Commentary: Why your best investment is a foreclosed home
By Michael Murphy
BOULDER, Colo. (MarketWatch) -- The recession is "officially" over according to GDP figures. Stocks are up 50% from the March 2009 bottom. Gold and silver are up dramatically, too. So what's the only remaining asset class that's still cheap?
Sure, in most parts of the country the market is still in the toilet. July marked the 17th straight month foreclosures exceeded 300,000, and the number of homeowners who lost their homes rose again on the month. But real estate is always a local market and different cities, neighborhoods and individual houses will bottom at different times. And now is that time for many areas.
Most of you will think I am way early on this recommendation, but here are three great advantages to buying today:
Desperate sellers. Not the homeowners, of course. They already know they'ree toast. It's the banks that financed the mortgages that are desperate. Everyone in the workout department has stacks of folders on their desks, their credenza, the floor -- everywhere -- all needing attention yesterday. That gives the few buyers out there big leverage.
Little competition. Most people don't have the patience and energy to push through a pre-foreclosure, short sale offer or a post-foreclosure real estate owned (REO) offer. Most real estate agents don't want to work that hard to get a deal done. But as with many things, those investors willing to be patient and do the work will reap big rewards down the road.
Low financing rates. If you believe major inflation is coming -- and I most certainly do -- getting 4-to-1 to 32-to-1 leverage at a low fixed rate of interest is like having someone give you money. As of this writing, rates for 30-year fixed mortgages are an incredible 4.5%. That's the lowest in 39 years, and a new bottom seems to be set each week.These trends point to a bottom. And if they're not enticing enough, remember that you can make $500,000 tax-free in as little as two years by buying and living in a short sale or REO home -- while either renting out your current home or simply changing your primary residence on the tax rolls. Then you sell the foreclosure and move back into your current place with a hefty payday.
With the summer winding down and Labor Day around the corner, now is the time to seriously consider making a low-ball bid on a distressed situation. Real estate is seasonal, and after September the buyers will be even scarcer as cold weather and the start of the school year slows down house hunters.
There are risks, of course, and not all houses make good investments. So how do you make the best buy?
A short sale is usually the most attractive way to buy distressed property, but also requires the most patience dealing with the hapless pre-foreclosure department at the lender. Before the actual foreclosure, you make an offer to buy the property for less than the mortgage loan. Most homeowners are eager for this because it is less of a hit to their credit report, and typically when things get so near to foreclosure there is no way for them to stay put anymore anyway.
If they need some enticing, you can offer to pay their moving expenses or even buy some of their personal property such as appliances or the lawn mower on the condition they don't trash the place before you move in. Start by researching the original sale price to the owners. Troubled loan departments at Bank of America Corp. (NYSE:BAC) , which took over Countrywide, or J.P. Morgan Chase Co. (NYSE:JPM) , which sucked up Washington Mutual, will usually take an offer equal to 80% of the loan without any argument.
Obviously, if you are looking at a property where the borrowers paid top dollar at the peak of the market and got a 100% loan, you might have to offer as low as 20% to 30% of the original mortgage to get a good deal. You should always start with a lowball offer and make them come back to you with a counteroffer, but the bigger loss the bank is faced with, the less eager they will be to avoid a foreclosure auction.
Second, get permission from the current borrowers to contact the bank's short sale department directly. The major banks' short sale people obviously were hired off the street for $10 an hour just to deal with the flood of paper, and most of them sound like they are 22 years old and still live with their parents. They have little or no knowledge about real estate, so be patient and realize that this inexperience will ultimately allow you to get a great deal.
Third, make sure you know the exact foreclosure date. The short sale people do not talk to the foreclosure people, who are something like an army of locusts mindlessly marching through a wheat field. Most likely, about three days before the foreclosure sale, the short sale people will panic and accept your low bid. If not, the foreclosed property will be handed over to the Real Estate Owned department and listed with a realtor, where you can make your offer again.
Of course, there are many other considerations that are typical to buying any home -- getting an inspection from a contractor, checking legal and insurance information, and not falling in love with a property just because of the price tag.
Investing in a short sale or REO home right now is certainly not easy, but the incentive of $500,000 tax free makes the move worth it for many. That figure comes from the husband and wife exclusion for the tax on the capital gain of a primary residence in which they have lived at least two of the prior five years
To make the full $500,000, you'll have to buy something nicer than a $150,000 house on a suburban lot, and get a heck of a deal. But it's not impossible. I have noticed that some good-sized houses on golf courses have gone into foreclosure, with the last transaction price maybe $800,000 and a $640,000 mortgage. If you buy that for 35% off, you pay $416,000. When inflation takes off, you sell it for $975,000, take your half a million tax-free and go home after two years.
Not a bad deal.
Michael Murphy is the editor of the New World Investor stock newsletter. 7:55 AM EDT August 20, 2010