It’s no secret that a lot of us have dealt with some serious reduction in value in our properties purchased prior to the market crash. Each situation has been unique and accordingly, handled in a different way by each homeowner. One of the most commonly asked questions I get asked today pertains to how to handle a situation where the value has dropped dramatically. There are countless homeowners with properties worth far less than what is owed on them. How are those situations best handled? The answer is, it depends.
Scenario: Property Currently Valued at $200k Below Initial Investment
To help illustrate just one scenario, below is an example of a recent client that was struggling with the decision of whether to wait the market out or proceed with alternatives. The home they had purchased in late 2005 was originally valued at $650,000 but this year in June after trying unsuccessfully to sell it for a long time, they were at a loss – in more ways than one. First, they didn’t know what to do as far as leaving it on the market or not. Second, they were unsure about how to handle the gaping difference in present day value compared to their initial investment.
The answer in their case is one of two things. The best option would be for them to come up with the difference owed as opposed to what the property sells for – pay the lender and walk away from the situation free and clear. However, this is highly impractical for many people and downright impossible for most.
The alternative is to consider either 1. Waiting the market out or 2. Going through a short sale.
Here is roughly how the numbers look:
Original Value: $650,000
Today’s Value: $450,000
If Sold Today the Net Profit: Approx. $418,000
Amount Owed Today (Seller Put Down 20%): $520,000
Difference To Be Made Up: About $100,000
CARRY THE PROPERTY UNTIL INITIAL INVESTMENT AMOUNT RECOVERS
The cost to carry the property is currently $3,500 per month, with the cost of principal, interest, taxes and insurance. Considering that we are located in a resort community, this property could be rented out with a $16,000 annual net income (after all fees are taken into consideration), leaving a negative cash flow of $26,000 each year after the annual expenses are factored in.
The problem with this scenario is that there is zero appreciation in our current market. For illustration’s sake, let’s say that we were appreciating 5% each year. Even in that case, it would take us ten years in the above situation of carrying the property with a negative cash flow each year, before it would be back at the original investment value. Keep in mind that it would also be ten years of negative cash flow in the amount of $260,000. This does not take into consideration wear and tear or other unforeseeable circumstances.
So ask yourself this: “Does it make sense to carry a property through a ten year period of time, knowing that at the end of the day it would cost more than the expected appreciated value?”
The percentage of appreciation you would need in order to break even is a very unrealistic fifty-four percent.
DO A SHORT SALE, BECOME DEBT FREE, REBUILD CREDIT, BUY AGAIN
What many homeowners are realizing today is that rather than invest so much time and energy hoping that the property will recover in value, it makes far more sense to cut your losses today and move on. A short sale is where a bank will accept less than what is owed on a property because its value has dropped. Yes, it will have a negative impact on your credit in most cases. But on the flip side, you will be free from a debt that could otherwise be very difficult to clear. A short sale’s impact on your credit report will typically result in a drop of 100-150 points. This can and does get rebuilt in a matter of 2 to 3 years.
What is your scenario? How do the numbers factor in with your situation? If you have been on the fence about selling or if you are struggling with how to handle your property under these current market conditions – have you considered the alternatives? Contact me today and we’ll go over each factor together and develop a workable plan that makes sense for you.
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