California’s New Anti-Deficiency Statute for Short Sales

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California’s New Anti-Deficiency Statute for Short Sales

Effective January 1, 2011, California’s newest anti-deficiency statute applies to short sales. Newly enacted Code of Civil Procedure section 580e prohibits a deficiency judgment where: (1) the obligation is a note secured by a first deed of trust; (2) the property is a dwelling of not more than four units; (3) the short sale is made with the written consent of the note holder; and (4) the borrower/trustor is not a corporation or a political subdivision of the state.

Except for situations involving borrower fraud or waste, the statute provides the following protection: “Written consent of the holder of the first deed of trust or first mortgage to that sale shall obligate that holder to accept the sale proceeds as full payment and to fully discharge the remaining amount of the indebtedness on the first deed of trust or first mortgage.”

This new statute is particularly noteworthy in the following respects: (a) by fully discharging the debt, in addition to precluding a deficiency judgment, it may preclude any recourse against a third party guarantor; (b) it excludes application to a trustor corporation, but not to a partnership or limited liability company (an odd distinction); (c) it includes no requirement that the dwelling be owner occupied; and (d) it only applies to notes secured by a first deed of trust.  Legislative intent with respect to some of these issues might be clarified by future amendment.

As for a second trust deed, if the anti-deficiency statute in CCP section 580b does not apply (for a seller’s note secured by a deed of trust, or a purchase money loan on an owner occupied dwelling), because section 580e does not address the issue, the borrower should make clear that any shortfall on repayment is waived as part of the short sale, or the lender should make clear that it reserves its rights to recover the deficiency.

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2011 Forecast – Foreclosure Wave

Hundreds of billions of dollars in commercial mortgages and construction loans will mature this year. Extend-and-pretend practices of banks and foreclosure reluctance by special servicers will decrease, based on recognition that increased absorption and rental growth will take more time, and an owner will not invest capital needed to preserve the asset knowing it may eventually be lost. Many banks have had sufficient time to build up cash reserves so they can now write down asset carrying values to market levels, foreclose, and sell the REO, without taking huge losses. The FDIC will likely continue to seize under-capitalized regional banks, which cannot mark-to-market without becoming insolvent, requiring successor financial firms to either work out and modify the loan or foreclose on it. Also, as banks and special servicers sell more defaulted notes, the note buyers will then foreclose. Consequently, expect a wave of foreclosures and REO sales in 2011.

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Opportunities Abound in 2011

In 2010, real estate values appear to have hit bottom and begun to stabilize in most markets, presenting fresh investment opportunities in the form of distressed properties and notes.

Though obtaining financing can still be difficult, an abundance of pent-up investment capital competes for favorable opportunities, creating some risk of irrational frenzy. Properties must now be re-valued in accordance with their over-supply, reduced rents, cost of replacement, and realistic potential uses in changing markets.

The good news — opportunity abounds for the savvy real estate investor. Carpe diem!

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