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Investing in foreclosed real estate

With interest rates at record lows and the stock market looking too perilous for small investors, many people are putting money in an asset they understand -- real estate.

One of the best places to invest is in foreclosure and bargain residential real estate.

The current market conditions make it a perfect time for a small investor to purchase one or more foreclosure properties for their private residence, rental or resale. In this difficult economy, more upscale homes are going into foreclosure, so the notion that foreclosure homes are only available in crime-ridden areas is inaccurate. Beachfront and homes in affluent areas are part of the mix of foreclosed properties available.

Recently, one man purchased a Florida ocean-view, four-bedroom townhouse in foreclosure for about $100,000. He renovated the home in his spare time, spending about $12,000 for materials, cabinets and fixtures to bring it up to "like new" condition. Then he sold it for $197,000, giving him an $85,000 before-tax profit.

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He also purchased an inland foreclosure property that after renovation has also doubled in value. He decided to rent the second one. The inland property's rent exceeds the monthly mortgage note and expenses by about $500 a month, giving him $6,000 annual income from the property.

Many owners of homes that go into foreclosure have been struggling financially for almost a year before they give up, which usually means that the house has not received needed repairs or general maintenance for a while.

This may include everything from light bulbs not being replaced to roofs leaks not being repaired. Tree limbs in front yards, broken appliances and windows and dirty carpets, floors and walls are found in very affluent-area foreclosures.

The first rule of real estate, "location, location, location," applies in these situations. If there is trash in every room of the house, but the foreclosure is in a good area with high property resale values, hold your nose, walk through the entire house and consider making a low offer.

Hidden foreclosures
Not all foreclosures are previously owned homes. Some foreclosed homes are new. These homes are not as easy to identify and rarely appear on national lists.

The slow economy has left many builders of new mid-scale and upscale homes without a market to purchase them. With thousands of homes for sale in every city, some builders have reached the end of their construction-loan periods without finding buyers for their homes.

In these cases, the banks that issued the construction loans take possession of the homes and attempt to sell them, using real estate agents to handle the deals.

These too are foreclosures. They are "hidden" foreclosures because no one associated with the sale of these properties will refer to them as foreclosed homes.

Competition is fierce in some cities, nonexistent in others
In some cities competition for foreclosures is fierce. In Mesquite, Texas and Collierville, Tenn., foreclosure homes are sold in one day to the top offer among many anxious bidders. In other cities, valuable properties sit for days without receiving one offer.

The climate of the competition for properties is largely dictated by the number of professional "rehabbers" in the area.

Rehabbers buy properties and renovate them quickly to resell them for a profit in 30 to 60 days. They have contract crews that help them complete the renovation work. They are constantly purchasing properties to keep their crews working.

But even in cities where rehabbers are present, a foreclosure home can be purchased. Many rehabbers had a maximum home price they'll pay that is very low compared with the value of other homes in the neighborhood. If you are willing to exceed their price by $3,000 to $5,000, you may obtain the home at a very low price but slightly above what a professional pays.

If you plan to do most of the repairs yourself and not employ a crew of subcontractors, you may have paid about the same amount for the home when you consider your savings on outside labor.

Getting started costs less than people think
With good credit, many banks will loan the full price of the foreclosure or more. If the home is to be used as a rental, many banks will require only a 10-percent down payment.

Individuals with a large amount of equity in another home may get a line of credit from their bank to purchase a foreclosure. When they convert the line of credit to a mortgage, no down payment may be required.

Foreclosure homes bought in good areas at below market values that appreciate annually can be a sound investment strategy for many investors. The appreciation of the homes is tax-exempt until the home is sold. If the home is a primary residence, the appreciation may be tax-free.

Homes used as rental properties give most investors valuable tax deductions while the house increases in value and builds equity. With many stock portfolios down, foreclosure real estate investing may be the alternative many people are seeking.


Elaine ZimmermanElaine Zimmerman is the author of How to Retire With a Million Dollars and the president of foreclosuresUS.com, a partner of Bankrate.com.

-- Updated: July 16, 2003
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