Mar052012

Steering: why realtors love short sales and banks should shun them

I have written a few times about flopping: realtors who sell REO for under-market prices to favored buyers. (see Flopping: unscrupulous realtors deceive lender clients and profit from fraud, Floppers: realtors who profit by ripping off their lender clients, and most recently realtor flop in San Juan Capistrano.)

A flopper doesn’t get the highest and best price for the property. The practice of flopping is unethical because the agent shirks their fiduciary responsibility to the seller to favor a buyer, most often for a kickback or promise of a future commission on the flip. Flop sales exasperate buyers who miss out on obtaining the property. Many buyers would have paid a higher price if given the chance, and they feel it’s unfair for realtors to favor other buyers, particularly for kickbacks and other incentives.

I had a long discussion with an agent recently who prompted me to make an important distinction between flopping and what I call steering. On a flop, the realtor is clearly violating their fiduciary responsibility because when they list an REO, they have a duty to the owner to get the best price, and in the case of REO, the owner is a lender. However, when the property is a short sale, the lender is not the owner, and the listing agent has no fiduciary responsibility to the lender — none. In fact, the listing agent has responsibility to the seller who has vastly different goals than the lender.

In a short sale, the seller has no equity; therefore, the seller could care less about getting the highest price for the property. The seller wants two things: (1) they want to close and get out of the property, and (2) they want to have no burden to repay the shortfall on the mortgage. When short sales first began happening early in the housing bust, sellers were responsible for any shortage, so sellers did have a strong desire to get the highest possible price for the property to minimize the debt. However, today debt forgiveness is part of the short sale by common practice and by law in many states including California. The listing agent’s duty to the seller is to make sure the seller doesn’t sign anything obligating them to repay the debt, but the listing agent has no obligation to get the highest price. In fact, since the agent’s first duty is to sell the property — and of course they want to get a commission — the agents incentive is to get the lowest price the bank will allow to facilitate a speedy sale.

Since both the listing agent and the buying agent have incentive to get the lowest possible price the lender will approve, banks should be wary of short sales. Nobody in the transaction is looking out for the bank’s interest. Lenders try to offset this problem by hiring their own appraisers, but if the appraiser misses the valuation to the low side, nobody else involved in the transaction is going to say so. In fact, if the listing agent were to tell the bank they could get more money, that would violate their duty to the seller to sell the property as quickly as possible and make sure the deal closes. The tiny amount of additional commission from a higher sales price does not make up for the extra work and hassle of trying to obtain a higher price.

Since listing agents are now have incentive to get the lowest price, agents will steer these transactions toward favored buyers, hence the title steering. Sometimes this is a family member or friend of the seller (prohibitions against familial sales are routinely ignored). Sometimes it is a business associate of the listing agent. Often accompanying the sale is the promise of a future commission, a kickback, or an additional payment outside of escrow. The worst part is, there is nothing wrong with it. Although buyers who are not favored may decry the unfairness of the arrangement, nobody involved in the transaction has violated any fiduciary responsibility they have.

It isn’t hard to see why realtors love short sales and why banks should shun them.

realtors have taken a strong public position favoring short sales over foreclosures. There are only a few possible reasons for this resistance. realtors undoubtedly favor short sales over foreclosures for public relations reasons, but realtors do very little that isn’t completely self serving, so there must be another reason. One reason may be ignorance. realtors may believe that a foreclosure represents a lost commission. However, since a foreclosure ends up being sold as an REO, a short sale is merely a failed listing and a delayed commission not a lost commission. Now that I understand steering, I think it more likely realtors favor short sales so strongly because they can use short sales to create other opportunities to make money. The flips for favored buyers generate a second commission or a split of proceeds on the second sale.

In any event, short sales create steering opportunities, and only buyers who know the listing agent get to take advantage of these opportunities. Short sale steering is unfair to buyers who aren’t as well connected, and it reduces the recovery banks could have obtained in a true arms-length transaction.