In the cases of both Kearny and Forest Properties, the buyers were able to acquire the assets because the lender agreed to a short sale. That mutual agreement is no small point because, as managing director Daniel Lisser of the New York City office of Johnson Capital points out, "Once the borrower has agreed to give up the property, it is the lender who is controlling the transaction" and determines whether to work out the distressed property via short sale, foreclosure or other means. Yet Lisser says that on the workouts with which he has been involved, the short sale has never been an option that was considered by either party. He adds: "I would expect that they would become more common because a short sale is almost a free option for the lender, since they can put in a reserve price to test the market."

He explains that a lender who goes the short-sale route and doesn't like the bids still has the option of foreclosure. He also sees short sales as "probably more likely to occur in markets where lenders can estimate the sales price on a fairly reliable basis." Secondary and tertiary markets, where there are few sales to establish values, are problematic, he says.

In addition, Lisser points out that lenders are more inclined toward short sales of properties that are well tenanted. "If the building is empty or under-occupied, it makes sense for the lender to take title, lease it up and then sell it versus trying to sell an empty building ," he says.

Another potential benefit for a short sale transaction, at least for the lender, is that the property may be sold for a higher price if it is not viewed as a distressed asset, says Steve Lurie, a partner with Los Angeles-based law firm Greenberg Glusker. Additionally, he points out that a short sale avoids the time and expense involved in a foreclosure. A non-judicial foreclosure takes at least four months to complete, he says. "A benefit to the borrower of a short-sale transaction is that the borrower will not have a foreclosure

or deed-in-lieu transaction as part of its credit history, which should make

it easier to borrow in the future." Short sales raise income tax issues regarding cancellation of indebtedness, but so do foreclosures because both are taxed under the same rules.

Whether a lender is more inclined to pursue a short sale or a foreclosure depends on a list of pros and cons that can vary according to the specific property. An important issue from the lender's point of view is that completing a foreclosure sale extinguishes any liens on the property, whereas a short sale or a deed-in-lieu will not, Lisser points out.

Beebe notes that the negotiations for the Olivine condominiums involved three different lenders, the former owners and the buyer. With many borrowers facing the real threat of foreclosure, many more like the borrowers and lenders in the Kearny and Forest Properties deals are looking for ways to avoid it. And although there are still negative ramifications associated with the short-sale option, for distressed borrowers, they are less damaging than the foreclosure or bankruptcy alternative.

"Short sales are typically preferred when all parties are cooperating with each other ," says Beebe. "If a lender has a cooperating borrower, then a short sale can be a faster and less expensive than filing foreclosure and going through the court system." Beebe points out that foreclosures can take a year or more, but a short sale could take just a few months or less if all parties agree to the sale. He adds that legal fees and court costs can really add up in foreclosure.

The difference in many cases, according to Beebe, is whether the loan is recourse or non-recourse. If the loan is recourse, the borrower and the lender have to agree on how to handle the difference between the purchase price and the loan amount, known as the deficiency, he says. The deficiency on a recourse loan is be negotiated between both parties.

"They have to come to agreement on what percentage of the deficiency each will be responsible for ," Beebe explains. "If they can agree on who is covering the deficiency, the short sale can be pretty quick. If the loan is non- recourse then the borrower can just walk away." He adds that foreclosure is typically necessary when the borrower and lender disagree on the best course of action.

This level of agreement, according to Lisser, means that, "From an image point of view, a short sale appears to be a more controlled and friendlier transaction to the public." On the other hand, a foreclosure, even a friendly one, "just sends a bad message out to the market ," he says. Short sales appear less negative because the borrower is more visible and seems more in control. However, from the lender's point of view, "A big concern on the short sale is that the property is selling at market price and the borrower is not working with a buyer to sell it below market ," Lisser says. The lender usually insists on hiring the sales broker, who then has a fiduciary responsibility to the lender.

For the distressed borrower, the biggest benefit of a short sale is the borrower's release of the debt obligation, according to Marty Higgins, a senior investment advisor at Hendricks & Partners' San Francisco office. "They also avoid a foreclosure on their credit report and retain some aspect of control in a short sale ," Higgins says.

The short sales that Higgins has done have actually been driven by the lender. He points out that for a number of reasons, a lender may not want to foreclose primarily to avoid exposure in owning an asset post-foreclosure. Lenders are also cooperating more on the short-sale process. According to Higgins, the reason for an increase in cooperation is that "the inventory is increasing and lenders may be under greater scrutiny from the FDIC to unload toxic assets from the balance sheets faster." He adds that "Banks are also realizing that they can avoid liability with a short sale and, in a lot of cases, may end up receiving the same net figure as if they took the asset and sold it on the open market."

Two recent short sales that Higgins closed took place for different reasons. One was related to a conduit loan that the lender originated. He explains that it made more sense for their investors to short the property and essentially re-write the conditions of their existing note with a new borrower. The other situation involved an asset that was acquired from a failed bank. "The acquiring bank had approval for a short sale from the FDIC, allowing it to exit much quicker than going through the foreclosure process."

Such quick exits are a chief concern of lenders, according to Lisser. "The key issues are speed and getting control of the property as fast as possible," he says. "Lenders fear that the longer a borrower with no equity is in control of a property, the worse condition it will be in once they obtain control, as the borrower has no incentive to spend money on maintenance and tenant retention." In addition, a property with a weak owner/ borrower will be unattractive to potential tenants and leasing brokers because tenants are leery of leasing space at a property that could be taken over by the lender, Lisser adds.

Except for the fact that short sales occur as a result of distress, typical transaction details closely resemble those of quality, market-rate deals.

In a transaction in Burbank, CA, for example, the locally based Cusumano Real Estate Group acquired the 145-unit Jefferson at Toluca Lake apartment complex on an all-cash

basis from developer JPI of Irving, TX in a lender-facilitated short sale. The price was undisclosed, but the property was being marketed at an asking rate of $31 million by listing agents Dean Zander and Vince Norris of Hendricks & Partners, an ask price that represents a considerable discount from the $43 million that the complex fetched in 2007 before a renovation program by JPI.

Although the complex was technically in distress, it is a quality asset that generated more than 25 qualified offers from both private and institutional investors, according to Zander and Norris. They point out that the bidders were attracted to the location and excellent condition of the property, as well as growth assumptions for the submarket. In addition, the complex was 99% occupied at the time of the sale.

The number and dollar volume of commercial real estate short sales shouldn't be difficult to calculate, according to Lurie, but in fact they are because the existence of a short sale is not apparent from the public records, and because the industry does not appear to be reporting the figures. However, New York City-based Real Capital Analytics does track the total dollar volume of all types of resolutions of troubled assets, which would include short sales. According to the latest RCA figures, resolutions of troubled assets skyrocketed to $14.6 billion in volume for the first half of this year, up from $3.8 billion in the first half of 2009. RCA points out, although "the volume of sales resolving distress is still only a fraction of investor demand ," the current trend suggests that sales will continue to increase.

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