Short Sales Are Hot but They Also Incur Risk, Loss

New industry research confirms what common sense has been indicating all along: Demand for short sales is on the rise.

Findings from "The Cost of Short Sales" 2010 study conducted by CoreLogic of Santa Ana, Calif., show the number of short sales has more than tripled since 2008 with the estimated annual volume at 400,000. (The study is based on a representative data sample of single-family residence short sale transactions from the past two years.)

Not surprisingly, over half, or 55.8%, of all short sales occurred in California, Florida, Texas and Arizona, the four states that have been hit the hardest by the crisis.

And according to CoreLogic, "Multiple variables indicate short sales will continue to be a frequent and important part of the mortgage industry."

What is fueling the current increase in short sales volume is the jobless economic recovery and weak home prices, says senior research director of consumer lending at the TowerGroup, Craig Focardi. "In many instances, government-sponsored or private short sale programs are a preferable alternative to foreclosure."

He warns, however, that problems may occur if important aspects of the short sales transactions such as "all potential buyers to the seller and accurate home price comparables" are not disclosed.

The study found that an important side effect of the renewed industry focus on short sales as a loss mitigation venue has been its financial impact on lenders and servicers.

It estimates short sale fraud related lender losses are $310 million annually. At 1.9% the risk of such "unnecessary losses" occurring in one in every 53 short sale transactions is estimated at an average of $41,500 per transaction.

CoreLogic senior vice president of fraud analytics, Tim Grace, argues that since by definition short sales constitute a financial loss to lenders but will continue to be a necessary part of the mortgage industry as it seeks stabilization, "the primary objective for lenders is to eliminate unnecessary loss."

He suggests a "collaborative effort where lenders collectively share preclosing and post-closing information" as the best way to mitigate fraud risk and unnecessary loss.

The study highlights that the exact definition of what constitutes fraud continues to evolve. CoreLogic analysis, however, indicates lenders are consistently incurring more loss than necessary if a short sale transaction was part of an egregious flip and therefore deemed risky.

The study highlights the value of investor-driven short sales is turning out "necessary liquidity" for the industry.

Industry veterans also note that during the past year both interest in short sales and investor interest in distressed property sales started to gain steam.

Cary Sternberg, president of Excellen REO, a full-service asset management unit of Titanium Holdings Inc., told this publication that as investor interest started to grow month-over-month, firms that were in the third-party sales market would "get involved on the short sale side of things."

Community advocacy and revitalization groups are also more involved in the REO market. But if REO inventory is running off at a greater pace, he says, that revitalization opportunity is lost, so they're trying to figure out a way to use it. "You cannot directly buy a short sale on an occupied property, so they've got to work through that challenge." But if they can work through that challenge, more and more of these trust type foundations will look "to connect their NSP monies with prequalified accounts and borrowers to short sale scenarios."

And they need be aware of short sale risk.

CoreLogic identifies as risky to the lender two cases of short sale transactions. First, when the second sale amount is vastly higher than the short sale amount, or when the two sale transactions are executed within a very short window of time.

The study highlights that "group, consortium analysis and reporting" are necessary to fully leverage multiple-lender data and mitigate risk.

To minimize loss and risk, given the long duration of mortgage defaults and potential loss upon home sales, Focardi says, it becomes indispensable to automate and outsource related technology.

Other service providers are walking that same path.

Early this year "in anticipation of an increased number of short sale transactions," Pittsburgh-based ServiceLink began expanding its loss mitigation operations.

It now reports its streamlined asset management approach has increased short sale processing efficiency completing package and contract acceptance in less than 30 days from the moment it receives the file assignment from the servicer.

Compared to an industry average of about three months just a year ago, and the fact that the timeline from contract approval to closing has been reduced to less than 45 days, a short sale is completed within 75 days-compared to over five months.

ServiceLink SVP of loss mitigation, Jane Johnson, attributes the increase in efficiency to streamlining and the firm's experienced short sale specialists, who helped "offset our clients' capacity struggles."