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Long, short of commercial short sales

Published: Sunday, Dec. 29, 2013 5:30 a.m. CDT

Before 2008, I had never heard the term “short sale.”

Thirty-five years in the business, and the subject had never come up. All that time I had been operating in the world of “long sales.” So I learned, as did many others, the back story behind this simple term as it relates to commercial real estate properties.

When you sell a property that has debt and the proceeds from the sale are not sufficient to pay off the note, you are said to be short. This is not a backhanded insult to your physical height. You are short the money needed to pay what you owe the bank.

Banks are notorious for expecting a borrower to pay back every penny owed. You can’t really blame them. After all, the note you signed was your personal guarantee that you would pay them back.

Some borrowers had to renege on their agreement to pay back the money lent to them. Why? Because something happened to their financial situation, and the money was no longer there to make the required payments. There were many variations to this unfortunate predicament of being between a rock and a hard place.

The worst thing you can do if you find yourself in this situation is to do nothing. You need to be proactive to come out of this with your shirt on and your credit intact.

When a property owner realizes he no longer can afford to pay the debt service on his existing loan, one option is to stop making the payments. In most cases, the lender has no option but to file a foreclosure lawsuit. This is the legal remedy afforded the lender to reclaim title to the property with a non-performing loan. Being subject to a foreclosure is highly detrimental to a person’s credit standing. Generally, you don’t want a foreclosure on your credit rating. A short sale is a method by which you can avoid the negative impact of a foreclosure process.

Lenders don’t like to have to foreclose on commercial properties as a general rule. They are costly and time consuming. Hence, lenders are open to participating in a short sale because the end result is often more profitable (or less unprofitable) than a foreclosure lawsuit. In order to start a short sale on a given property, there needs to be a buyer.

Usually you have to first list the property for sale in order to find that buyer. Let’s forget for a moment what the asking or appraised price of a property is and focus on the loan balance. Let’s assume, for example, the loan balance (what the property owner owes the lender) is $100,000. And let’s assume the buyer offers $75,000 to the property owner. The seller is short $25,000 in this example.

At the point at which the offer comes in, the seller hires a broker or a third-party negotiator to convey the offer to the lender with certain paperwork. Among the paperwork critical to the lender’s decision process is an appraisal of the property or a broker opinion of value, and a letter of explanation from the seller about their particular hardship.

There needs to be a hardship for the lender to participate in this process. You can’t just walk away from your obligations because you feel like it. But you also need to understand that the lender is under no obligation to participate in a short sale, and if they are hardnosed about it, they will drag you through a foreclosure.

It is important for a seller who desires to do a short sale to seek professional help. One major reason is that a short sale is construed by the IRS as a forgiveness of a portion of a debt. In many cases, when a loan is forgiven by a lender, the IRS construes that forgiveness as a taxable event. They treat it is as the same thing as getting an income windfall, such as winning the lottery. Professional help can cause the short sale to be structured so that the seller is not taxed on the deficiency.

The last thing you want to be obligated for is a chunk of income tax after you just lost your building in a short sale.

• Bruce Kaplan is a senior broker associate with Premier Commercial Realty in Lake in the Hills. Reach him at brucek@profit-success.net or www.profit-success.net.

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