10 Minute Investor Guide

Investing in foreclosures for Resale is not so different from Investing in foreclosures for Rental income. Many of the same rules apply and many guidelines remain constant. As with any type of investment the point at which you enter will determine how profitably you exit. The single largest distinction between real estate and stocks, bonds, mutual funds or precious metal is that real estate allows the Investor the opportunity to have a more direct and immediate impact on the Investment (the property) through rehab, paint, carpet, etc. This article in this series on Real Estate Investing will demonstrate how to quickly make an assessment of a potential Real Estate investment.

The guide should allow the average investor to make a rapid and well-thought-out decision. An informed investor will not "lose out" because of third-party factors such-as obtaining appraisals or contractor/repair people. An aggressive, proactive approach by the Investor can reduce the time it takes to obtain properties. A passive approach or an offhand attitude does not promote good opportunities. Remember, work with your agent and get pro-active!

How to determine Equity
The old adage about the only three words in business being "Location, Location, Location" is as true as ever. In Real Estate, however, those three words are "Equity, Equity, Equity". The difference between what is owed on a property and its Market Value is called equity. As an investor, the goal is to buy for less than the full value and sell for market value and make a profit in the process. So at what point does caution balance against risk to make a profit?

A strong equity position is generally targeted at 25% after repairs. An equity position less than 25% can work for rental investments, but for resale purposes 25% is a safe figure. In order to determine if 25% after repairs can be achieved there are only three variables that need to be weighed in the mind of an investor.

■ How much can I get it for?
■ How much can I sell it for?
■ How much will it cost to repair it?

It is not difficult to obtain answers to these questions as long as the readily available data can be quickly and accurately distilled into usable information. By using the following guide and examining each property in terms of these three variables it should not take more than fifteen minutes to determine if a particular foreclosure is a wise investment.

How much can I get it for?
First, ask what your agent knows about the particular foreclosure property.

■ How long has it been on the market? (Not vacant, but available for sale)

■ Can Investors bid on it? (Some properties are for owner/occupants only)

■ What does your agent think? (A good agent is worth his/her weight in gold.)

Second, look at the property yourself.
Is it a "fixer upper?" Is it "market-ready?" The cost to make a property ready to sell has to be considered as part of the cost of buying a property. Usually an eyeball will tell you how much of a commitment in funds will be required.

Third, be sure that you are willing to own the property for the duration.
While it is certainly possible to get in and get out without a serious commitment of finances, be ready to own the property until it is sold. Some banks have regulations stating you must take possession of a property before you can sell it again. If, for whatever reason, your buyer is unable to complete his end of the transaction, you need to be prepared to be the owner of the investment property until it eventually sells.

Fourth, Bid quickly and often.
Nothing is more frustrating than investing a lot of effort into a project for nothing. When considering Investments, do not hesitate and risk missing an opportunity. If a deal looks so-so (only a 10% equity position, for instance) BID LOW to achieve that 25% potentiality. It could be a good rental, or even a modest resale. And there is always the chance you might win the bid. In Investing, as in life, "he who hesitates is lost". After submitting a bid, start looking for the next Investment. Don't delay a possible "big dessert" while waiting on the first course.

How much can I sell it for?
As a general rule of thumb most Investors are motivated to purchase with a minimum 25% equity position (after repairs). This requires two separate deductions in order to be sure of a 25% equity position. First the true market value of the subject property (after repairs) and second, the repairs.

In order to determine the true market value without ordering a full-blown appraisal, (both time and financially prohibitive) an Investor must look at comparable sales. "Comps" are available from your agent. While the online services may serve as a general guide the comparables your agent can obtain will take into consideration many more factors. Look at the entire neighborhood in print format. Then consider the most recent sales that reflect the style and neighborhood of the subject property and compare them to your Investment property.

Tip#1: The rewards are greatest when the investor is a knowledgeable, pro-active force in the process. Take an active roll in your investment. (Placing Advertisements and selling your own properties is covered in another article.)

Tip#2: The figure for how many days on market (DOM) a property was available before its eventual sale will be found on the MLS listing. Be sure to ask your Real Estate Agent for these figures specifically so that a determination can be made regarding the desirability of a particular neighborhood, style of home etc…

Tip#3 Along with "Sold" properties a look should be taken (in print) at other properties that are still "available" or "withdrawn" from the market to determine the health of the market.
 

Determining "True Market Value"
The following should offer some quick factors for market value adjustments on properties in the $100,000 range.

DOM (days on market):
No impact on market value under 180 days. Extended periods in excess of 180 days approach with caution. Think laterally, there could be possible rental opportunities.

Sales Price:
"List Price" does not equal "Sales Price".

Bedroom and bathroom count:
add or subtract $3000 for each full bath, $2000 for ½ baths.

Garage:
add or subtract $4000 per car, divide by half for carport.

Basement:
add or subtract $8000 for a full basement, additional $2000 if finished.

Basements are not common in Texas.

Pools/Tennis Courts:
No Adjustment

Be careful not to come up with an artificially high pre-determined value. Stay open-minded and objective. If the math looks strange, remember to ADD adjustments to the compared property to value it AS IF it had the same features as the subject property.

How much will it cost to repair it?
After looking at the comparable sales the investor need only reduce the repairs to understandable figures in order to calculate if the property can be purchased and repaired for 75% of it's market value (the 25% equity magic number).

To estimate repairs one could have any number of contractors offer bids and submit proposals, however the time required for meeting with three contractors and getting proposals may not be available. A quick-thinking, fast-acting investor can estimate work required by walking through the subject property and tallying the figures without a second appointment.

These figures are not hardcore, written in cement numbers but should allow a quick and easy comparison of value allowing a decision to be made after the estimates of repair have been performed.

The following should offer some averages for the more common repairs to a 1200 square foot rancher without a basement.

■ Paint w/minor drywall repairs: $800.00-$1000.00 per house
■ Carpet (one grade above builders): $1000.00-$1200.00
■ Kitchen and Bath flooring: $300.00-$500.00 per room
■ New Roof (try to repair first): $2,0000.00-$3,000.00 per house
■ New Heating and Air: $1,000.00-$2,500.00
■ Appliances (Save Money-buy used): $250.00 per appliance
■ Miscellaneous Expenses: add 10% to total

Tip: Be sure that you are true to your investigation and do not allow passion or trepidation to sway your decision-making either way. It is more important that you swing than it is you hit a home run. (Bid often!)

Investing in Foreclosures                                                                                                   top ▲

Risks and Rewards

The mortgage foreclosure process creates three sets of real estate investing opportunities: the "Default/Pre-Foreclosure" phase, the "Auction/Sale" phase and the "REO" phase. This article discusses the risks and the rewards of each opportunity.

Buying Pre-Foreclosures:
Buying pre-foreclosures involves working directly with the homeowner and sometimes the lender. Your goal is to create a Win-Win scenario. One win is for the homeowners (they make a sale) and one win is for yourself (you buy the property at a substantial discount).

To accomplish a successful purchase, most experts recommend the following: (1) locate loans in default, (2) evaluate and narrow selections to pursue, (3) inspect the property, (4) evaluate the property owner's needs, (5) determine the market value of the property, fix-up costs, potential sales price and profits, (7) arrange default work out by negotiating with the owner and the lender, (8) close on the property, repair and resell it quickly.

Pros:

This is a great investing opportunity if done correctly. Discounts off market value can range from 20% to 35% on average. A low cash down payment is possible if structured properly. You have ample time to research properties. Unique and flexible sales agreements are possible.

Cons:

It is sometimes difficult to contact the property owner. You will usually have a lot of competition. The court house research can be cumbersome. You may need to negotiate with the lien holders.

Buying At The Auction
Buying on the court house steps at the auction can be the most rewarding way to buy properties and the most dangerous at the same time. The property is publicly auctioned off to the highest bidder, and the process moves very quickly. When bidding at the auction, you compete against the lender and other investors.

Auction buyers (1) research properties prior to the sale date, (2) pursue realistic opportunities, (3) calculate values and potential profits, (4) determine bid price and (6) follow the property to the auction and participate.

Pros:

Very good to excellent discounts. Investors can achieve 35% to 45% savings off market values and earn an excellent return on investment. This is the only investing method where you can really hit the jackpot.

Cons:

Auctions are frequently postponed, wasting your time and effort. It is rarely possible to inspect the property. To be safe, you should have a title search performed, which can be costly. Unusually large cash outlays deter most investors (note that this can also be seen as a benefit). Certified checks for 10% of the purchase amount may be required with the balance due in weeks, days or even hours. Improper research can lead to devastating results.

Buying REOs
Perhaps the easiest way to buy foreclosed property is buying REOs ("real estate owned"). An REO occurs when the lender takes back the property to gain possession and cut its losses. The lender, however, does not want the property because it is not in the real estate business and is therefore usually motivated to move the property quickly.

Pros:

The lender is almost always the senior lien holder, thereby wiping out all other liens at the auction. This means an REO will always have clear title, which saves a lot of time, expense and worries when buying foreclosures. Most likely, the lender will also have paid any property taxes in arrears. The lender may either repair the property to acceptable standards or allow a discount to the buyer to accomplish the repairs.

Cons:

Rewards follow risk. This is a low risk investing method and the rewards can be on the low side as well. Average savings may range from only 5% to 15% off market value, although discounts of 25% or more are possible if you know how.

Investing in foreclosures can provide excellent profits. Each of the three foreclosure opportunities presents both rewards and certain risks. Be sure to do your homework before you start investing.

Foreclosures Facts & Fictions                                                                                            top ▲

Many new investors want to buy properties directly from the bank. You never hear anyone say, "I want to buy a property from a mortgage company, credit union or savings and loan."

The attraction to bank owned properties is understandable, as it is the bank you borrow money from to buy a home. It is natural to assume that the bank owns the property. Whether a Deed of Trust or Mortgage, the title to your property is either held by a third party or pledged as security for the loan, so in fact the bank does not own the property.

You borrow money from and give a mortgage to the bank. The mortgage is the security instrument utilized to protect the bank from loss should you default on the loan. Unless you bought a bank foreclosure directly from the bank, the bank has never owned the property at all.

The Lenders Profits
The goal of the foreclosing lender is to gain possession of the property. The financial goal is the recovery of the principle loan balance, accrued interest, late fees, penalties, taxes paid on behalf of the property owner, court costs and attorneys' fees. In most states, the laws are written so that the lender can only attempt to recover these widely accepted standard losses.

The lender will add in every legitimate expense when foreclosing. This is what is sued for: the total the lender claims is owed by the property owner. In most states, this is the maximum amount the lender can collect. The laws are written this way to protect home owners from unfair practices.

The commonly held notion that a bank (or any other lender) must sell a repossessed property for the same amount it cost to gain possession and therefore cannot make a profit is false. If the foreclosing lender is the successful bidder at the auction, it will take possession of the property for the very first time. When this happens, all the rules change. The lender, now the legal property owner, can do anything it wants with the property, Rent it, keep it, whatever. It can also sell the property for any amount it so desires.

Condition of Title
Often when purchasing foreclosures buyers are concerned about the quality issued by the lender. A common belief is that there may be liens or judgments clouding the title. This is a myth. The lender will bid at auction only if it wants the property. The lender, typically the senior lien holder, wipes out all junior lien holders or judgments in the process.

If the foreclosing lender does not bid at that sheriff's sale or auction, it probably doesn't want the property. This may be due to excessive superior liens, such as IRS or tax liens. (Tip: If the lender doesn't bid for the property at auction, you probably shouldn't either.)

The lender, in an effort to recoup its losses, will bid on the property, wipe out other lien holders, then pay the balance of outstanding property taxes to secure the property's clear title. No lender will go through the time, effort and expense of foreclosing, only to lose the property for a few thousand in back taxes.

Having absorbed these costs, the lender generally adds them to the asking price and will sell the property with clear title.

If you have heard that the lender must sell the property for what they paid for it at auction, forget it.

Another myth is that all banks are bending over backwards to give away foreclosed homes. It's true that the lenders want to sell their foreclosures. Lenders, banks in particular, are corporations. These corporations are driven to make money, not to lose it. A bank has to answer to its shareholders just like other corporations do.

The business of repossessing properties is not new. Over the years, many lenders have developed effective methods of selling their REO's quickly, with minimal loss.

Property Disposition
Lender practices and procedures vary greatly. Some widely market their inventory of REO's, while others practically hide them.

We know of some banks that advertise foreclosures in daily newspapers, while others demand that you maintain an account with them (or better yet, become a stockholder) just to get their list of properties.

Lenders are in the money business, not the real estate business. This is why most properties are marketed through recognized real estate brokers or agencies. Some agencies specialize in foreclosures and may represent several lenders' properties.

Brokers may have several investors lined up just waiting for a good property to turn up. Brokers can also assist the lender in determining market prices, suggest marketing strategies, recommend appraisers or contractors, etc.

Some lenders establish a set price for the property and will not allow the sales agent to consider offers for less. Many lenders dispose of their own properties. Depending on the size and complexity of its REO inventory, the lender may have one part-time clerk or a staff of special asset managers handling property sales.

Lenders with larger inventories often have a staff dedicated to analyzing and managing the properties, while at the same time coordinating and managing the brokers retained to market the properties. The lender determines the strategy and the broker markets the properties accordingly.

Investing Overview
Purchasing directly from the bank is the most popular way to buy foreclosures. It's fairly easy, and less of a headache than other investing methods because it involves less complications and risks.

Find properties that meet your investing criteria, those that are in your area, price range, size and style. Determine whether you are buying to resell or to secure a residence for yourself. Determine if the property is a bargain by deducting the lender's asking price from the average market price of very similar properties in the immediate area.

Your goal as an investor is to realize a tidy profit. You can buy property at a 15%-20% discount and earn a 35%-40% return. As a home buyer, you want to buy below market value with a low down payment, low interest rate and reduced closing costs.

Contact the lender or the broker and meet him at the property so you can inspect it. Record any damages and deduct the repair estimates from your price. Use a good property inspection checklist.

Investors must deduct all expenses associated with buying, repairing, borrowing, holding and closing again, from the price they think they can get.

Homebuyers should negotiate around the four discount factors: price, down payment, interest rate and closing costs. The bank, being a lender, can negotiate all these items.

If you still like the numbers and the property, proceed with a written offer containing the following:

A statement indicating your intent to purchase the real estate.
The physical address of the property.
The legal description of the property.
Your price.
Your down payment terms.
Your financing terms.
Your desired closing date.
Any contingencies.
Your deposit information.
Your name, address and phone number.

Depending on the property and several other variables, you may want to buy a property at 15%-25% below market value. Start your offers accordingly.

Unrealistic offers will be rejected quickly. Learn to work with the banks. You can negotiate around interest rates, price, down payment, whatever, just stay within reasonable boundaries if you want to succeed.

Some lenders sell thousands of REO's every year. Many sell their properties at or near market price. We know one lender who has sold almost 10,000 properties in the last 3 years, with average sales of 99% of market value.

Not all lenders behave the same way. Try to locate those that are more flexible in their property disposition policies.

When the bank accepts your offer, close as quickly as possible. Avoid delays and complications from competitive offers.

Advantages
The advantages to this buying method are many. There are no liens or judgments to contend with, no homeowners or tenants to evict, no back taxes due, and accessing the property for evaluation or inspections is easy.

The fact that the property has officially changed hands means that all that work has been done by the lender. With all the legal work done, the complications of buying and the associated risks are removed.

Lower down payments, better interest rates, reduced closing costs and a discount off the market value of the property, taken all together, make for a better than average home purchase.

While you may not be able to steal a property from the bank, a properly structured deal will make you the envy of the neighborhood because you will have a low down payment, low monthly payments, and a low total price.
For those looking to save money buying their first home, this is usually the way to go.

Disadvantages
In this industry the rewards follow the risks. Therefore, the payoff from this investing method is typically lower than that of buying pre-foreclosures or buying at the auction.

An REO investor should have no problems achieving 10%-20% discount from the market value of comparable properties. Savings of 25%-35% are harder to find. Savings of 40%-60% are possible, but getting rarer.

Other disadvantages include: the lender that moves at a snail's pace; a lender selling the property "as is," with no cooperation in making reparations or allowances; and the very rare, but always possible problem of evicting a tenant or homeowner.

Why buy a foreclosure?                                                                                                        top ▲

What is the big deal about government foreclosures?

Foreclosures are a hot topic these days. There are several types of foreclosures and we will explain the process, pros and cons of each throughout our site.

Divorce, loss of employment, loss of life and/or market conditions are the most common reasons for a foreclosure to occur. When one of these three things transpire and the home buyer is not adequately prepared, a foreclosure is most likely to be the end result. Soon after one of the big three occur the homeowner is several months behind and the mortgage holder will not negotiate with the homeowner as special exemptions cannot be made for every home owner going through difficult times. It seems evil and possibly oppressive but very often a foreclosure can be the best thing for the homeowner. Removing the pressure and allowing the homeowner to potentially live in the house for several months free of charges.