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Devil Is In the Details of Foreclosure 'Bargains'

Buying foreclosed properties isn't a game for beginners

By Broderick Perkins

December 14, 2008

Buying a foreclosure can save you tens of thousands of dollars if you're buying a home or investing in real estate, but if you don't know what you are doing, the ordeal can cost you more than you'll save.

Foreclosure experts say there's so much potential risk for consumers, choosing alternative methods to make a buck in real estate could be better deals.

The American Homeowners Foundation (AHA) says with more and more homes facing foreclosure, more and more home buyers are taking a hard look at foreclosures, with some of them being led by the nose to the "deals."

RealtyTrac, an online foreclosure marketplace, said November's 259,085 foreclosure filings default notices, auction sale notices and bank repossessions — 147,708 foreclosure filings — were up 28 percent from November 2007. One in every 488 U.S. housing units received a foreclosure filing in November, RealtyTrac reported.

"Whenever the real estate market shifts, there's always this tendency to say, 'Hey. It's a good time to buy,' perhaps to cash in on those who maybe didn't understand what that really means," says Newport Beach, CA-based consultant Danielle Babb who, along with Corona, CA-based mortgage banker and investor William Nazur, is co-author of "Finding Foreclosures: An Insider's Guide to Cashing in on This Hidden Market" (Entrepreneur Pr, $21.95).

Not for beginners

Cashing in, however, requires time — lots of it.

AHA president Bruce Hahn says the foreclosure market is dominated by real estate professionals who specialize in the market because it's a full time job, not an on-the-job-training opportunity. Even as for-sale-by-owner sellers have to get up to the speed and agility of a real estate agent in the time it takes them to sell their home, foreclosure buyers have even less time to seal a deal with professionl aplomb.

"Buying a home at a foreclosure sale requires a lot of work and due diligence and is fraught with risks. You can end up spending a lot of time and money doing your homework, only to learn at the last minute the auction was canceled because the borrower filed for bankruptcy protection (which temporarily suspends the auction). Even if the sale proceeds, you may not be the successful bidder," Hahn says.

Hahn says you should not initially venture into foreclosures without competent assistance, a real estate attorney, investor or other professional familiar with local laws.

In California, for example, the "Home Equity Sales Contract Act" is designed to protect foreclosure suffering home owners from fraud. The law, with special contracting, disclosure and procedural requirements, makes the already legally entwined normal home buying transaction even more daunting.

"I find that most salespeople who have not experienced a market with a lot of foreclosure activity have no idea that this code exists, the required forms for equity purchases and the potential penalties that may be imposed for violation," says Linda Kaneko, vice-president of Paul Law Realty/GMAC in Grass Valley, CA.

Connections required

In addition to related legal savvy, your foreclosure point person should also be endowed with ample connections to other savvy professionals you may also need on the way, among them, perhaps, a home inspector, appraiser and real estate agent.

Given the many unknowns associated with buying foreclosures, you also must have the right financial stuff to give you a tolerance for risk.

Babb says foreclosure buyers need cash flow, without the restraint of high credit card and revolving debt balances. Any current property they hold should have ample equity to tap.

"They should be able to afford to take a little risk and they should be considering this an investment; perhaps diverting some of their investment dollars to this endeavor as a replacement for others," says Babb.

After the necessary prerequisites, buying foreclosures becomes a game of timing. When you buy is as important as what you buy.

Preforeclosure

The period after a homeowner goes into default (misses one payment or more) and the lender files a public default notice to that affect (Notice of Default or Lis Pendens), is the period when the foreclosure process begins.

You can find the notices in your local public records office or, for a fee, get them, with varying levels of detail, from on- and offline firms that track the data.

This is one of the best times to buy foreclosure properties, experts say, because you'll have more time to get a comparable market analysis, research the title and have the home inspected.

It's also a time when the seller may be most accommodating, especially if he or she can walk away with something to show for any equity and if he or she can avoid further ruining his or her credit standing, says Babb.

During preforeclosure, the home likely isn't up for sale, so you'll avoid competition that comes with listed homes. That means, relatively speaking, there's a greater chance you can offer a price that's less than market value but more than the amount owed the bank.

Hahn suggests, whenever possible, selecting homes with substantial equity. That's often evidenced by the owners' tenure.

"The longer someone has lived in a home, the more equity will be built in, even if they made interest-only payments," Hahn said.

Auction

The next phrase, the lender's auction, can represent a potential for the highest return, but, wouldn't you know it, it could also represent a potential for the greatest risk.

"We don't recommend waiting until the auction. Usually bigger investors or institutions will buy these homes and the equity position is lower," says Babb.

Foreclosure auctions vary from state to state and may be held on the courthouse steps, in a county office or at the foreclosed home.

Unless you met the home in its preforeclosure stage or pre-auction events gave you time, you may not be able to inspect it, you may not have time to run comparables or do a title search, but you'll have to pay in cash, usually with a cashier's check.

Auctions typically attract hard core investors looking to flip the property (sell within a short period for a profit) and others who've been around the foreclosure block a few times.

If you buy and things get nasty, you may have to evict residents reluctant to leave their lost home. That gives them plenty of time to trash the place or otherwise strip it for their own financial gain.

"Even if the foreclosed-upon family took care of the property, which is unlikely; the property probably has not been lived in for some time," said Dane Hahn (no relation to Bruce) with Keller Williams Coastal in New Hampshire.

"Expect the (homes) to be really dirty, maybe without appliances (even without toilets and sinks), probably without acceptable carpets, and in Northern states, showing the damages of ice and water. It's very easy to get swept-up in the potential future profits of a flip and to ignore the out-of-pocket expenses required to make the property whole," Dane Hahn added.

Real Estate Owned (REO)

Banks repossess homes that aren't auctioned off, say if the highest auction offer is less than the homeowner owes the lender. Banks aren't in the business of holding and selling homes, but don't expect to land an REO for a song.

"Often, banks are trying to get top dollar based on what was owed, not what's based on a fair appraisal that takes condition and location into account," said Dane Hahn.

At least there's time to arrange for an inspection and a title search, removing some of the risk from the cost.

Babb says no matter what strategy you take, there's an inherent risk in the current market that property values will decline.

"It is possible that you could be in an upside down position even on a foreclosure, which is why doing real comparative analyses and knowing your equity position up front is absolutely crucial in this market. Remember that excessive foreclosures in an area can reduce property values, so it doesn't hurt to also check and make sure that a lot of the neighbors aren't in notice of default status, Babb said.

Exit Strategy

Then there's the exit strategy, which you'll have to consider at the onset of your decision to buy a foreclosure.

Why are you buying the foreclosed property? As your primary residence? To flip? As a rental?

"You basically have to know a little bit about every aspect of investing to include, contracts, financing, negotiating, acquiring, rehabbing and distributing these properties," said Richard James, owner/investor of New Home Investment Group in Lorton, VA.

James is fond of multi-family housing investments that come with cash-flow from rental income.

"Distribution is the key in any real estate investment. You must have a good exit strategy. In the meantime, you must be prepared for some holding costs. It's a lot to juggle for a seasoned investor. A novice would really be gambling. Foreclosures aren't for the novice," James added.

Broderick Perkins parlayed 30 years of old-school journalism into a digital real estate news service, the DeadlineNews Group, offering "News that really hits home!"™. The Silicon Valley bootstrap includes the Web site DeadlineNews.Com and the back shop Deadline Newsroom. Contact him at news@deadlinenews.com.

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