As a real estate investor, you always hear that foreclosures are a great place to get good investment properties at bargain prices. Sometimes that it true - but like all deals, you must do your homework first.
In this article, we will examine the three stages of foreclosures and what they mean to you as an investor. The three stages are pre-foreclosure or default, the foreclosure sale and the REO (real estate owned) that is created when the property ownership reverts back to the bank rather than to a buyer.
Stage 1: Default
At this point in the process, the bank is worried about getting their investment back so they have put the homeowner on notice that they will no longer tolerate missed payments and are starting the costly legal proceedings to take back the property so they can liquidate it and recover their investment in the property.
The homeowner at this stage is usually in a bit of shock. His financial world is tumbling. The phone is ringing off the hook from creditors. Collection letters are piling up in the mailbox. Life is not fun.
As an investor, you may be able to get a good property at a substantial discount from its appraised value if you do your homework and can penetrate the owners shell of denial. You need to do some homework though before approaching the owner. Find out what is owed on the house and what the house is worth. That will let you know if it is even worth approaching the homeowner and if it is, you will know how much potential profit is in the deal.
Stage 2: Auction
If the homeowner could not get finances in order or arrange a sale quickly enough, the process is completed and a judge orders that the house be sold at a foreclosure auction. When the auction day comes, the house may or may not be sold. Many times a sale is canceled or delayed at the last minute.
At this stage, the only choice an investor has is to buy the home for a cash price at the auction. This process has challenges. When you buy at the auction, you
- cannot inspect the property
- must pay an immediate deposit on the property - in cash or cashier’s check
- must be prepared to pay the full balance quickly - sometimes as soon as that same day depending on the laws in that jurisdiction.
- take the property as is. There is no disclosure of problems or warranties of any type in this sale.
- must be aware that there could be additional liens against the property that are not wiped out at the foreclosure auction. This means that you may not own that house free and clear after the sale.
- must be aware that on any really good deal, there will be other bidders. It is essential that you set a maximum price you will pay on a property and not exceed that bid amount.
- must know your local laws. In some jurisdictions, the homeowner can actually buy back the house up to one year after the foreclosure sale. Chances of that happening are remote but it is a possibility in some jurisdictions.
In spite of these challenges, buying at a foreclosure auction can be a very good way to acquire an investment property. Just be sure to do your homework in advance so that you do not get burned.
Stage 3: REO
An REO is a property that went through the foreclosure process with no bidders on the property. That means that the lender took back the property and now owns it. Lenders are not in business to own properties. They are in business to lend money. So a lender with an REO is a classic don’t wanter.
REOs can be available directly through the lender or through a real estate agent. Most larger lenders do not want to deal with the details of the sale and will pass the property onto a realtor to sell. But smaller lenders often will deal directly with an interested buyer to save on the real estate commission.
Buying an REO is relatively simple. You go look at the house and make an offer. It is either accepted or declined. The bank’s mission in the sale is to get as much as possible for the property. The investor’s goal is getting the property for as little money as possible. The end result will be somewhere in the middle.
There are some techniques that work well in getting a lender to accept a lower selling price. They include
- making an offer at the end of the month or the end of the quarter
- including photos of any damage to the property with the offer
- making an all cash offer (i.e. tell them you do not need to wait on financing arrangements to purchase the property)
Again, you want to do your homework to be sure the house at the price you are willing to pay is a good value to you. If it is not, or if a counteroffer doesn’t work for you, walk away from the deal. And if the property is still available at the end of the next month, submit your original offer again. With lenders, time is against them. They become more motivated to clean their books the longer they hold onto the property.
As an investor, it is important for you to understand each of the three stages of a foreclosure and how you can profit from each one. By knowing the motivations of the entity on the other side of the negotiations and doing your homework on each potential deal you will find some great diamonds in the rough at each stage of the foreclosure process.
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