If you are new to real estate investing and considering buying foreclosure properties, you need to be realistic about what you are facing. Foreclosure investing is not a good investment approach for beginners. I recommend that you have at least a couple of years' experience with more traditional real estate investing first or work with some professionals. The profits from foreclosure investing can be huge and that makes foreclosures attractive. There is an awful lot to know in order to avoid the problems that can occur. If you don't know what you are doing, one disastrous foreclosure investment can wipe out your capital and your enthusiasm for all real estate investing.
Three ways to buy a foreclosure property
There are three basic approaches to buying properties in foreclosure depending on the stage of the foreclosure process: buying pre-foreclosures, buying at the foreclosure auction, and buying from lender after the foreclosure sale.
a) If you buy from the delinquent property owner before it goes to auction, you have bought a pre-foreclosure deal.
b) Buying at the auction is self-explanatory. If nobody bids, the lender ends up with the property.
c) Buying from the lender after the auction is called buying REOs (real estate owned) or Repos, (repossessions). Sometimes you will see them referred to as "corporation owned" or, "lender owned."
REOs are the least risky way to buy foreclosures
You may have more risk than you would in a regular real estate transaction, but REOs are less risky than in buying at the auction. Since REOs are somewhat similar to a regular sale, they can be pretty safe.
The risks of buying pre-foreclosure real estate
The next riskiest foreclosure purchase is the pre-foreclosure.
a) If an owner of a pre-foreclosure disappears, you risk not getting anything from him after the sale. A pre-foreclosure seller might be desperate and lie to you about the condition of the property and the neighborhood.
b) There might be liens on the property that the seller "forgot" to mention. The big utility bills become the buyer's responsibility if the pre-foreclosure investor failed to check them out. Ditto for unpaid property taxes. There may be another person on title who did not sign the deed, and so on.
c) If the contracts and the sale are not done according to the law, the seller has the right to rescind the sale and could, long after the sale, sue to have the sale reversed. There are extreme penalties for violating the law. Remember, "Ignorance of the law is no excuse." You need to know the state law when you do pre-foreclosure investing.
Sometimes the buyers will give money to the owner, get a deed, and record the deed themselves in the land records office of the county. The pre-foreclosure buyer has to be very alert to a lot of possibilities and check them out. You must have superior knowledge of real estate investing before you start doing pre-foreclosure investing.
But, if you sign a proper sales contract with the owner, get appropriate inspections, go through an escrow with a knowledgeable escrow agent, and look at the property yourself, you probably will not be at great risk. If you use these safeguards , you are going to have less risk than in most foreclosure auction buys.
The risk of buying at the foreclosure auction
Buying at the auction is the riskiest foreclosure purchase because of the following reasons.
1) You have no escrow and no title report let alone title insurance.
In most jurisdictions it is an all cash sale. In some states you may have a week to a month to come up with the full purchase price. If you do not raise the money, you lose your deposit.
2) At the auction the people conducting the sale will announce that the successful bidder will receive NO WARRANTY OF ANY KIND. You have no assurance that there are not other liens or loans on the property.
3) You do not have any inspections by contractors, roofers, pest inspectors, building inspections, water well, or septic system experts. You get no disclosure from the seller as to the condition of the building or what is happening in the neighborhood.
Usually you cannot see the inside of the building; perhaps not even the back of the outside. You know nothing about the electrical system, the plumbing, the heating, or air conditioning.
4) If you buy an occupied property, you have to do an eviction, which, in some states, can drag out for a while, preventing you from getting into the property quickly to prepare for resale. Sometimes the occupants, if they are former owners, will vandalize the properties before leaving or steal items, such as cabinets, doors, fixtures, lamps, etc.
5) When you get a very good deal at a foreclosure auction, you may find that the former owner files a lawsuit to attempt to overturn the sale. So be prepared to hire an attorney and fight for your profit.
We wanted to go over the risks of buying foreclosures. Obviously, the rewards are good financial success and return on your investment!
For people willing to do some homework, the foreclosure market offers some of the best opportunities in real estate today.
Recap of the 3 stages and the benefits
- Highest potential savings
- Buyer / Seller negotiations can be difficult\
- High potential savings
- 100% of the sale price required in cash
- Affords significant time to evaluate property
- Lowest potential savings
Tips to get started....
1. Secure financing early unless you are buying with cash
It's important for a buyer to be pre-qualified before engaging in discussions with a seller. This ensures that the buyer is in a financial position to purchase the property, and is in the strongest possible position to negotiate. It's best to work with a lender who understands the foreclosure process, and can guide the buyer through certain steps, such as ensuring that a property is FHA-compliant. Another reason to consider pre-qualification is that not all lenders finance foreclosure properties. Having approved financing in-hand makes negotiations with both the seller and the lender easier, and may even make it possible for the buyer to simply cure the default and take over the existing loan to reduce loan processing fees.
2. Engage a real estate agent as a "buyer's representative"
Most people hire a real estate agent to sell their home. These "seller's representatives" are charged with making the sale and negotiating the best deal for their clients. "Buyer's representatives" have the home buyer's interests at heart, and are charged with finding the right property and negotiating the best price for their clients. Picking the right real estate agent will make a buyer's life much easier
3. Do your homework
Stocks offer higher potential returns for investors than traditional savings programs, but are also riskier. Similarly, purchasing foreclosure properties is somewhat more risky than buying traditional real estate properties, but offer much higher potential savings. With the right examination and due diligence, buyers can significantly reduce the risks. It makes sense to give any property under consideration a thorough examination. Here are eight steps for doing a professional-level exam.
CHART: Examination process steps
• Identify desirable neighborhoods - Identify specific neighborhoods where you'd like to live or own a home. This will limit your search to a manageable size for you and your real estate agent, and give your a sense of relative property values.
• Cast a wide net - There are a number of Web-based services that can put hundreds of thousands of foreclosure properties at your fingertips. Since the best savings are often found in pre-foreclosure properties, it's important to check the percentage of pre-foreclosure (vs. REO) properties in any database before subscribing.
• Determine the property value -Look at the original purchase price, and recent comparable property sales to determine the current value of the property.
• Find out the amount in default and the remaining loan balance - In order to determine a reasonable offer price, you'll need to know-at a minimum-how much money it will take just to satisfy the debt to the lender.
• Run a legal investing report - Before purchasing any foreclosure property, make sure it is free and clear of any bankruptcies, tax liens or other financial liabilities.
• Assess the condition of the property- If at all possible, visit the property, ask your realtor's opinion, and review pest and structural reports to make sure that the property is in acceptable condition, or to determine how much of a rehab budget you'll need to build in to your deal.
• Build a positive relationship with the seller - Before purchasing the property, try to make sure that you're entering into a win-win situation with the seller, so that they'll do what they can to make the process easier and leave the property in good condition
• Leverage your timing - Knowing when a property is going to be auctioned gives you an extra bargaining chip when negotiating with the seller or the lender.
4. Make a realistic offer
Despite what you may see on late-night cable TV, investing in foreclosure properties isn't a sure fire "get rich quick" formula. Lenders aren't likely to give properties away, particularly in a real estate market where prices continue to rise. And homeowners in financial distress may be difficult to deal with, particularly early in the foreclosure process. The keys to a successful foreclosure property purchase are diligence and patience.
As a rule of thumb, the best savings can be made at the pre-foreclosure stage, where home owners can avoid a foreclosure and lenders can save the time and cost involved in going through the process. Another critical point in the process is immediately prior to the auction date, when all parties might be most open to a last-minute solution. It's not unusual to save from 10-30% of the market value on a foreclosure property, and certain properties offer savings of 50% or even more. An educated buyer-one who knows how much is owed on the property and what its market value is-can usually come up with a realistic offer; one that offers significant savings, while meeting the requirements of the lender.