Short sales don’t happen every day, but they’re relatively common in real estate. Some sellers who struggle to pay their mortgages will take a lower price for their property in an effort to avoid foreclosure.
Like many aspects of real estate, short sales can pose some risks to you as the real estate agent, and it’s important to protect yourself and your business.
In this blog, we explore what a short sale is, how it differs from a foreclosure, potential areas of risk for real estate professionals and what you can do to protect your business.
What is a Short Sale and How is it Different From a Foreclosure?
A short sale occurs when a homeowner sells their property for less than they owe on the property mortgage and other associated costs, such as agent commissions, property and transfer taxes.
Short sales may be necessary for many reasons, including:
- When a purchaser dies shortly after buying a property
- Divorces/separations requiring a quick sale
- When a buyer purchased at peak prices, but the market has dropped significantly
- Buyers who have withdrawn equity from their properties but now need to sell
In some cases, a lender will forgive the deficit left as a result of the short sale. In other cases, they will order the mortgagee to pay part or all of the difference between the sale price and the total of the mortgage. Short sales are an avenue often pursued as an alternative to bankruptcy or foreclosure.
A foreclosure occurs when a homeowner is behind in mortgage payments and their ownership rights are forfeited and transferred to the lender. If the homeowner cannot remedy the shortfall, the lender will sell the property and use the proceeds to pay off the homeowner’s debt. Foreclosures are a last resort option and can damage a seller’s credit significantly.
How Short Sales Can Affect Real Estate Professionals in a Negative Way
While short sales are fast becoming a niche of choice for some real estate professionals, they’re a more complex transaction than a regular property sale. Short sales can take much longer to negotiate and are higher risk.
Sales prices are typically lower for short sales, and you may also find your commission will be reduced. With short sales, the lender will pay your commissions — and it’s common for lenders to ask you to discount your commission to below-market rates.
Areas of Risk and Possible Claims
The most common reasons why real estate professionals find themselves facing lawsuits after a short sale are:
- Breach of fiduciary duty
- Facilitating incentives not approved by the lender
You may face a claim for misrepresentation if you accidentally provide the seller with poor advice about aspects of the short sale. For example, if you provide advice on tax consequences, the legalities of short sales, impact on credit, or treatment of the debt by the lender — all beyond a real estate agent’s scope of work.
Even if this advice is given casually and with the best of intentions, that advice could influence the seller’s decisions relating to the transaction. And, if things go wrong, a seller may make a claim against you.
Ensure you stick to your area of expertise. Always suggest to the sellers that they obtain independent legal and financial advice about their financial situation and how the short sales process may work with their lender.
Breach of fiduciary duty
Real estate professionals are in a trusted role. You have a fiduciary obligation to undertake actions in the best interest of your clients, above all else.
Lawsuits based on fiduciary duty breaches occur when the sellers feel the agent has not acted in their best financial interests. This type of claim could arise in a short sales scenario if:
- You, as the agent, somehow benefit from the sale of the property at a reduced price. For example, if you purchase the property;
- A close associate of yours benefits from the short sale;
- Investors negotiate with the lender directly, bypassing the agent, then ‘double close and flip’ the property; or
- You provide advice to your client which is not in their best interests
You must act in the best interest of your client and be sure to disclose any conflict of interest relating to the transaction.
Facilitating incentives not approved by the lender
Investors will sometimes offer incentives to a seller to expedite a transaction. For example, they may offer to purchase furniture or other items in the property. However, the terms of a short sale negotiated with a lender are very strict. Such incentives are frowned upon and, in some cases, are even illegal.
As a real estate professional, you may face a lawsuit even for communicating these types of incentives to your clients, so be cautious.
Protecting Your Real Estate Business
Insurance is essential to protect yourself and your real estate business against potential lawsuits relating to short sales and other industry-related risks. CRES E&O + ClaimPrevent® offers superior protection designed specifically for real estate professionals. CRES also offers free access to qualified attorneys, so if you need advice about a short sale, you can obtain expert advice 7 days a week.
Contact the friendly team at CRES at 800-880-2747 for a confidential discussion today and find out how you can get a customized insurance solution to suit your individual needs.