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JUST FUNDED — Neighborhood Shopping Center Loan in Visalia, CA!

$5,730,000 Loan

3.85% Fixed for 10 years

Interest-only for 10 years

30-year amortization


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Overleveraged — Corporations vs Commercial Real Estate

Many corporations continue to binge on cheap debt to inflate their stock prices — enriching their current executives and shareholders at the expense of future growth and earnings.  However, when interest rates inevitably rise and/or earnings fall, stock prices will plummet and workers (i.e. consumers) will be fired so those companies can continue paying the interest to avoid default on their debt. This explains why the Fed keeps dropping the rates despite full employment and a seemingly robust economy.  This time around commercial real estate has not become overleveraged. Nor has excessive inventory development occurred in most product types in the majority of U.S. metro areas. Any increases in property valuations are now primarily reflective of increasing property income through rising, but not excessive, rent increases. Property value increases resulting from CAP rate compression have ceased in most areas of the country. Since 2005, commercial loan-to-value ratios have dropped from about 71% to about 62% on average, while average debt-service coverage ratios have increased from approximately 1.53% to 1.73% — meaning lenders are requiring borrowers to have more cash flow relative to the underlying debt payments.

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Recession indicators which overwhelmingly signal a major economic slowdown brought on by slower growth abroad and Trump’s escalating trade war with China include:

  • The U.S. bond market and the inverted yield curve — the yield on the benchmark 10-year Treasury note has fallen below the 2-year yield multiple times in the last month, and this inversion has preceded the last 7 recessions.
  • Gross domestic product in the U.S. is slowing. The economy expanded by 2% in the second quarter, which is the lowest growth rate since the fourth quarter of 2018 and down from 3% growth in the first three months of this year.
  • Corporate Earnings growth estimates have come down drastically this year from previous estimates for the S&P of 7.6% to current estimates of 2.3%.
  • U.S. manufacturer growth slowed to the lowest level in almost 10 years in August, such that the reading is below the neutral 50.0 threshold for the first time since September 2009. Any reading below 50 signals a contraction.  The Trump/China trade war, coinciding with global growth worries, continues “to weigh on business confidence and firms’ capital expenditure plans,” according to minutes from the Fed’s July meeting.
  • The economic outlook from Freight’s perspective looks grim, as the Cass Shipments Index fell 5.9% in July, following a 5.3% decline in June and a 6% drop in May, “signaling an economic contraction,” the July report said, and “we see a growing risk that GDP will go negative by year’s end.”
  • Copper, known as a barometer of economic health because of its use in homebuilding and commercial construction, is down over 13% in the last half year.
  • Gold prices have soared more than 20% since May when and Trump and China escalated their tariff fight. Similar to government bonds, gold is known as a safe haven trade in times of economic uncertainty.
  • The Global Economic Policy Uncertainty Index, an index designed to measure policy-related worries around the world, hit its all-time highest level, 342, in June.
  • Business spending tumbled 5.5% in the second quarter, the worst since the fourth quarter of 2015, according to the Commerce Department’s quarterly GDP report.  Coming off of a sugar high from Trump’s 2017 tax windfall, businesses are hesitant to invest in future initiatives due to uncertainty.
  • Confidence in US policymakers has reached historic lows, while wealth becomes increasing concentrated and wages stagnate.
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Amazon Kills and Then Revives Malls as Fulfillment Centers

Online retailer Amazon has spent the past two decades luring shoppers out of stores and onto the internet, leading a retail transformation resulting in a wake of dead malls. Now the Seattle-based company is buying more of those empty shopping centers, converting them into warehouses for processing deliveries to consumer doorsteps.  The company plans to open two more Ohio warehouses, including one at the site of a closed mall in Akron, the third shopping center in northeastern Ohio the company has bought and converted into a fulfillment center. Around the country, at least 24 projects exist where developers have turned closed malls and shopping centers into logistics properties since 2016, with almost 8 million square feet of retail either converted to or replaced with 11 million square feet of new industrial space.  Among the advantages of converting malls to logistics facilities are their locations near population centers, making it easier to provide next-day or same-day delivery to customers, with easy access to highways and mass transit and water, sewer and parking systems already in place.

With online shopping increasing at roughly four times the rate of total retail sales and cutting deeper into spending at physical stores, owners are stepping up the sale or conversion of dead malls and distressed shopping centers, particularly in suburbs and rural areas most vulnerable to the effects of e-commerce and store closings, CoStar Portfolio Strategy Managing Consultant Drew Myers said in the midyear State of the U.S. Retail Market report.  The converted malls and big-box retail stores favored by Amazon and other logistics developers are mostly in areas with lower median household incomes than the national average where industrial space is also in short supply, which makes the properties more valuable as industrial space than retail.

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Housing Bubble Burst Ahead?

Data from the National Association of Realtors suggests a housing bubble may be on the verge or bursting in some markets, like coastal California. Overall, U.S. home prices in the second quarter were up 4.3% vs. a year earlier to $279,600, with 16 markets posting declines. That’s a slight appreciation dip from averaging 5.5% annual gains in 2016-2018, a period when just eight U.S. markets were losers.  Silicon Valley prices in California took the nation’s second-biggest loss in the quarter: a 5.3% year-over-year decline, which is a huge contrast from 2016-2018, when the San Jose-Santa Clara market’s prices averaged 15.7% annual gains — the No. 1 gain nationally. San Francisco suffered the seventh-biggest U.S. decline of 1.9% in the year, which is again quite the decline from 9.6% annual increases. Three other coastal California markets had eroding gains: (1) Orange County with 0.6% gain, down from 5.8%, (2) San Diego with a 1.6% increase, down from 6.7%, and (3) Los Angeles with a 1.8% increase, down from 8%. California’s more affordable inland markets fared better at 5.6%, but still dipped from a previous 8% yearly rate.  These declines may be attributed to the steep run-up of prices in recent years and a recent cooling of the state’s business growth pace. However, California has company, as second-quarter depreciation also occurred in markets in Illinois, New York, Wisconsin, Florida, Oklahoma, Hawaii, Colorado, Kansas and Connecticut.

People talk about the need for more “affordable” housing in California, but the creation of relative bargains with price cuts on existing homes often scares off the same house hunters who claim they want to pay less — fearing overpaying as a price slide begins, and choosing to wait to buy in hopes of steeper discounts. This wait-and-see mentality can amplify an already souring situation. 

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Regal Properties Represents 5 TIC Exchange Buyers of Strong Credit Retail Center in SoCal for 8.37% Cap

Regal Properties represented 5 TICs in multiple 1031 exchanges in the recent purchase of a 54,750 square foot shopping center, predominantly leased by national credit tenants, located within the desired Southern California retail market of Hemet.  The below replacement cost price of $8,600,000 equates to an 8.37% cap rate with a 13% leveraged cash on cash return for a high-performing retail center shadow anchored by Stater Bros Supermarket (NAP), a regionally dominant grocer, and junior anchored by CVS and Dollar Tree. 

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Your aim is to do something GREAT and wonderful with your life, and to accomplish extraordinary things.  However, you cannot simply go out and have a great life; you must go out and make a great life!

 The word “GREAT” has 5 letters, which stand for the 5 keys to success in your life, and in anything you decide to be, have, do and accomplish:

 1.    GOALS:  You must know exactly what you desire to be, have, do and accomplish.  Many people wander through their entire life never taking this critical first step.  Determine what you want and write it down.  Highly successful people write down goals as if they already have accomplished them (for example, “I am a straight ‘A’ student.”), and they review and re-write them often.  [Derek Jeter decided he would be the shortstop for the New York Yankees when he was a young boy. It didn’t just happen because he was lucky!]

 2.    RESULTS:  You must deliberately focus and direct your thoughts, words, feelings, gratitude and emotions toward the desired results. Meditate daily and visualize the end results, seeing yourself in the picture, using all 5 senses, for 5 minutes before going to sleep and/or after waking up.  [Example: Fist pumping the air and high-fiving teammates after making a perfect tackle, receiving an “A” on a math test, or getting that job promotion and pay raise — feeling, seeing, hearing, smelling and tasting the experience.]  Think, speak and act as if you already are a star player, an “A” student, or a business executive earning your desired income!

3.    EXCELLENCE:  Strive for excellence!  The key to success in any field is to get good, get better, and be the best!  When you resolve to be the very best at what you do, and to do more than the minimum required or expected, you will find very little competition.  Your weakest skill usually sets the height at which you can use all your other skills.  Ask someone you trust (teacher, coach, parent, brother) if they see any weaknesses in your performance (“feedback is the breakfast of champions”).  Continually invest in yourself.  Use your time wisely to improve your knowledge and skill and become excellent at what you do.  Your daily choices of what to do, and what not to do, will determine everything that happens to you.  [Example: You can choose to study and practice, or to watch TV and play video games – but either choice will lead to very different results.] Your actions must be consistent with your goals. Use your time in a manner that most helps you produce the desired results for yourself and your team.

4.    Act Now! You must take action in the direction of your goal.  Do something daily — homework, study, practice, work, research, exercise, etc., that moves you closer toward your goal. Procrastination is the big killer of human potential (putting off big, important tasks until later, or never getting to them at all).  Procrastination is a habit based on inertia or fear. You can and must get over it!  Make a habit of deciding what you want to do and then moving quickly, before you have time to think too much or become afraid.  “Act boldly, and unseen forces will come to your aid.”  Action gives you momentum that keeps you going after the average person has quit.

 5.    Try, Try, Try!  You must persist.  Never, ever give up!  As you follow these 5 steps to make a GREAT life and accomplish your goals, unseen forces in the universe are working tirelessly on your behalf, moving mountains, to help your dreams come true, and making progress in ways often invisible to you.  Your persistence is a direct measure of your belief in yourself.  Great success comes with great risk, and often follows great failure.  But no one ever succeeded by quitting.  Continue relentlessly focusing on what you want and taking action to achieve it, without regard to critics, doubters, obstacles and setbacks.  Repeat to yourself, “If it’s meant to be, it’s up to me!”

Copyright Murnane 2014

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Recession Amendments to California’s Anti-Deficiency Laws

During the recent recession, California’s legislature has amended the real estate anti-deficiency laws in the Code of Civil Procedure in three important ways:

No Deficiency Judgment for Approved Short Sales: SB 931 added subsection “e” to CCP Section 580, which prohibited any first lender who approved a short sale from obtaining a deficiency judgment against the seller.  Subsequently, the enactment of SB 458 provided that any home mortgage lenders who approved short sale transactions, which closed escrow, thereby released the borrower from any deficiency, for senior and junior trust deeds, purchase money and recourse loans, owner occupied homes, second homes, vacant homes, and investor properties with one to four residential units; and, further, lenders could no longer require sellers to contribute money as a condition for short sale approval.

Purchase Money Loan Protection Extended to Refinance Loans: Prior to January 2013, California law protected borrowers from personal liability at foreclosure for the difference between the principal balance and what a lender receives if the loan was a purchase money loan secured by an owner occupied property with one to four residential units. SB 1069 extended this anti-deficiency protection to include any loan used to refinance the purchase money loan, plus any loan fees, costs and related expenses for the refinance. This anti-deficiency protection does not extend to any cash-out refinance when the lender advances new principal.

No Collection Actions Against the Borrower: Even though lenders could not obtain a deficiency judgment for a purchase money loan under CCP 580b, some lenders made it a practice to report these debts as delinquent on the debtor’s credit reports, and to seek payment on the deficiency from the borrower, or they would sell the debt to a third party who then pursued collection. SB 426 amended CCP 580b and 580d to add that no deficiency “shall be owed or collected” under the circumstances covered by the above statutes. The legislature subsequently clarified the statute does not affect the liability a guarantor might otherwise have with respect to the deficiency, or that might otherwise be satisfied from other collateral pledged to secure the obligation.

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Commercial Real Estate Loan Workout Strategies

Increasing vacancies, decreasing rents, negative cash flows, rising cap rates, imprecise valuations, severely constrained financing, and personal guaranties will continue to put severe pressure on over-leveraged commercial real estate owners during the next few years. As the wave of commercial property loan defaults begins to crest, borrowers should be armed and prepared with practical strategies and solutions for dealing with their under-performing properties and maturing loans.

Foresight Analytics recently estimated about two-thirds of the $800 billion in commercial real estate (“CRE”) loans held by banks, maturing in the next 5 years, exceed the value of the property. U.S. bank regulators increasingly complain losses on souring CRE loans pose the biggest risk to lenders. “The most prominent area of risk for rising credit losses at FDIC-insured institutions during the next several quarters is in CRE lending,” FDIC Chairman Sheila Bair recently said. “Prudent loan workouts are often in the best interest of financial institutions and borrowers.”

Consequently, regulators have recently issued new guidelines to help the institutions modify loan agreements. On September 16, 2009, the IRS issued eagerly anticipated guidance of significant help to borrowers with conduit financing (securitized loans). This guidance will allow some commercial mortgage loans held by Real Estate Mortgage Investment Conduits (“REMICS”) to be modified prior to default, without triggering adverse tax consequences to the holder. According to Foresight Analytics, the flexibility recently extended by regulators will apply to about $110-$130 billion of the $800 billion in underwater loans.

Lenders and loan servicers will almost certainly become increasingly overwhelmed and inundated with troubled loans in 2010. Borrowers with distressed properties must prepare themselves to understand and compare all of their options, and then take a proactive and timely approach to alleviating their financial distress.

Maturing Loans

In a maturing loan situation, when no other financing seems to be available, it may be possible to simply extend the existing loan for a fee (usually ½ to 1 point), in order to buy up to 2 years. Under these circumstances, a borrower would be well advised to approach its lender, approximately 4-6 months before the loan matures, with evidence of the borrower’s unsuccessful refinance efforts and a specific proposal for the extension. As part of the proposed extension, the borrower might also request other modifications such as an interest rate reduction, if appropriate.

Good Money After Bad

In a distressed property situation, a borrower should first carefully consider whether it makes economic sense to even try to save the property. Throwing good money after bad makes no sense. In making this determination, the borrower must formulate realistic projections about the net operating income, cash flow and cap rate over the next 1-3 years, and consider the opportunity cost of nursing an ailing property back to health instead of investing the resources into something more stable and profitable. Tax ramifications should also be carefully considered.

Perhaps some equity and profit can still be preserved by a normal sale. However, if the borrower has no remaining equity, and his or her projections show little prospect for a timely recovery, then a short sale or deed in lieu of foreclosure might make more economic sense. Both of these options require the lender’s cooperation, and both may have significant tax and legal consequences, including with respect to previous tax-deferred exchanges and any forgiveness of recourse debt.

Loan Workouts and Modifications

In other situations, modification of various loan terms and other workout possibilities might provide the means for the investors and lender to salvage more of their investment and minimize their respective losses. The workout might include an interest rate reduction, amortization schedule adjustment and, in rare cases, a forbearance or principal reduction.

Several factors can influence the loan workout process. For example, a commercial bank will generally have more flexibility than a special servicer for a commercial mortgage-backed security (“CMBS”), especially with regard to principal reduction. The lender’s willingness to negotiate a workout may also depend on the story of how the property has changed, and whether the proposed modification will fix the problem causing the distress.

Certain strategies will also enhance the borrower’s ability to achieve a desired loan modification. The borrower should approach the lender early, before feeding the property for several months, and before going into default. Though not a necessity, it sometimes takes a monetary default for a CMBS loan to get transferred from a general servicer to a special servicer with workout authority.

Lenders and loan servicers have their hands full now and, therefore, the borrower should make its case easily comprehensible and thorough by including an historical and pro-forma cash flow model, credible and fresh market research, and a detailed strategy for emerging from the distress situation. The borrower must recognize that the lender/servicer desires a sound borrower and asset manager, who contribute to the modification and who will not default in the future. In general, the borrower will benefit by presenting multiple modification options. CMBS loan servicers may also require an illustration of the net present value of various modification options.


The following example illustrates some typical differences in commercial underwriting criteria and economics for the same property in 2007 and 2009:

2007 Origination Underwriting

2009 Refinance Underwriting




Cap Rate









Loan Amount



Required Equity


$5,053,333 additional


Interest-only 2 years of 30

25 years

10 Yr Treasury



Credit Spread



Swap Spread



Total Interest Rate



Debt Service






In addition to more stringent underwriting criteria shown in the 2009 refinance column, the NOI in this example decreased after the loan origination in 2007, due to increased vacancy rates, rent reductions, and expenses. Assuming the vacancy rate is now 15% instead of 5%, and rents are now 20% less than they were in 2007, then the NOI might approximate $408,000 instead of $600,000, and the property might easily have gone from having a good positive cash flow to a distressing negative cash flow. Using today’s cap rate of 9%, the property value has plummeted from $10,000,000 to $4,533,333, as shown in the 2009 column, such that all equity has been lost, and refinancing has become economically infeasible due to the current equity shortfall of $5,053,333.

In this situation, the borrower might consider multiple concurrent strategies, including a short sale or deed in lieu of foreclosure (with a release of any guarantor), and a loan modification. The loan modification might include re-amortization over a longer period, with a reduction in the interest rate, and an elimination of principal reduction for a period of time sufficient to allow the property owner an opportunity to fill vacancies and improve rental income. In appropriate situations, the loan modification might even include a discount of the principal balance on the note as a means of incentivizing the owner to continue operating the property at least until it returns to stabilization. However, the lender may also require the borrower to demonstrate its continued financial commitment to the property by putting additional cash into an interest reserve or toward a principal pay-down.

Importance of Consultants

The importance of knowledgeable and experienced consultants to guide the borrower and guarantors through the process of a loan workout cannot be overstated. Borrowers will need to perform objective and sophisticated economic analyses and feasibility studies, income and expense projections, and property valuations. Terms and agreements will need to be negotiated with lenders and servicers. Transactions must be carefully documented for legal and tax purposes. Additionally, even a capable borrower would do well to employ a third party consultant to act as his or her negotiator and intermediary, and to provide emotionally and financially detached objectivity and advice.

In a typical workout situation, the borrower will need a team of professionals which include a CRE lawyer, tax advisor, possibly a broker to provide a Broker Price Opinion to the lender and/or to market the property, and an economic/financial consultant to assist with preparing income and expense projections, forecasts, valuations and feasibility analyses. In some less common situations, other consultants may be beneficial, including bankruptcy counsel and litigation counsel.

Planning and Preparation

Strategic planning and preparation will greatly enhance a borrower’s chances of preserving invested capital, minimizing economic losses, and weathering the CRE storm. Borrowers and guarantors should carefully consider all of their options, and the consequences of each, with the assistance of qualified consultants. Then, if the workout strategy includes a potential loan modification, the borrower should present the lender or servicer with substantiated cash flow models, credible market research, and a detailed strategy for emerging from the distress situation.


* Larry Murnane is a broker and lawyer in San Diego, California, emphasizing commercial real estate transactions, including CRE loan modifications and extensions. He is also the founder of Regal Properties, a Commercial Real Estate Investment Company licensed by the California Department of Real Estate, which works with a team of experienced consultants handling a variety of CRE loan workouts.

This article is for general informational purposes only, and should not be considered legal, tax, business or investment advice for any particular person or matter. Each situation is unique in some respect, and the law as well as the real estate and financial markets and institutions are constantly changing, such that this article or the information in it may not apply to a particular situation, or may no longer be current and accurate.

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California Real Estate Foreclosure Procedures, Timelines and Strategies for Lenders and Borrowers

This article will provide a general summary of real property foreclosure procedures, timelines and strategies for borrowers and lenders in California.

As a precursor, it helps to understand that the creditor typically has a promissory note evidencing the loan or mortgage, which is secured by a recorded deed of trust. The deed of trust identifies the trustor, trustee and beneficiary, as well as the property securing the note. The truster is the debtor, and the beneficiary is the lender. The trustee is a neutral third party instructed to cancel the note and reconvey the deed of trust upon payment of the obligation, or to foreclose on the property in the event of a default on payment of the note. Trustees will almost always require the original note to do either.

The beneficiary/lender holding a deed of trust may generally foreclose by two different methods in California: (1) judicial foreclosure, and (2) non-judicial foreclosure (power of sale auction). The latter method constitutes about 99% of all foreclosures in California, for reasons discussed below.

Judicial Foreclosure 

A judicial foreclosure requires court action (lawsuit before a judge), and is generally used only to resolve complex and subjective issues and disputes involving the chain of title, destruction of property (“waste”), and fraud. The other primary advantage to this method of foreclosure is the possibility of obtaining a deficiency judgment (i.e., a judgment against the debtor for the difference between the value of the foreclosed property and the amount of the debt).

The primary disadvantage to a judicial foreclosure, and the reason so few creditors choose this route, is that the court action typically takes 8-14 months, at substantial expense to the creditor. The foreclosing creditor usually must hire an attorney to prosecute the case, while the debtor continues to occupy the property (and sometimes intentionally damage and strip it) without making any mortgage payments. Further, the outcome of the lawsuit can be uncertain. For these reasons, very few creditors pursue this method of foreclosure.

Non-Judicial Foreclosure

 A secured creditor may pursue a non-judicial foreclosure if the deed of trust includes a “power-of-sale” clause authorizing the trustee to sell the property for monetary default, as is common. This primary advantages to this method include expediency, relatively low costs, and a more certain schedule and outcome. A non-judicial foreclosure generally takes about 4-5 months to complete if handled by a qualified trustee. The primary disadvantage is the creditor’s inability to obtain a deficiency judgment against the debtor.

The non-judicial foreclosure process basically involves three stages: (1) recording a Notice of Default, (2) publication, posting and mailing of a Notice of Sale, and (3) the trustee’s sale.

In the first stage, the lender/beneficiary informs the trustee that the borrower/trustor has defaulted. The trustee then prepares and has the lender execute a Substitution of Trustee and a Notice of Default, which the trustee then records with the County Recorder and mails to the borrower and other parties who have recorded a Special Request for Notice. The trustee also orders a trustee sale guarantee from a title company. (For owner-occupied residential property, Senate Bill 1137, effective as of September 6, 2008, requires the lender/beneficiary make certain efforts to contact the borrower at least 30 days prior to recording a Notice of Default.) The borrower has a 3-month opportunity from the recording of the Notice of Default to bring the account current with the lender or to pay off the entire debt. (Senate Bill 7 and Assembly Bill 7, expected to become effective in May 2009, and expire on January 1, 2011, provide that for loans secured by a first deed of trust, recorded between January 1, 2003 and January 1, 2008, on the borrower’s principal residence, the reinstatement period is 3 months plus 90 days, subject to possible exemption for a lender with a “comprehensive loan modification program.”)

In the second stage, the trustee mails a Notice of Sale to the IRS and California Franchise Tax Board, if required, at least 25 days prior to the sale date; and at least 20 days prior to the sale date mails the same notice to the borrower and other parties requesting notice, and posts the Notice of Sale on the property and in a public place, usually the county courthouse. The trustee must also publish the notice for three consecutive weeks in a newspaper within the judicial district, the cost of which can be substantial in some areas. For owner-occupied residential property, Senate Bill 1137 also requires posting of a Notice to Residents and mailing of a Notice to Residents. The Notice of Sale is recorded with the County Recorder’s Office 14 days prior to the sale.

In the third and final stage, the borrower’s reinstatement right expires five business days prior to the sale date, and the property is sold on the sale date, usually on the courthouse steps, to the highest bidder. At the sale, the beneficiary gets a credit for the opening bid, in an amount equal to the monies due the lender plus foreclosure fees and costs. Anyone else bidding at the sale must have cashier’s checks (payable to the bidder in case they are not used). After the sale, the trustee records the trustee’s deed and disburses funds to the lender. The successful bidder cannot obtain title insurance with respect to the purchase, though subsequent purchasers can.

Under Senate Bill 1137, the party taking title at the trustee’s sale must also maintain the property, or risk a fine of $1,000 per day, and any tenants (other than the borrower/owner) must be given 60 days notice prior to being required to quit the property. Tenants can be required to pay rent during their occupancy.

Lender Strategic Recommendations 

Contact a reputable trustee to handle the entire foreclosure proceeding. The California Civil Code generally allows for either the trustee’s fees or attorney’s fees to be passed on to the borrower through a non-judicial foreclosure, but not both. The trustee’s fees are fixed by statute at 1% of the debt balance, so unless the attorney can handle the entire foreclosure proceeding for less, it will be more economical to retain the trustee as soon as possible.

After the sale, make sure any former owner-occupants receive a 3-day notice to quit, and any other tenants receive a 60-day notice to quit (assuming the city in which the property is located has not imposed a moratorium on evicting tenants of foreclosed residential properties). Because it can be tough to identify all of the occupants, and a defective notice has no legal effect, a 60-day notice is always safer. A plan to reasonably maintain the property should also be promptly implemented to avoid potential fines. In this regard, some lenders may find it economically prudent to offer the occupants approximately $1,000 to turn over the property in good and undamaged condition, along with the keys at the time of sale.

Borrower Strategic Recommendations

A borrower in default or on the verge of default should promptly contact the lender to discuss options, including: (1) forbearance or restructuring of the loan, (2) a short sale, and (3) a deed-in-lieu-of-foreclosure. Often lenders would rather modify the loan (e.g., lower the interest rate, re-amortize the loan over 40 years, reduce or defer a portion of the principal balance, etc.) and forgive late fees than take the property back. However, assuming the borrower and the lender cannot agree on a loan modification or forbearance, the borrower should ask the lender if it will agree to a short sale or a deed-in-lieu-of-foreclosure.

In a short sale, the lender agrees to accept less than the amount owed on the loan because the loan amount exceeds the property value. Before signing a purchase and sale agreement contemplating a short sale, the seller should get the lender’s approval, or condition the sale on the lender’s approval within a specific timeframe. If more than one lender is involved, both will have to be consulted, and the holder of the first deed of trust will usually need to agree to give the holder of the second at least a small portion of the sale proceeds in exchange for cooperation.

A deed-in-lieu-of-foreclosure only works if the lender desires to take back the property. If so, the borrower can offer to deed the property back to the lender, and pay for the lender’s title insurance policy (to protect against junior liens), for the purpose of avoiding the expense and embarrassment of foreclosure and, possibly, preserving a better credit rating. The lender will also want to make sure commercial property or vacant land has not been environmentally contaminated, and may even require the borrower’s indemnification against this risk.

If the lender will not cooperate with the above three strategies, and the foreclosure sale appears imminent, the borrower can possibly delay the sale by: (1) asking the lender to postpone the sale to allow more time for reinstatement, (2) filing for bankruptcy protection, (3) seeking a court injunction, and (4) requiring the lender to produce the original promissory note (which sometimes gets lost in the packaging and bulk-selling of loans). However, employing any of these tactics will simply delay the trustee’s sale, not prevent it. Filing a homestead exemption, transferring title, leasing the property, and even death, will not likely avoid or delay the inevitable.

As stated above, the debtor has no personal liability for the deficiency in the event of a trustee’s sale. However, this difference between the balance of the mortgage and the sale price has generally resulted in taxable “phantom income” to the borrower in the form of forgiveness of debt, causing the lender to send the borrower a 1099-C. The recent Mortgage Forgiveness Debt Relief Act of 2007, now excludes from gross income any amounts attributable to discharge of indebtedness incurred to acquire a principal residence, up to $2,000,000, until January 1, 2010. California’s Franchise Tax Board has adopted similar provisions. This benefit only applies to taxpayers who lose their homes in 2007-2009, and does not apply to investment properties or second homes, or to mortgages incurred subsequent to the home purchase.

Summary & Conclusions

Foreclosures have grown at such an alarming rate in recent years that law makers have attempted to stem the tide with recent legislation designed to force lenders to slow down the process and work with borrowers for alternative solutions. Lenders have been encouraged to adopt loan modification programs intended to help borrowers stay in their homes. Such programs typically include some combination of an interest rate reduction, extended amortization period, deferral of a portion of the principal amount until loan maturity, and reduction of principal, in order to target a ratio of the borrower’s housing-related debt to the borrower’s gross income of 38% or less.

In those situations where the borrower simply cannot or will not cure the default or reach a loan modification agreement with the lender, or the lender will not agree to a short sale or a deed-in-lieu-of-foreclosure, then the lender will likely commence a non-judicial foreclosure, which will take at least four months to complete (while the borrower is not making any payments). Upon such foreclosure, the borrower loses his or her entire ownership interest in the property, but will not be liable for the deficiency; and the lender now has a distressed property on the books to maintain and sell. Therefore, the borrower and the lender might both have been better off if they had successfully negotiated an alternative solution with the help of an objective, qualified professional.

This article is for general informational purposes only, and should not be considered legal advice for any particular matter. Each situation is unique in some respect, and the law is constantly and rapidly changing, such that the information in this article might not apply to a particular situation, or may no longer be current and accurate at the time of reading.

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