NOTE: I am not an attorney and this article merely relates different strategies I have seen friends and customers try when faced with land that is worth less than the amount borrowed against it. Please visit our Professional Resources page to find an attorney that knows far more about these issues than I do. The goal of this article is to give landowners some frame of reference to engage in dialogue with their lender before the situation becomes desperate.
I hear the same story all too often about land developers and builders who hold on until the very end trying to make payments on raw land or developed subdivisions until all their money is gone. Land speculation and development is very different from other forms of real estate investment because there is no possibility of income until the very end of the investment cycle when the property is sold. Unlike houses, apartments, office buildings, warehouses, or retail stores, it is next to impossible to derive lease income from land and lots. When the market for land evaporates as it has done in the last 12-18 months in Metro Atlanta, the land owners have no way to generate cash from their holdings. Many have tried to find work, but there aren’t many vacancies in the two industries hit hardest by the Great Recession in Atlanta: Construction and Real Estate. To complicate matters, the loan payments must still be paid on a regular schedule.
So what is a land owner to do in this current environment? One option is to continue making loan payments until all resources are depleted and then turn over the property by a process known as deed-in-lieu foreclosure and file bankruptcy. Another option is to stop making loan payments, lose the property by foreclosure and then defend a lawsuit filed by the bank for their loss on the deal. Neither of these options seems very attractive to the land owner. Relocating to Belize might be somewhat more attractive.
A third option is a short sale – yes these work for land too. A short sale is when the bank agrees to release the lien on the real estate for a payment that is “short” of the amount due on the loan. There are two types of short sales – recourse and non-recourse. In a recourse short sale the bank does not forgive the remaining debt and may pursue the borrower to collect that debt just as if the bank foreclosed on the property. There are two benefits to a recourse short sale: 1) the borrower won’t have a foreclosure on his record and 2) the borrower has some control over the selling price of the land. In a foreclosure situation, the bank takes the property back in at their most current appraised amount and that’s the number they use as a basis for the deficiency lawsuit.
The non-recourse short sale is the best option for the land owner – in this arrangement, the lender and land owner work together to market and sell the property at a price they can both live with. The borrower then agrees to pay some portion (or in some cases none) of the deficiency between the selling price and the loan balance. The bank in turn agrees to forgive the unpaid balance and will not pursue the borrower for this amount in the future. There are two disadvantages to the borrower however: 1) The bank will send the borrower a 1099 for the forgiven debt and the borrower may have to pay income tax and 2) the borrower may have a notation on his credit report that says that the loan was satisfied for less than the amount owed.