Updated August 16, 2026
Yes, but the sale cannot close unless the lender is paid in full or agrees to accept less, so the lender becomes a party to the decision whether you involve them early or late. Three paths exist: bring cash to closing to cover the shortfall, negotiate a short sale in which the lender accepts less than the payoff and releases the lien, or restructure with the lender and not sell at all. In Los Angeles this situation has become less unusual — buildings acquired at peak pricing in 2021 and 2022, financed at low rates, now face higher capitalization rates, sharply higher insurance costs, and a rewritten rent ordinance that constrains income growth. Being underwater is a solvable problem. Being underwater and silent with your lender is a much worse one.
Cash to close. If the shortfall is modest and you have the liquidity, this is the cleanest option. The sale proceeds as a normal transaction, you write a check at closing, and the loan is retired.
Short sale. The lender agrees to release its lien for less than the full payoff. Requires the lender's cooperation, a documented hardship, and substantially more time. The deficiency — the unpaid balance — may or may not be forgiven, and that has both credit and tax consequences.
Restructure and hold. Loan modification, extension, forbearance, or a recapitalization with new equity. Often the better answer if the shortfall is driven by a temporary rate or occupancy condition rather than a permanent change in the building's income.
A cooperative lender. Different lenders behave very differently. Agency servicers, banks, and CMBS special servicers each have their own process, and a CMBS loan in special servicing is a materially slower and more procedural experience than a relationship bank loan.
Documented hardship and a complete package. Operating statements, rent roll, market evidence, and a credible explanation of why the value is below the balance.
A real buyer at a real price. Lenders approve or reject a specific offer. The offer has to be supported by market evidence, which means a properly marketed sale produces a stronger case than a quiet one — the lender wants to see that the price is the market's answer, not a favor.
Time. Approval takes considerably longer than a normal escrow, and buyers must be prepared for that. Buyers who are not warned tend to leave.
Clarity on the deficiency. Whether the lender pursues the shortfall, and whether any forgiven amount is treated as taxable income, are questions for a real estate attorney and a CPA. Do not accept a short sale approval without understanding what happens to the unpaid balance.
Waiting until default. Approaching the lender before missing payments preserves options. Approaching them after a default has been reported narrows them, and a receivership or foreclosure filing changes the dynamic entirely.
Marketing at the loan balance rather than at market value. Buyers do not care what you owe. A building priced at the payoff rather than the value sits, accumulates market time, and ends up selling for less than it would have with correct pricing at the start.
Not getting an honest valuation. Some owners who believe they are underwater are not — insurance and expense assumptions have moved so much that owners frequently misjudge their own NOI in both directions. The first step is finding out where the value actually is.
Deferring maintenance to conserve cash. Understandable and expensive. It reduces value faster than it saves money, and in Los Angeles it can escalate into code enforcement and the rent escrow program, which suppresses income further.
Get a defensible current value before deciding anything. Not a hoped-for number and not the loan balance — a real value grounded in what comparable buildings have actually closed at recently. That number determines which of the three paths is available, and it is the number the lender will want to see as well.
If the gap is small, cash to close or a modest restructure usually resolves it. If the gap is large, the conversation with the lender needs to start immediately, and it goes considerably better when the owner arrives with a marketing plan and evidence rather than a request.
Being underwater does not prevent a sale — it changes who has to agree to it. Get an honest valuation first, talk to your lender before you are in default rather than after, and price the building to the market rather than to the payoff. And bring in a real estate attorney and a CPA before accepting any short sale approval, because how the deficiency is treated is frequently the largest financial question in the entire transaction.
Will the lender come after me for the shortfall?
It depends on the loan documents, whether the loan is recourse or non-recourse, and what the short sale approval says. Some approvals release the deficiency and some expressly reserve it. This has to be read carefully by an attorney before you sign — it is the difference between the sale ending the problem and the sale continuing it.
Is forgiven debt taxable?
Cancellation of debt can be taxable income, with exceptions that depend on your circumstances and the nature of the debt. It is a question for your CPA and it should be answered before the short sale closes, not at filing time.
Should I just let it go to foreclosure?
Almost never the better outcome if a sale is achievable. A marketed sale generally realizes more value than a foreclosure, gives you some control over timing and terms, and often produces a better result in negotiating what happens to the deficiency.
Michael Sterman is Senior Managing Director Investments at Marcus & Millichap.
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