Tuesday, August 28, 2012

Non-bankruptcy strategies for troubled real estate

In these demanding financial times, many clients of Shenwick & Associates are seeking to modify troubled real estate loans without filing for bankruptcy. As we have discussed in prior e-mails, many alternatives exist in bankruptcy to deal with troubled real estate loans. Now we will look at strategies to deal with troubled real estate loans outside of bankruptcy.

If an individual owns real estate and the property is underwater (the fair market value of the property is less than the outstanding liens encumbering the property (mortgages, home equity lines of credit, etc.)), and/or the owner/borrower of the property is having difficulty making mortgage payments, there are a number of options or strategies that the owner/borrower may want to discuss with their lender(s):

1. Many banks take the position that they will consider hardship issues with borrowers unless the loan is in default (the loan payments are past due). The consequences of being in default from loan payments range from lower credit scores for the owner/borrower to the lender commencing a foreclosure action on the property, which may be irreversible. The issue of whether a borrower should default on a loan is an extremely important decision, and should be discussed and analyzed with an accountant and/or attorney.

2. Short Sale. A short sale is a sale of the property which will net less than the amount required to pay off the principal amount of the loan on the property. In these difficult times for real estate, many banks are more amenable to approving short sales than they used to be. The first step in this process is to find a buyer for the property, then enter into a contract of sale with a special rider provision that discloses to the purchaser that the property will only be sold if the short sale is consented to by the seller's bank. Another issue that must be addressed in the short sale is relief of indebtedness income. This topic was addressed in this prior post, but there are tax consequences when the property is sold for less than the balance of the mortgage, which must be discussed with the owner/borrower's accountant and/or attorney. However, if the bank will approve the short sale, then this will allow the seller to sell the property, with some impact on his or her credit report and tax consequences; however, the net result is that the seller longer has to worry about a property that is underwater.

3. Another strategy is to ask the bank to do a "workout." The borrower may ask the bank to reduce the principal amount of the loan, decrease the interest rate or lengthen the term of the loan to reduce the amount of the monthly payments. In order to do a workout with a bank, the borrower must show a hardship. It is this attorney's experience that many banks are loathe to reduce the principal amount of the loan, and if the loan has been packaged and sold to investors, then it is more difficult for the bank to do a workout.

4. Deed in Lieu of Foreclosure. If a loan is in default and the property is underwater, then the borrower may ask the bank to do a "deed in lieu of foreclosure." Under New York law, in lieu of a foreclosure, the owner of the property can agree to deed the property to the bank. Again, there are tax consequences and credit implications in this strategy, and the bank will only agree to take back the property if they truly believe that there are no sellers available to purchase the property. An issue that often comes up in deeds in lieu of foreclosure is what happens to the deficiency–that is, the difference between the value of the property and the amount of the loan. The bank may require the seller to pay all or some portion of that deficiency over time.

5. Purchase of the Mortgage. Another strategy is for the owner of the property to have a friend, family member or investor approach the bank and purchase the defaulted or troubled mortgage loan at a discount.

There is no perfect fit or solution to many troubled real estate purchases; however, the owner/borrower needs to be flexible, and oftentimes one of the above strategies can help ameliorate the problem. Before a borrower undertakes one of these strategies, they should consult with their accountant and an experienced real estate/workout attorney, such as Jim Shenwick.

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