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Short Sales: Disclosing Distress

As home prices stagnate, real estate practitioners are more likely to face the question of when, how, and how much to disclose about a financially distressed property.

Such properties present two disclosure challenges—finding a reliable source of correct information about the physical condition of the property and deciding how and when to make a situational disclosure about the owner’s financial distress.

Disclosing Property Issues Is Critical

In a short sale, the net proceeds from the sale are insufficient to cover the mortgage debt and all other costs of selling. Home owners may already be in default on a mortgage or may recognize that they will not be able to continue to make payments much longer. Sellers in such circumstances may feel desperate and be particularly reluctant to disclose property defects.

A seller who is unable to pay a mortgage has often failed to maintain the property. In these situations, it’s critical to explain to the seller that withholding information will not improve the situation.

In addition, distressed sellers should understand that they will still be vulnerable to a buyer’s lawsuit if known defects aren’t disclosed.

Timing Is Tricky in Short Sale Disclosure

An agent for a distressed seller also faces the decision of when to disclose the owner’s situation and how much to disclose. In general, a salesperson representing the seller should advise prospective buyers about the property’s financial status before they sign a purchase contract because the need for the lender’s approval of such sales can affect the terms of the sale and the timing of the closing.

NAR’s MLS policy was amended earlier this year to require multiple listing services to give their participants the ability to disclose any possibility of a short sale to other MLS participants. Participants may also, but are not required to, communicate to other participants how any lender-mandated reduction in the gross commission stated in the listing contract will be apportioned between the listing and cooperating brokers.

The policy also gives MLSs discretionary authority to require participants to disclose potential short sales when participants have reason to believe that the transaction may result in a short sale. The policy provides that short sale information should be included in the confidential remarks field of a listing as soon as the listing broker knows about the possibility of a short sale.

In particular, practitioners must be careful not to compromise the seller’s chance of getting the best price possible for a home by disclosing the sellers’ distressed condition too early.

After a Foreclosure

Once a property has been foreclosed and is owned by the lender, there’s no longer an issue about disclosing the property’s distressed status. Foreclosures, after all, are matters of public record. However, getting reliable information about a foreclosed property’s physical condition becomes even more challenging.

When a property’s owner is no longer in possession, it’s extremely difficult for a sales associate to get the facts about property condition, in part because the lender may have little, if any, information about the property’s condition.

Lenders are usually required to disclose what they know about REO properties but are generally exempt from requirements to complete property condition disclosure forms required for sellers in many states. However, agents must still make all disclosures of known defects required by their state’s law. Associates should encourage buyers to have a thorough inspection of any property prior to purchase.
Providing such advice may help protect you from liability if the property is later found to have a defect. For example, in Reed v. Bank of America, 1995, a buyer whose lender had repeatedly advised him to get a home inspection, even though the practitioners involved did not notice any defects, lost in his suit against the bank because he chose to self-inspect instead of hiring a professional.

More Tips for Disclosures

•   Ask for copies of all relevant permits, repair receipts, and inspection reports from a home owner who is still in residence at a distressed property.

•   Take photos of any property defects you see, send copies to the lender, and get a written receipt.

•   Inquire about past-due condominium assessments or homeowners association dues that might create a lien.