This article first appeared in the 2nd quarter 2018 edition of Personal Finance magazine.
Typically, banks regard a property as being “in distress” after three missed mortgage payments in a row. This could happen to any of us and can be due to many factors, including over-capitalising (buying a house that’s simply too expensive, or spending too much on a renovation), losing your job, getting divorced, or by taking on too much risk and, for example, basing the purchase on two salaries without any wriggle-room for emergencies.
It’s important to know that as a distressed property owner, you can get assistance from the bank and cut your losses before it’s too late. Often, it’s far better to let go of your emotions and acknowledge financial loss so that you can nip the problem in the bud and move on.
On the other side of the coin are the investors who know that distressed properties can be good investments – provided you’ve done your homework. Investors often look to buy a distressed property at a discount and then resell it at a gain or rent it out. A distressed residential property can be a great alternative to fixed-interest investments, such as money market funds, or property investments, including commercial properties, listed property companies and property unit trusts.
There are many different parties involved in the selling of distressed properties, including owners in financial distress, banks that provide the mortgages and hold the title deeds, estate agents, sheriffs of the court and auctioneers. Not surprisingly, it can be something of a legal minefield that has been known to attract unscrupulous operators.
To a certain extent, owners of distressed properties are protected by the Consumer Protection Act, as there may be questions about why they were granted a mortgage they couldn’t afford. For this reason, banks offer assistance to the distressed owner to avoid selling the properties via an auction, where they typically achieve much lower selling prices.
Depending on how quickly the distressed owner acknowledges that he or she can’t afford the house and needs to let it go, the situation can pan out in a few different ways.
STEP 1: BANK-ASSISTED SALES PROCESS
The bank will usually contact the owner to find out what the situation is after a specified number of mortage repayment defaults (usually three). At this point, if the owner can’t come to some repayment agreement with the bank, he or she will be offered a bank-assisted sales process.
The benefit of is this is that the distressed owner can minimise his/her losses as the bank literally assists them to sell as quickly as possible. In fact, you don’t even have to wait for the bank to make the first move.
You can apply for bank assistance if you:
Expect to go into distress after being fired/retrenched or after losing an income earner;
Are really battling to keep up with your monthly repayments;
Are struggling to sell because your outstanding bond amount exceeds the market value;
Have sold your house but the transfer cannot go through due to outstanding municipal accounts or because of you being unable to afford electrical clearances, among other things.
The longer you wait and the more you default on your mortgage, the more interest you owe the bank. If you agree to the programme, the bank will assign the property to an estate agent who values the property at a realistic market price, which speeds up the sale. Accepting assistance can also alleviate stress for the distressed owner and stave off the possibility of adverse credit ratings.
Howard Markham, the head of industry stakeholder services at Pam Golding Properties, says: “The bank-assisted sales programme we operate affords us several opportunities.
First and foremost, these include the reward of assisting a property owner to exit his or her stressful financial burden in a safe, dignified and supported manner, and thereby contribute to securing clients for life. The programme also helps us to develop and foster our relationships with the banks, with whom we liaise on several levels. In addition, we also obtain market related stock, allocated to us from the banks, for our second-hand property sales operations.”
Sometimes the owner of a distressed property can enter the bank-assisted sales process through what’s known as a “reverse lead”. This is when the owner in distress contacts an estate agent for a valuation (before the bank has made contact) and reveals to the agent that they’re in financial trouble. The agent then introduces them to the bank-assisted process.
The process can have significant financial benefits for the distressed owner.
The bank can absorb up to half of the shortfall if you sell at a loss. For example, If your home mortgaged at R1 million but you only realise R900 000 on its sale, the bank could absorb R50 000 of the loss.
Most banks will allow you to repay the total amount owed to them (shortfall) over a period, with no interest due.
The bank will not record a credit judgement against you.
If you’re a buyer, it’s almost guaranteed that the property will be valued correctly, because of the urgent need to sell. Be aware, however, that estate agents don’t have to disclose to buyers that the owners are in financial distress and that it’s in the estate agent’s interests to sell the property for market value, as they are acting on behalf of the seller and bank and to protect their commission
That said, some banks list the properties online as properties in distress. This gives investors a potential edge in price negotiation. There is also an opportunity for banks to market distressed properties directly to members of their existing client base who are known to be property investors. Banks can identify these clients from their databases, but this can be problematic, as banks need to adhere to the Protection of Personal Information Act.
STEP 2: SALE IN EXECUTION
If the distressed property owner chooses not to accept a bank-assisted sales programme, the bank’s legal team will get a court order to enforce a public sheriff’s auction, otherwise known as a sale in execution.
The law has changed recently, and the sheriff is now responsible for determining the reserve price of the home at auction. This can be problematic as sheriffs are not generally expert evaluators and they could want to expedite the process by selling the home at a price below market value.
This scenario brings with it very real risks for distressed owners. Properties seldom reach market value at auction, due in part to the negative connotations associated with property auctions in South Africa. What’s more, the bank will record a credit judgement against the seller, and any shortfalls (the difference between the price achieved and the amount owing) must be repaid with interest.
But there are also risks for investors who buy at auctions. Not being able to inspect the property properly means there’s seldom time for an accurate price evaluation.
Because the property is sold voetstoets (“as is”), it could be badly in need of maintenance or even have serious structural damage. There might also be tenants in the house without written contracts – and we all know how tricky it is to get rid of illegal tenants in South Africa.
Some of the buyer’s responsibilities at a sale in execution:
Pay a deposit of 10% of the purchase price (cash, bank guaranteed cheque or electronic transfer) in the sheriff’s office, immediately after the auction is concluded.
Pay commission to the sheriff on the date of purchase.
Evict the owner or tenants
That said, there are still good investment opportunities to be had at sales in execution. The properties are advertised in the Government Gazette and in at least one local newspaper distributed in the area in which the property is situated. In the past, the banks have got into trouble as they’ve been accused of attending the auctions and buying at prices far below market value before reselling them at a profit, but this has changed now that the sheriff is able to set the reserve price.
STEP 3: PROPERTY IN POSSESSION
If the reserve price is not achieved at auction, a property becomes a property in possession (PIP) or a bank repossessed property. The bank now has the right to set the price (usually at mortgage value only) and will market the property directly or through estate agents. This is the least desirable option for sellers, to be avoided at all costs.
THE BOTTOM LINE
For owners: The sooner you acknowledge that you’re going to have to sell, the better. If possible, reach out to the bank before they contact you. This way you can protect your credit rating, write-off losses and find a home you can afford. Whatever you do, don’t live in hope of a quick hike in property prices – the market moves slowly … and not always in the direction you’re hoping for.
For property investors: Do your homework and find out whether the owner has decided to accept bank assistance or if the home has reached the sale of execution or repossession stage. And remember, people that have defaulted on mortgage payments usually haven’t spent money on maintenance for a long time. There could be all kind of hidden faults lurking beneath the surface.
Linda Graham, a Certified Financial Planner, is the founder of FinCommunication, a marketing consultancy for financial services companies.