Buyers face many challenges in today's real estate market, from finding the right purchase financing to finding the right property. Buyers today shouldn't have to worry about possible "buyer traps" once they have found the right home. Due to the current economic climate, i.e. the housing bust, buyers may find that the majority of homes in the market they are looking at will include properties listed as both "short sales" and "REO" properties as well as the traditional sales that once dominated our market just 3 to 4 years ago.

Here is what you should know about the different types of property sales that you may encounter in today's real estate market and how each kind of sale can create their own risks and challenges.

Short Sales

For any of you that invest in the stock market, we're not talking about short selling a home the same way you would short sell a stock. A short sale on a home happens when the homeowner must sell their property for less than what they currently owe to their mortgage holders.

A short sale typically is executed to prevent the homeowner from having their property foreclosed or repossessed by their bank. Often a bank will choose to allow a short sale if they believe that it will result in a smaller financial loss than the foreclosure proceedings.

A short sale requires much paperwork and preparation on behalf of the borrower, and the lender agrees to discount the loan balance due to an economic or financial hardship on the part of the borrower. Typically, before applying for a short sale, the seller must have a ready buyer and all the paper work prepared to present to the lender.

Special Considerations for the Buyer:

Since a short sale transaction is never a guaranteed solution for the seller, i.e. the seller's bank is not obligated to accept a short payoff on their outstanding loan, buyers who decide to make offers on short sale properties should be aware of several important considerations:

• Short sales can take any where from a little as 2 months to as long as 6 months to complete successfully - since most lenders will not even consider a short sale until the seller has become delinquent on their mortgage, and not until the seller has been able to market the property for sale and produce and offer, there is usually no way to expedite a short sale transaction. Depending on how the buyer makes their offer they can find that their good faith deposit can be tied up for several months or longer. The acceptance of the short payoff by the seller's lender is only a contingency of the offer, so buyers can find themselves in a contractual obligation without a definitive time period to close escrow.
• Short sellers usually do not have the resources to pay for inspections or repairs - since a short seller is most likely facing foreclosure, they will usually not have the resources to pay for any inspections or repairs that might need to be made to the property. Even though the buyer will most likely front the cost of the inspections, the real estate agents may still be able to negotiate the repairs of the property with the seller's lender footing the bill.
• Short sellers may have more than one lender - some short sales require all of the seller's lenders' approvals before the transaction can be successfully closed. This can add additional complications depending on whether or not the seller's loans were purchase money or refinanced, as well as the way that different banks handle the short sale process.
• Short Sales may require extra monetary compensation to junior lien holders - when there is not enough equity in the property to cover both the second and the first mortgage, some junior lien holders (second mortgagor) will require more compensation that what the senior lien holders (first mortgagor) will allow to be paid from their proceeds. This can cause a complication in which the buyer must pay the junior lien holder extra monetary compensation over and above the actual purchase price of the home - increasing the buyer's down payment and closing costs significantly.
• Buyers can find themselves ousted from a short sale if a higher offer is received prior to the short sale acceptance - Buyers may submit an offer and wait 2-3 months as the short sale approval process is worked out, but all the while the property may still be marketed for sale and the seller's lender may require that all offers made be presented to them. This may allow another offer to be made at the last minute and accepted in front of an earlier offer.

As you can see, there are many pitfalls to be aware of when a buyer considers making an offer on a short sale. Buyers should seek the assistance of a professional who has had experience and is knowledgeable in short sale transactions.

Real Estate Owned (REO's), a.k.a. Foreclosures

The other common sales transaction that a buyer will find available in today's market is an REO property. REO, which is an acronym which stands for Real Estate Owned by a bank, is exactly that, a property that has been foreclosed and repossessed by the bank that made the loan on the property.

From what you have probably heard about foreclosures you may expect to get the best deal by purchasing these kinds of properties, but BUYER BEWARE, especially when purchasing a foreclosure, a buyer can unknowingly inherit costly repairs, hazards, and more. Here are a few considerations that should be made when shopping for REO properties:

• REO's may not always be the best deal - Many times once a bank has repossessed a property, they will turn it over to a separate asset management department that specializes in mitigating the banks loss by marketing the property for sale a price that will cover as much of the loss as possible. Although REO’s are mainly sold by local realtors, sometimes these asset management companies, most being located out of state, can be unrealistic in their perception of pricing for the property meaning the home may be marketed at a higher price than what the true market value may be. Although the bank wants to get the best price possible they have no interest in "dumping" real estate cheaply.
• Limited disclosure when purchasing REO’s – Since the banks that repossess these properties have never lived in them, they are excused from providing certain disclosures regarding the condition of the property to the buyers. Buyer’s of REO’s are truly taking a risk and must be sure to order all possible reports and inspections that may be suggested by their agents and other advising professionals.
• REO properties tend to be in run down condition – Buyers need to think twice about purchasing an REO property, especially if they are using FHA financing, as most REO properties need a considerable amount of work just to make the home livable and most FHA loans require the property to be an inhabitable condition. Well, a lot of REO properties for sale today may be distressed as a result of simple neglect, intentional vandalism, or both. If you think about it, if the previous homeowner knew they were defaulting then they either could not afford to or just plain refused to spend money on repairs needed to maintain the property. And as for intentional vandalism, when some homeowners lose their properties through foreclosure they have been known to take their anger and frustration out on the property. It’s not uncommon for them to strip a property of its fixtures, cabinets, appliances, and even copper plumbing, as well as damage the property by smashing out the walls, breaking window panes, pouring cement down the toilet, or flooding the property by leaving the faucets on.
• Financing can be restricted on an REO property – Due to their often neglected or vandalized condition most lenders will require the property to be inhabitable and free of all possible health and safety issues. This often means that the buyer has to front the bill to repair the property to an inhabitable condition. This can put the buyer at additional risk as they would be putting money into a property that they don’t own yet, and if there is a glitch in their financing or with the bank selling the REO, they may be out the money they spent on any such repairs if the sale does not close.

A bank owned property might not be a great bargain. Do your homework before making an offer. Make sure that the price you pay (if you’re successful) is comparable to other homes in the neighborhood. Consider the costs of renovation, including time to complete them. Don’t get caught up in a “bidding war” and pay over market value... It’s an old myth that “foreclosures” are always a bargain.

Final Considerations

It is also important realize, that for every horror story that you may hear about buying either a foreclosure or a short sale, there are multiple success stories in which buyers have found wonderful opportunities and were able to pick up these properties at great values in a successful manner. What buyers need to realize is that they should seek the assistance of a real estate professional that is knowledgeable and experienced in these types of transactions to help guide them through all the potential pitfalls of purchasing such a property.