Successful Foreclosure Investing Strategies

The Benefits Of Investing In Foreclosed Homes

When buying a foreclosure investment property, the seller is typically motivated. Therein lies the true benefit of working with distressed properties: motivated sellers. Due, in large part, to the homeowner’s inherent need to sell his or her property as quickly as possible, an investor may leverage their position to facilitate a deal that benefits both parties involved.

The following list represents some of the most common benefits awarded to those that know how to find foreclosure homes:

  • Motivated Sellers: Motivated sellers are more inclined to accept an offer because of their particular situation. As a result, they are usually easier to work with. Investors with the owner’s best interests in mind will certainly appreciate extending a helping hand, and there’s no reason not to expect the owner to reciprocate their appreciation.
  • Leverage: Investors may leverage their position in a number of different ways. It is entirely possible for resourceful investors to provide unique solutions to the owner’s distressed situation. For example, in return for a discount, investors may offer to help the owner move or even shorten the closing window. Provided everyone is on the same page, there’s no reason the impending solution couldn’t benefit everyone involved.
  • Equity Spreads: Buying homes in pre-foreclosure allows buyers to create significantly larger equity spreads. Banks don’t want to take back homes if they don’t have to, which enables buyers to request a significant discount.
  • Great Deals: Distressed homeowners selling during the pre-foreclosure process are desperate to get out of their mortgage payment in order to avoid foreclosure. As such, distressed properties typically sell for a discount to facilitate a faster deal.
  • Quick Buying Process: If the price is right and the seller is motivated, buying foreclosure properties is typically faster than purchasing an investment property the traditional way.
  • Niche Market: The more specific a new investor’s exit strategy is, the better. Focusing on pre-foreclosures could be a smart move for anyone looking to hone their skills. Creating a personalized niche can help you sharpen your marketing strategies to be more effective, as well as build business systems and standardized processes to get these types of deals completed and closed.

Step 3: Physical due diligence

One of the trickiest parts about buying at auction is that you cannot get into the property that is being foreclosed on. You should still drive by it though and take a good look at the exterior. Look online as it may have been listed recently and have pictures available. Generally speaking, the interior’s condition will mirror the exterior. That being said, you should be extra careful when coming up with your rehab budget in your house flipping business plan.

Always err on the side of caution and make sure to estimate more than you think you will need to rehab the home. Unless you are able to get in the property to evaluate its condition, assume the interior is worse than you think it is. You may very well be pleasantly surprised and get a better deal than you anticipated. But you don’t want to be stuck with a lemon.

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Are Foreclosed Homes Right for Beginning Investors?

If you’re looking to become a property owner, a foreclosed house can be a wonderfully inexpensive way to obtain an investment property. Remember, though, that buying foreclosures is an aspect of real estate investing that can have some potential landmines, especially if you are buying a distressed property in an area you are not familiar with.

Buying foreclosures is not the only way to get started in real estate. Sometimes a fresh investor will avoid the foreclosure market entirely and purchase a home directly from the seller. This allows them to obtain a decent discount because a real estate agent (and their commission) are not in the picture. The real estate investor also has a better chance of working out a deal with the homeowner, especially if the homeowner has paid off their mortgage.

For example, the buyer and seller could agree to something called seller financing, where the buyer puts a decent down payment forward and agrees to pay off the remainder of the sale price over time. Usually, the buyer will get a renter into the property in order to cover the rent. This type of property stands a greater chance of being move-in ready without needing the extra expense of lots of renovation. Sometimes the seller may even assist in finding a renter for the property. After all, it helps them make sure they get paid every month.

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Foreclosure traps to avoid

Buying a foreclosed property is much more complicated than purchasing a home for owner occupancy. Some of the traps and workarounds you should be aware of include:

You’ll need plenty of extra cash

Even if you’re able to get financing to purchase the property, you’ll still need to have plenty of extra cash to:

  • pay renovations
  • cover unexpected expenses
  • cover carrying costs (debt service, insurance, property taxes, and utilities)

Buying foreclosures should never be attempted on a shoestring budget.

Right of redemption laws

Most states have laws that give the original homeowner the right to reclaim the property if they can pay past-due amounts and fees on the house within a certain time limit. This means that you can lose a property you’ve successfully bid on.

Beware of auctions

You likely think of auctions when you think of the foreclosure process, but it’s best to avoid them. The property is, quite literally, put up for auction, either on the courthouse steps, at the property itself, or at a convention center.

Be very careful if you’re bidding on such a property. Competitive bidding can lead to the value being run up so high that you end up losing money on the purchase. I’ve seen a couple of examples of auction-bought properties that were purchased over market value, which can be a financial black hole.

Related: How To Buy A House At Auction

Sellers may not be cooperative

Though it may seem logical that a bank or a government agency will want to unload a property quickly and cleanly, this is usually not the case. The bank or the agency stands to lose money on the sale, and will hold out for the best offer they can get. For that reason, the process may drag out a lot longer than you planned.

Time is money

If you’re buying a foreclosure to flip and make a profit, you will have to make the entire process move quickly. Once you close on the house, you will have to have your contractors lined up and ready to get to work immediately. The longer it takes to get the property ready for sale, the more money you’ll be paying for carrying costs.

Always get a home inspection

Foreclosures are sold “as is”, but you still need to know exactly what the deficiencies in the property are. The seller should enable you to bring in a competent home inspector, which you will have to pay for out of pocket.

Like a preliminary appraisal, it will be money well spent. You need the inspector to give you a detailed list of everything that’s wrong with the property, as well as a breakdown of how much it will cost in order to complete the renovations. This will help you know if the property is actually profitable, or if it’s likely to turn into a money pit.

Owning Strategies

Investors should also be sure of what to do once the asset is acquired. Will the property be “flipped” back into the market, or will it be held and seasoned awaiting a market change before sale?

Flipping Properties

Investors considering buying foreclosures and then remarketing them shortly after purchase should find ways to improve the property. Those that provide the greatest bang for the buck include adding bedrooms and bathrooms, remodeling kitchens, and finishing basements or other unused spaces.

As property transaction information is public knowledge, some prospective buyers will be wary of paying a premium for a property immediately after a foreclosure sale, even if its price is in line with other properties in the area. Creating value through redevelopment helps provide a rationale for the higher resale price and can reduce the risk of long marketing periods. However, investors should be wary of improving the property so much that its price is considerably higher than neighboring properties.

It’s a bad idea to improve a foreclosed home so much that you price it out of the market.

Holding Properties

Another strategy is to hold assets as rental properties until something happens in the marketplace to enhance property values. Investors must be sufficiently aware of the rental market to be confident that there is an adequate amount of demand for rental space and the property will generate enough rent to cover the cost of maintaining it.

For those who can handle the additional time and effort that it requires to be a landlord, buying distressed properties at a discount and converting them to rental properties can create significant wealth. The ability to get attractive financing, such as interest-only loans, in concert with the deductibility of mortgage interest from income taxes, can provide a way to create cash flow while waiting for the right time to sell.

Although residential real estate is not as volatile as other asset classes, it is characterized by long periods of low returns and then a spike in the value corresponding to some major change in demand that explains a significant portion of return. Again, this is the impetus for ongoing research and a holding-period strategy that will help estimate the timing of the value jump and create a plan for the asset in preparation for sale.

Foreclosure vs Deed in Lieu 

Real estate investors may confuse a foreclosure with a deed in lieu, but there are noticeable differences.

A deed in lieu of foreclosure is a document that transfers deed ownership from the borrower to the mortgage lender instead of going through the formal foreclosure process. 

It is usually the last resort before a foreclosure after homeowners have attempted to do a loan modification or short sale

There are pros and cons for both the lender and the borrower to choose a deed in lieu compared to a foreclosure. 

Lenders can avoid costly attorney fees and a time-consuming process by accepting a deed in lieu. 

On the other hand, borrowers can mitigate credit damage by opting for a deed in lieu and get themselves out of a situation where they are underwater on a property. 

When Will a Deed in Lieu Be Accepted or Rejected?

A deed of lieu will be most likely accepted by a lender when there is a financial incentive to do so. 

Lenders may opt to avoid the costly legal fees and time-consuming process of foreclosure. 

Lenders also have added incentive to accept a deed in lieu of foreclosure if the property has appreciated in value. 

However, if the mortgage loan is backed by the government, it may not be in the lender’s best interest to do a deed in lieu. 

What Real Estate Investors Need to Know About A Deed In Lieu

A deed in lieu of foreclosure is a great investment opportunity. 

They are similar to foreclosures because lenders do not want to hold onto the properties for an extensive amount of time. 

The properties often have strong investment potential to be upgraded and increase in equity. 

A strong offer will allow you to purchase the property and flip it for profit.

Finding Foreclosure Properties To Invest In

The first part of learning how to buy a foreclosure — and most forms of real estate investing  — is finding a property. 

In some ways, it's not too different from looking for traditional home sales, with some additional steps.

Where to Find Foreclosed Homes for Sale

There are several ways to find foreclosed homes. 

Since foreclosure is highly regulated, foreclosed homes must be documented in public. You can find records of foreclosing homes at your local County Recorder's Office. 

Notices of Sale for foreclosed homes must be published in local newspapers and their websites. You can also search websites for banks and government agencies. 

Auction houses that hold foreclosure sales can also tell you when the next one's happening.

Or, you can utilize relationships with local real estate agents specialize in foreclosures. 

Online realty sites like Zillow or Redfin also identify homes in the foreclosure process in area searches, but keep in mind that some foreclosures may be so new that they haven't made it to online sites yet.

Financing Foreclosed Homes

There are many ways to finance the buying of a foreclosed home, and it comes down to your experience, network, and overall business strategy. 

Some lenders offer renovation loans that cover the purchase price and expected repair costs of foreclosed homes. 

You may even be able to obtain a conventional loan for a foreclosed home if it is in good and sound condition. 

Another option is loans outside the traditional banking system — these include hard-money and private money loans. 

How the auction process works

When a homeowner falls behind on his or her mortgage payments, eventually the lender files the 1st Legal Action, which is either a recorded document, or a court filing, depending on the state and assigns an attorney or trustee to conduct a foreclosure. At any time prior to the auction, the borrower can reinstate the loan by paying the arrearages, or the overdue amount, but unless the borrower sells his/her home, it is rare for the delinquency to be rectified.

Real estate foreclosures usually take several months from the first missed payment until the home is sold on the courthouse steps. The exact time depends on state law and the bank foreclosing. After the 2008 financial crisis, when banks were inundated with foreclosures, it could take well over a year. But nowadays, it is usually closer to six months.

A Note About Purchasing Through Short Sale

A short sale occurs when the homeowner sells a home for less than what they owe on the mortgage because the value has declined. Foreclosure has not been completed with a home up for short sale. The homeowner still owns the home so you work through their REALTOR®.

When you buy a home in a short sale, the lender (not the homeowner) needs to approve your offer. You might spend a lot of time waiting for approval.

Where to find foreclosed houses

There are actually several sources where you can find foreclosed houses. Each has its own benefits and drawbacks.

Newspapers

These can be good sources since foreclosures are typically posted in local newspapers. They can allow you to get into the process before the general public. For example, if a property is listed as a Notice of Default (NOD) you may be able to contact the current homeowner and work out a purchase before the property goes to auction.

The drawback is that you will probably need to be an all-cash buyer if you come in at this stage of the process. And competition from other foreclosure buyers can be heavy for these properties.

Foreclosure websites

There are actually websites that specialize in foreclosures. Zillow.com is a source here, but you should also check out RealtyTrac.com, since foreclosures are most of what they do. There are also online county public records databases, but this can be akin to sifting through the sand, since they include so much detail and much of it is dated.

The advantage of foreclosure websites is that you can search for many prospective properties quickly. Some of the websites often provide tools and calculators to help you in your search, and can even enable you to zero in on specific searches.

Eventually, you will still have to contact the lender selling the property or the real estate agent who listed it in order to get the process moving.

Real estate agents

Real estate agents are an excellent source IF you can find an agent who specializes in the foreclosure field. They have the advantage in that they can let you know as soon as foreclosed properties hit the listing services. The downside is that not many real estate agents actually specialize in foreclosures.

Mortgage lenders

This is really about working directly with the property seller—which is the bank. That can simplify the whole process. Banks will allow you to inspect the property before you make an offer. However, that inspection may have limited value. When you purchase foreclosure properties they are typically being sold “as is”. There’ll be no ability to negotiate certain repairs.

Also, be advised that competition for properties through banks can be heavy. For this reason, the banks may not be entirely cooperative in dealing with your offer. They may prefer to wait and see if they get better ones.

Government agencies

This can include government owned mortgage lenders and insurers, such as Fannie Mae, Freddie Mac, the FHA and VA. They can also include other government agencies, such as the Internal Revenue Service (IRS).

The advantage with government agencies is that they usually have a large number of foreclosures available. They can also provide you with an opportunity to buy foreclosures before they reach listing services.

In addition, some agencies, such as the FHA, may offer you financing in order to purchase those properties. Conversely, the IRS typically requires that you pay cash on any properties they are offering for sale.

Also be aware that buying a property from a government agency tends to be a highly bureaucratic process. You’ll need to be extraordinarily patient, and fully prepared to cooperate with any agency requirements.

The Bottom Line

Investing in nonperforming real estate assets to build wealth is a viable strategy, but it’s not a way to get rich quick. For every rags-to-riches story, there are 10 more people who have lost their capital because they did not keep abreast of changes in market trends. 

Those who succeed in the foreclosure market have studied the strategies and tactics of other successful investors. They have put the time and resources into making the appropriate market contacts needed to create a competitive advantage over others. Still, pouring time and energy into getting to know the local real estate market is only one of several strategies that investors can use to get a leg up on the competition. Success comes from smart, carefully crafted, and executed acquisition and exit strategies.

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