Should you invest in foreclosure properties? The high rate of foreclosed properties in recent years has enticed many beginning real estate investors into the market. The combination of low prices and low interest rates have lulled a lot of newcomers to real estate investing into believing they’ve found the Holy Grail of investment strategies: buy real estate at discounted prices, make improvements and sell the properties at market value. Unfortunately, for far too many real estate investors, it doesn’t quite go that way.
That doesn’t mean that you shouldn’t invest in foreclosure properties. If you take the initiative and the time to do your research, you can turn foreclosure homes into real estate investment gold. Here’s what you should know.
Foreclosure Investing Is Not for Beginners
There’s a lot to know and understand about real estate law, especially with this current waves of foreclosures. In the past, buyers were usually dealing with one set of owners, clear titles and could be reasonably certain that the foreclosure had been carried out legally and appropriately. These days, foreclosure sales are a bit trickier. The headlines have trumpeted the failings of many banks and the mortgage processors they used. Courts have rejected some foreclosure proceedings, while reporters and investigators have turned up thousands of cases where banks and mortgage companies didn’t even have the appropriate paperwork to file for foreclosure on a property. The overall effect of the controversies and uncertainties has been to cast a pall on the real estate investment market because all it takes is one big mistake in foreclosure investments to wipe out the capital you’ve spent years building.
That said, the profits from foreclosure investing can be enormous. You really should only consider foreclosure investing if you’ve put in a couple of years in more conventional real estate investing.
Three Ways to Buy Foreclosure Properties
While there are always exceptions, in general, there are three ways to buy properties, corresponding to the stage of the foreclosure process the owner is in. The three ways are:
- Buying pre-foreclosures, including short sales
- Buying at a foreclosure auction
- Buying REO (real estate owned) properties from lender after the foreclosure auction
Each of these has its own benefits and drawbacks. Let’s start at the beginning of the process.
Pre-foreclosure Sales and Short Sales
In many states, there are special laws dealing with property sold by an owner who is in default on a mortgage. If you’re not careful to make sure that all of the laws are carefully followed, you could find yourself paying a lot of money out of pocket – and still end up without the property you thought you were buying. These are just a few of the issues that may arise if you buy foreclosure property at the beginning of the foreclosure process.
- If there are undisclosed liens on the property, they will become your responsibility after the sale.
- There may be another person on the title who did not sign the deed and has not released property rights.
- The property may be in arrears on taxes and/or utilities, which will become the responsibility of the new owner.
- In some states, the sale can be rescinded long after the sale has gone through – sometimes after you have sold the house, if any part of real estate law wasn’t followed. It’s your responsibility to know the applicable state law and follow it to the letter.
- Is the seller in bankruptcy court? If so, he may not have the legal right to sell the foreclosure property to you.
- Depending on the state, if the seller files for bankruptcy after you purchase the property, you may have to deed it back to the seller up to three years after the purchase if the court determines that the sale made the seller destitute and the seller sold the property far below market value. In that case, the courts see the sale as a fraudulent transfer that the seller used to deprive his creditors of an asset to pay off his debts.
And those are just a few of the ways that a pre-foreclosure real estate deal can go very, very wrong for the buyer. The only way to protect yourself when you buy pre-foreclosure investment real estate is to know your stuff. Learn the laws in the state where you’re buying, sign a proper sales contract, go through all the appropriate inspections and go through escrow with an experienced and reputable escrow agent to minimize the risks of loss.
Buying at Foreclosure Auction
Buying foreclosed properties at auction is probably the most exciting way to acquire real estate properties, so it should be no surprise that it’s also the riskiest way to buy foreclosure property. It’s also the place where you can potentially pick up the best bargains – if you know what to look for. These properties are those that have gone through the foreclosure process, been repossessed by the bank and are being put up for auction to the highest bidder. In some cases, the lender may place a minimum bid amount on particular properties, but many others will go for whatever the market will bear.
So, what are the risks of buying foreclosure properties at a trustee auction?
- You’re on your own. You have no real estate agent to guide you through the process, no escrow and no title report or insurance.
- Without a title report, you have no way of being certain that the title to the property is clear and that the lender actually has the right to sell the property. There can be multiple problems that will crop up only after you’ve paid your money and the seller has signed over the deed.
- In some states, you must pay in cash on the day of the sale. In other jurisdictions, you must put down a minimum deposit and come up with the full purchase price within a specified time – generally within a week to a month. The deposit is non-refundable.
- The winning bidder will get no warranty of any kind on the property, not even an assurance that there are no other liens or loans on the property. If there are other obligations outstanding, you may have to satisfy them, or you risk losing the property after you’ve paid for it.
- You will be unable to do any inspections on the property. You’re buying the property as-is, and you will generally get no disclosure at all about the condition of the building from the seller. Occasionally, a seller may disclose pertinent information, such as that there is fire damage or that the utilities are turned off. Other than that, you’re buying whatever is behind the door.
- You generally will not be allowed to tour the building, and sometimes may not even be able to see the back of the building.
- If the property you buy is occupied, you will have to go through the eviction process to remove the tenants from the property. This can drag on for months. In the meantime, you may have no access to the property to prepare it for resale or new tenancy.
These aren’t even all the risks you’re taking when you buy foreclosed properties at auction. So why do people do it? It’s also the place where you’re most likely to get the best deals on foreclosed properties. And there are ways to insulate yourself from some of the risks. In most cases, the list of properties to be sold at auction is available well before the sale. That gives you the opportunity to do some of your own research. You can visit the property, examine it as closely as the locks and security allow and perhaps even talk with some of the neighbors to learn about the recent history of the place. In some cases, particularly for multi-family or rental properties, you may be able to work out rental or lease arrangements, saving yourself the trouble of finding new tenants and immediately beginning to collect rental income. At the sale, you’ll be bidding against many experienced foreclosure buyers. Their bidding patterns may give you hints on which properties are potentially good deals. Keep in mind, though, that they are competitors, and could be deliberately misleading other bidders about their intents.
Buying Foreclosure Properties as REOs
The safest way to buy foreclosed properties is to buy REOs – real estate owned properties. These are properties that were foreclosed upon but that did not sell at auction. There are a few attendant risks to buying lender-owned properties, but in general, the process is very similar to a standard real estate sale.
- Because these are homes that did not sell at auction, the properties sold as REO are frequently in worse condition than typical auction properties.
- You may not get a seller’s disclosure about property conditions, however, depending on the state, you may have legal recourse if you find major problems with the property or the title after the sale is completed.
Mitigating the Risks of Foreclosure Investments
There are a few steps you can take to insulate yourself from some of the risks involved in foreclosure investments. Your most important allies are experience and knowledge.
- Most real estate investment experts recommend that you get some experience in simpler real estate transactions so that you can build a foundation of understanding the real estate laws in your jurisdiction.
- Learn to do your own title searches so that you can research properties that will be coming up for auction.
- Familiarize yourself with property values in the areas where you choose to invest in real estate.
- Learn as much as you can about the neighborhoods in which you’re thinking of buying. It can save you from making expensive mistakes like buying a property in an area where soil contamination will require costly abatement procedures. Knowing that a buildings in a particular subdivision frequently have structural problems can help you adjust your pricing and bidding strategies so that you don’t end up with surprise expenses.
- Learn the foreclosure laws in your state. Study the laws on lien priority, title insurance, bankruptcy and auction bidding.
Once you’ve built up the experience and knowledge to feel confident, get your feet wet slowly, but never let your guard down completely. Even when you’ve been in the business of real estate investments with foreclosure properties, you can still rack up unexpected losses. You can also make very healthy profits, though. If you’re ready to take the risk for high gains, foreclosure investing just may be right for you.