Risks and Rewards of Foreclosure Investing

The great thing about real estate is that there are many different ways to invest and make money. As an exit strategy one can wholesale, rehab, buy and hold and more. To acquire properties, an investor can use conventional or private financing, cash, and partnering. An investor can be creative and utilize seller financing, such as subject-to and lease options; to name a few.

In addition, an investor has many different types of sellers he or she can target for property acquisition. Distressed properties, vacant, free and clear, non owner occupied houses and other types of properties can be successfully done in a deal where you actually help a homeowner out of a situation and make a fair profit for your real estate investing business. Honestly, it doesn’t get much better than that!

One investment route which investors can choose is in regard to foreclosures.  Foreclosures occur when the current homeowner of a property fails to pay their monthly mortgage and the property is repossessed by the lender.  Please note that the foreclosure laws, procedures, rules, regulations and the length of time this process will take; vary greatly, state by state. It is important that you are educated on the foreclosure process, timeline and the laws and regulations surrounding this process in your specific area. There are various risks and rewards which go along with investments of this type and some of these will be discussed below.

We will be discussing purchasing a property both before the actual foreclosure sale, purchasing at the foreclosure auction itself and later on, purchasing a property after the foreclosure sale.

The term, pre-foreclosure, can be used a couple of different ways. One meaning is that it can refer to the time a seller is in default until the property owner gets the foreclosure notice from their local authorities (in most case the county in which the property is located) The second meaning can be that the property is in the “official” foreclosure process but hasn’t yet been sold at a foreclosure auction. For purposes of this article, we will use the second definition.

Advantages and Disadvantages to Buying Pre-Foreclosure Properties.

One type of property sale which relates to foreclosures, is a pre-foreclosure sale, also known as a short sale. (the terms can be used synonymously) A pre-foreclosure sale occurs when the lender allows the homeowner with past due mortgage payments to sell the home on their own and pay back the lender what they can from the sale of the home. A short sale is where the amount actually owed is more than what the lender will ultimately accept to pay off the loan.  The lender often agrees to this so that they do not have to get involved with the actual foreclosure process, which can cost them even more money by having to legally repossess, and resell the home. In addition to the time factor and various legal costs involved in a foreclosure, the lender incurs additional holding costs and has to provide for the security and upkeep on the property until it gets resold. Often, the homeowner likes the short sale option because it prevents the pain of a foreclosure and keeps the foreclosure off of their credit. The investor can also benefit from this type of sale as well.

Some advantages for an investor to purchasing an investment property via pre-foreclosure/short sale include discounted price, a possible speedy purchase and good profit opportunities.  For the property owner, it can prevent a foreclosure, help their credit, and become a huge relief in a bad situation.

As far as the disadvantages, the investor who buys properties by way of a short sale may find that the homeowner is hard to contact and/or unwilling to sell. In addition, the short sale process can be cumbersome and involves paperwork, seller cooperation and necessitates becoming educated on the short sale process. For the property owner, there can be some repercussions after the sale, including some tax ramifications (rare when it is a primary residence) and a possibility of a deficiency judgment; where the lender goes after the seller for the unpaid balance that wasn’t paid off with the short sale itself. Most times this can be negotiated in the short sale, so that the lender agrees in writing, not to pursue the property owner afterwards.

Those who wish to purchase property via a short sale, should do their due diligence, understand the rules, regulations and processes of a short sale, and be familiar with their particular state and local rules regarding foreclosures. They also must approach the homeowner in a courteous manner and ensure that they make an offer that will be high enough to arouse the lender’s interest but low enough to insure profitability.  By doing so, the investor may find that buying a house by a short sale will work to their advantage.

Advantages and Disadvantages to Buying at a Foreclosure Auction.

Another way to purchase foreclosure property is through a foreclosure auction.  Auctions of this type are usually held at the local courthouse of the county where the property is located.  This is a common way for foreclosed properties to be sold and this too has its pros and cons. Understand that each state has its own rules and each county within the state may have some slight variations as to how they conduct a foreclosure auction, so it is vitally important to have a thorough understanding of each state and counties’ processes and procedures.

The main advantage to purchasing property at a foreclosure auction is the potentially reasonable price for which one can bid on a property.  Although there will likely be other bidders, the resulting purchase price can be quite attractive.  Another possible advantage relates to the profit which the purchaser will see when they resell the home.  If the property is initially purchased for enough of a discount, when the investor goes to resell the property, they should see a good profit from the sale, assuming they did their due diligence beforehand.

With regard to the disadvantages, purchasing a home at a foreclosure auction has a few issues that a buyer must be concerned with.  A disadvantage to buying a home this way relates to the inability to inspect the property- especially the interior.  Because foreclosure auction homes are usually sold as-is, the bidder who wants to inspect the home beforehand will be unlikely to do so.  Most astute investors will at least drive by a home they plan to bid on, before the auction, however. Another disadvantage to purchasing a home via auction is that the purchase price and deposit is due via cash or cashier’s check in many instances which may be difficult for many investors to obtain on short notice.  Some counties want the exact amount at the time the bid is won, which can necessitate an investor having several cashier’s checks in varying amounts. Some counties, on the other hand, will allow a 3 or 4 hour window once the high bid is accepted, for the investor to come in and settle up. Finally, there may be some issues such as a proprietary judgment or lien on a property that has to be settled before the investor has a free and clear title. In some states, a property owner may have a redemption period of a short period of time after the foreclosure in order to make good on the deficiency before an investor has clear title.

If a property is not bid upon, or does not meet the lenders’ reserve amount, then the property goes back to the lender and become an REO (Real Estate Owned) property, which we will discuss next.

Advantages and Disadvantages to Buying Real Estate Owned (REO) Properties.

The last type of property purchase relating to foreclosures, are the real estate owned properties, or REOs.  An REO is when the property returns to the hands of the lender and then needs to be sold.  The lender is normally looking to sell their newly acquired property as soon as possible since they do not want to be in charge of the property and its security and maintenance.  However, if there are a great number of these types of properties in a specific area, the lender may “trickle” them out for sale so as not to flood the market and drastically lower property values in a particular area .The lender will then look for potential buyers of the property. Some smaller lenders, such as local banks and credit unions may actually entertain a direct offer from an investor on one of these. The big lenders, however, will normally use a real estate agent to list the property on the local MLS and try to get the highest offer possible. One disadvantage is; depending on the market in that area, you also may experience a “bidding war” on some of these properties. Just like in the auction process, don’t get caught up in a buyers frenzy and overpay for the property! Determine beforehand what your walk-away point is and stick to it!

Some advantages to buying an REO are that these properties usually have good title, property taxes will be up to date and some repairs may have been made to the property by the lender to ready it for sale.  As for the disadvantages, those who purchase REOs and overpay, may find that the savings in purchasing an REO are not as great as they could have been and therefore, the potential for profit may not be as great either.  In addition, you may have the unpleasant task of having to evict the owner or tenant that is currently living in the property.

Conclusion.

When purchasing property with any of the previously mentioned techniques, there are a few things to keep in mind when doing so.  It is important to do independent research with regard to the properties and be familiar with the various purchase strategies, ensure necessary funds are readily available for purchase and try to inspect, or at least drive by, the property whenever possible.  Also be sure to run a title search whenever possible to make sure no other liens or judgments will interfere with you obtaining a free and clear title. Make sure you understand and are familiar with the laws and regulations of purchasing a pre-foreclosure or foreclosure property in your state. Lastly, be sure to become thoroughly familiar with the foreclosure process and timeline in your state too. This will help to ensure that the buying process goes as smoothly and as profitably as possible. Here’s to your success!

 

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Shortsales and Foreclosures


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About the Author Attorney William Bronchick

Attorney William ("Bill") Bronchick, host of Legalwiz.com, has authored six best-selling books and is sought nationwide for his 25+ years of real estate and legal knowledge. He has been interviewed by numerous media outlets, such as CNBC, TIME Magazine, USA Today, Investor Business Daily, Forbes, and the LA Times, to name a few. William Bronchick is the co-founder and past President of the Colorado Association of Real Estate Investors and the Executive Director and founder of the College of American Real Estate Investors. Click on the "About" link above for more information on William Bronchick.

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