Buying Foreclosures 'Not For The Novice'

by Broderick Perkins
© 2007 DeadlineNews.Com

Deadline Newsroom – On a scale of fear where 1 is a sort of "pshaw" and 10 is your life flashing before you, the fear of buying foreclosures should be right up there with the out-of-body experience.

Be afraid. Be very afraid.

No doubt a foreclosure purchase can be a good way to save money on buying a home or investing in real estate, but if you don't know what you are doing the ordeal can smother you under a shroud of financial losses.

There's simply too much risk in foreclosure acquisition for most financial portfolios and there are easier ways to make a buck in real estate.

The American Homeowners Foundation (AHA) says with more and more homes facing foreclosure, some home buyers are considering acquiring foreclosures -- or they are being led by the nose to the "deals".

[Also see: Foreclosures, Short Sales Already Less Taxing]

More than 2 million Americans stand to lose their home to foreclosure in the current mortgage market morass.

"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, to cash in on the shifting market, to cash in on a returning or new trend," says Newport Beach, CA-based consultant Danielle Babb.

Babb, 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).

"Foreclosures are already shaping up to be the next 'good time'," says Babb.

That's provided you have the time.

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.

"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. That 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.

"Establish a relationship in advance," Hahn advises.

Given the many unknowns associated with buying foreclosures, you'll also have to be endowed with the right financial stuff that gives you a tolerance for risk.

"Those who venture into the area should have solid equity positions in their primary residencies, they shouldn't be up to their eyeballs in credit card or revolving debt, 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, the approach to buying foreclosures is a timing game. 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.

"People should know that foreclosures are not always in the best of shape and they should always hire an inspector who is very detailed that will give them not only the list of items that needs to be fixed, but bids to fix it (or at least a contractor that can do that). Repairs, as well as real estate agency fees (if you aren't selling by owner, which is what I would recommend doing to avoid the fees) are all going to come out of the purchaser's bottom line and need to be considered.

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

"Normally only consider houses owned by people who have lived there for a minimum of two years. However, appreciation stopped in most areas two years ago, and in many areas prices have dropped since then. Make it four years in this market. 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 the highest potential return, but, wouldn't you know it, also represents the greatest potential for 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 you can't inspect it, you won't 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 broker/owner Exit 11 Real Estate in Stratham, NH.

"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 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.

"When banks offer the property for sale, they are not necessarily pricing the property fairly. Often, they 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. Just because it's bank-owned, don't expect a bargain," 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 value, 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.

"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.

Also see: Foreclosures, Short Sales Already Less Taxing

© 2007 DeadlineNews.Com

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Broderick Perkins, an award-winning consumer journalist of 30 years, is publisher and executive editor of San Jose, CA-based DeadlineNews.Com, a real estate news and consulting service, and the new Deadline Newsroom, DeadlineNews.Com's new backshop. In both cases, it's where all the news really hits home.

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DeadlineNews.Com's Editorial Content Is Intellectual Property - Unauthorized Use Is A Federal Crime