In the last few years, short sales have become a growth industry. At the end of 2008 and especially in early Spring 2009, the federal government moved to make the market for toxic real estate assets more liquid through policy changes, asset purchase programs and capital infusion. Toxic assets are assets that are worth less than what has been invested in them. If a market contains too many toxic assets, the assets become hard to sell, even at a loss. Such assets are then said to be “illiquid.” Time on market is a measure of liquidity in the residential real estate market.

Short sales are a mechanism for marketing toxic assets in an illiquid market. Normally, and this was certainly the case when the residential housing market first turned sour, there is little incentive for lenders to participate in short sales. Unless a short sale will result in significantly less loss to the lender than foreclosing on the property, the lender has no incentive to discount their loan. Short sales, therefore, are traditionally about convincing the lender that taking the short sale deal will actually make them money. See the Do the Numbers section of this subject.

In economic terms, the government’s intervention in the distressed property market created a market entry opportunity. In a sense, this new distressed property entry opportunity is an echo of the residential real estate market entry opportunity created by the easy credit that caused the real estate market bubble in the first place. Indeed, many of the same mortgage brokers, property flippers and real estate speculators who drove the real estate bubble are back as foreclosure consultants and equity purchasers. Basically, the government is using its money and influence to encourage sales at well below what would otherwise be the market price in order to increase liquidity and, therefore, clear the market of distressed properties.

Encouraging sales at below market price does two things. First, it increases market activity, particularly market activity in distressed property. Today distressed properties in the guise of short sales and REOs make up about 20% of real estate listings in the average market but account for more than half of all sales. Secondly, encouraging below market sales creates a new market bubble. The distressed property bubble is intended to stop the deflation created by the end of the original bubble. In many markets it is generating the same kind of frenzied activity as was seen market-wide at the height of the original bubble.
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