As commercial real estate (CRE) borrowers continue to navigate a challenging environment marked by rising interest rates, maturing debt, and declining asset valuations, one strategy is quietly regaining relevance: the short sale.
Though long associated with residential distress, short sales are becoming a practical, lender-approved alternative to foreclosure in the commercial sector. Borrowers facing default and lenders seeking efficient exits are increasingly turning to negotiated sales below the outstanding loan balance as a way to manage risk, preserve value, and avoid prolonged legal proceedings.
What Is a Commercial Short Sale?
A commercial short sale occurs when a property is sold for less than the total debt owed—typically including the primary mortgage—and the lender agrees to release its lien in exchange for partial repayment. Unlike a foreclosure, which is time-consuming and adversarial, a short sale allows for a more collaborative resolution. Lenders often view it as a more efficient way to recover losses, while borrowers avoid the reputational damage and credit impact of foreclosure.
Why They’re Gaining Traction
There are several reasons short sales are becoming more common in commercial deals:
- Tightening credit markets have made refinancing difficult for borrowers with maturing debt.
- Interest rate hikes have increased debt service obligations, leading to defaults, especially in variable-rate loans.
- Asset devaluation across certain CRE segments—particularly office and retail—has left many properties underwater.
- Judicial and statutory foreclosure processes are time-consuming and can be more expensive for lenders than taking a haircut on a short sale.
In many cases, the short sale presents a win-win: the borrower can walk away from a non-performing asset, and the lender avoids litigation, maintenance costs, and asset deterioration.
How These Transactions Work
While each deal is unique, the general process involves the following steps:
- Borrower Request & Lender Engagement: The borrower, often through counsel, submits a hardship explanation and supporting financials.
- Valuation: The lender commissions its own appraisal or broker opinion of value (BOV).
- Negotiation: Attorneys and consultants negotiate on issues such as price, release of liability, and timing.
- Offer & Approval: A third-party buyer submits an offer, and the lender must approve the terms.
- Closing: If approved, the lender releases its lien, and the transaction closes—often with the borrower receiving no proceeds.
Borrowers frequently request a full or partial release from deficiency liability—the difference between the sale price and outstanding debt. While some lenders agree, others may require cash contributions or promissory notes from borrowers or guarantors.
Legal Considerations
From a legal standpoint, these deals are anything but routine. Attorneys play a vital role in:
- Negotiating deficiency waivers and ensuring the borrower is not liable post-closing.
- Coordinating title clearance.
- Advising clients on bankruptcy alternatives, foreclosure timelines, and leverage strategies.
- Preparing and reviewing contracts, closing documents, and release terms.
Short sales often intersect with other legal concerns—such as tenant disputes, structural defects, or pending litigation—that must be addressed before closing.
What’s Next?
Given the macroeconomic headwinds and the volume of CRE debt set to mature in the next 18–24 months, commercial short sales are likely to become an even more important workout tool.
For lenders, borrowers, and buyers alike, understanding the mechanics and legal landscape of these transactions is critical. Short sales may not make headlines like bankruptcies or foreclosures, but in today’s market, they may offer the most practical path forward.
Our firm regularly advises commercial borrowers, lenders, and investors on distressed real estate transactions. To learn more about short sales or discuss a specific situation, please contact Andrew Gregg at (703) 284-7254 or agregg@beankinney.com.
This article is for informational purposes only and does not contain or convey legal advice. Consult a lawyer. Any views or opinions expressed herein are those of the authors and are not necessarily the views of any client.