The traditional idea of a short sale is selling something you don't have so that you can buy it back at a lower price. The easiest example is stock. The short sale of a stock involves borrowing stocks from a broker in order to sell them, and when prices fall, buying back the stocks to return to the broker, keeping any profit made.

Key Takeaways

  • A "short sale," in real estate, is a way to sell a financially distressed property before it enters the foreclosure process.
  • Investors looking to "short" the real estate market can sell a real estate ETF short in the stock market.
  • Likewise, traders can sell REITs short to profit from a decline in their value.

Sell Short ETFs or REITs

One option that is similar to shorting a stock is to invest in ETFs that are short on real estate. These ETFs are typically designed to give inverse returns to a pool of real estate investments, usually real estate investment trusts, or REITs.

By using ETFs short on real estate an investor can get similar results to going short on an individual security. You can even sell short one or more individual REIT, each of which will contain a portfolio of investment real estate, often linked thematically (e.g., an REIT that holds hotels and resort properties, or one that holds shopping malls). These can be sold short in a brokerage account as long as you have margin enabled and are approved for short selling.

If the price of real estate falls, and the corresponding REIT or ETF shares also fall in turn, you can buy back your shorts for a lower price and profit.

Real Estate Short Sales

The transaction usually referred to as the "short sale of a house" is the selling of a house in pre-foreclosure state at a price that is less than the amount owed on the house. Houses that are short sold are typically either in pre-foreclosure (or about to be foreclosed upon). A homeowner normally short-sells a house after notice of foreclosure has been delivered. Before a house can be short-sold, the bank needs to be notified and give its approval for the sale.

Short sales and foreclosures are two financial options available to homeowners who are behind on their mortgage payments, or have a home that is underwater, or both. The owner, in both cases, is forced to part with the home, but the timeline and consequences are different in each situation.

A foreclosure is the act of the lender seizing the home after the borrower fails to make payments. It is the last option for the lender since the home is used as collateral on the note.

Unlike a short sale, foreclosures are initiated by lenders only. The lender moves against the delinquent borrowers to force the sale of a home, hoping to make good on its initial investment of the mortgage. Also, unlike most short sales, many foreclosures take place when the homeowner has abandoned the home. If the occupants have not yet left the home, they are evicted by the lender in the foreclosure process.

Once the lender has access to the home, it orders an appraisal and proceeds with trying to sell the home. Foreclosures do not normally take as long to complete as a short sale because the lender is concerned with liquidating the asset quickly. Foreclosed homes may also be auctioned off at a trustee sale, where buyers bid on homes in a public process.