is helping ensure that the bank is truly getting the best deal it presently can.

Property Retention

Some banks also require that the buyer retain the property for a certain period of time before placing it back on the market. This eliminates the likelihood of property flipping and double escrows. Basically, if the bank requires that the buyer refrain from placing the property for sale for a reasonable time, the bank ensures that the property will not be resold for an immediately higher value than the bank agreed to accept.

Property retention clauses have become so common that the government now requires buyer “retention periods” for any short sale that is procured as part of a federal program. For example, short sales that are part of the Obama Administration’s Home Affordable Foreclosure Alternatives (HAFA) program require the buyer to hold the property for at least 90 days. In essence, the federal government disallows double escrows and property flips for any short sale transaction under its jurisdiction. This is a subtle concession to lenders and it works to reinforce the highest and best return clause.

Seller Kickbacks

Most lenders will strictly refuse to allow the seller to receive any “thing of value” in a short sale other than those benefits disclosed on the HUD-1. This common sense term ensures that the bank is getting every penny of value out of the deal. Of course, sellers are not meant to profit from a short sale. The whole benefit to the seller is the inherent value of dropping a destructive economic burden and escaping the credit harm of foreclosure. However, in order to make sellers happy, some agents try to help their sellers get money out of the short sale by putting together separate agreements between buyer and seller. These agreements are outside of the property contract, and they create a clever avenue for the buyer to pay the seller without the bank’s knowledge. The buyer may purchase personal property from the seller at an inflated price, or the buyer may rent the property from the seller prior to close, or the seller may rent back the property from the buyer at a discount. These agreements are not always struck in bad faith. However, any profit or value that the seller earns due to the sale, other than those values strictly disclosed in the HUD-1, could demonstrate that the bank failed to earn the highest and best return.

Repercussions

Lenders have authority to refuse to honor a short sale payoff if their conditions are not met. Even if approval has already been granted, the lender’s performance is not required until the debtor performs first. Therefore, agents should be careful to ensure that they are strictly adhering to the bank’s conditions so that the transaction is not aborted at the last minute. However, the more serious consequences involve criminal charges for bank fraud and a civil suit by the lender – which can lead to punitive damages if fraud is demonstrated. These liabilities can end an agent’s real estate career and possibly bring a prison sentence.

In sum, every short sale approval includes some form of the “highest and best return” clause. Banks will protect their right to receive the highest possible return by throwing in contingencies like buyer residency requirements, property retention requirements, or seller profit limits. Also, many government programs use the power of law to prevent double escrows and property flips in short sale transactions. These terms are less standard but they all serve the same purpose – they give the lender power to blow up your deal or hold you accountable if the bank gets swindled. So, be careful to ensure that each contingency is strictly met, and transparently strive to get the bank the best possible return on each short sale.