For thousands of business owners, the failure of a business means more than just closing the doors and walking away. It also means dealing with the emotional anguish of having a piece of real estate forcibly taken from them by their lender. For many people, this is a confusing and stressful process. The purpose of this article is to explain how short sales work, what’s involved, and factors that play into a successful short sale.
First, let’s discuss what a short sale is. Simply put, a short sale is when a piece of real estate sells for less than the amount owed to the bank. This has become quite common in the residential sector, and has also become more common on commercial properties. To further drive home the meaning of “short sale”, let’s look at an example:
Bob’s Widget Factory Inc owns a piece of commercial real estate that they purchased in 2008 for $1,000,000. In order to buy the real estate, Bob took a $900,000 loan. Before Bob could blink, the economy went south and the business went belly up. In order to make good on his obligation despite his failed venture, Bob decides to put his building up for sale. To his dismay, the local real estate market has weakened, and the best offer he has received for the building is $700,000. Bob has found himself in a classic short sale situation. He owes $900,000, but the most the building will sell for $700,000, Now what?
In order for any short sale to be successful, first and foremost, ALL the lien holders must agree to release their liens. This means not just the first lien holder, but the 2nd, 3rd, 4th etc. Why is this the case? Here’s why: Because a short sale is a voluntary sale, therefore all the lien holders must agree. Contrast this with a foreclosure, which is a forced sale. In these cases, not all the lien holders need to agree. In the example above, if the 1st lien holder were to foreclose, all the remaining lien holders would get “wiped out”, which means all the remaining lien holders lose their lien on the property.
Some other factors to consider when contemplating a short sale:
- A successful short sale typically does not mean you are off the hook for the deficiency (ie the money you still owe to the bank), so a settlement (OIC) will be needed.
- The OIC cannot be done in conjunction with the sale of the real estate. The settlement comes only after all business assets have been liquidated.
- The more liens there are on a property, the more difficult a short sale is to accomplish.
- Some lenders will allow a portion of the proceeds to go to more junior lien holders, while others who are in 1st position will foreclosure instead of sharing the proceeds from a short sale with junior lien holders.
Overall, short sales have become a way of life in today’s economy. No matter what side of the deal you are on, be prepared for a transaction that will take longer and cause more headaches than “regular” transactions due the fact that there are typically more players involved.