cheap, but not THAT cheap
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 foreclosures
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. During
economic downturns, more upscale homes go 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.
But anyone considering buying a foreclosed home should
forget about paying pennies on the dollar.
"You can buy foreclosures for as cheap as 30
or 40 percent below market, but most foreclosures sell for 5 percent
below market," said John T. Reed, editor of Real Estate Investor's
Monthly, a newsletter based in Alamo, Calif.
Yet the savings may be twofold if the property
is purchased from the lender who holds the mortgage that's in default.
That lender may be willing to waive some closing costs, maybe even
offer a break on the interest rate or the down payment.
Investment of time
A novice must learn to navigate the foreclosure
process. Todd Beitler, owner of the Real Estate Library in Boca
Raton, Fla., says the time and effort can translate to savings.
"If somebody spends 10 hours a week for five weeks to do research,
it's worth it."
For most consumers, however, the foreclosure process
can prove daunting, Reed says. Good buys are available, but they
require research, preparation, patience and persistence.
process starts when a property owner falls behind on mortgage
payments. 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 missing light bulbs
to roofs leaks. Tree limbs in front yards, broken appliances and
windows and dirty carpets, floors and walls are found in even very
This can be a boon -- or boondoggle -- for a buyer.
Houses in poor condition might fetch bargain prices, but repairs
can boost the cost again. 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.
When a lender decides to foreclose on a property,
a notice of default or a lis pendens (Latin for "lawsuit pending")
is filed, depending on the state. This document is a public record,
and for buyers, it's the first step in locating a property in foreclosure.
A buyer looking for foreclosures also can buy magazines and newsletters
that list properties in default.
Once a home has been located, search public records.
Look for liens on the property, since they can drive up the purchase
price. Liens typically are placed on a house for unpaid property
taxes. Also check assessed values and sale prices of neighboring
Research local state foreclosure laws, since they
differ. Some states -- such as Florida, New York, Ohio and Pennsylvania
-- require the lender to sue the borrower and get a court order
for the sale of the property, a process known as judicial foreclosure.
Other states -- including California and Texas -- follow the non-judicial
foreclosure process, which doesn't require a lawsuit.
For novice investors, buying from the lender is the
safest way to buy. Most foreclosures are taken back by the bank
during auction, Beitler says. While well-located homes in good shape
generally don't sell for deep discounts, rundown properties can
be sold more cheaply.
Often, the banks hire a real estate agent and sell
foreclosed homes in the traditional manner, Reed says. But sometimes
buyers can succeed by pestering bank loan officers with low offers.
Buyers might try low-balling the lender's REO (for
"real estate owned") officer shortly before the nonperforming
assets have to be reported to supervisors, Beitler says.
The safest deals
Bank-owned properties offer the safest deal for
inexperienced foreclosure buyers, Beitler says: "There's no
risk. There are no taxes, no liens, no tenants to evict."
A lender that's eager to sell might be willing to
offer attractive terms, says George Tribble, broker of record at
Jetstream Mortgage. in Oakland, Calif., and past president of the
California Association of Mortgage Brokers
The lender might offer to finance the property at
a below-market rate or with a lower-than-usual down payment. Because
the bank already has done an appraisal, the buyer might not have
to pay an appraisal fee, Tribble says. And lender deals typically
include title insurance, which removes much of the risk that accompanies
buying homes earlier in the foreclosure process.
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.
In some areas the slow economy has left many builders
of new mid-scale and upscale homes 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.
For more daring investors, there are two other
points in the foreclosure process to buy homes:
" Before foreclosure. The buyer finds a homeowner
about to go into default. The homeowner doesn't want to lose all
of the equity in the property, so accepts a portion of the difference
between the equity and the home's market value.
Pre-foreclosure buys offer bargains but demand persistence.
That's because creditors are often hounding owners at this stage.
"Trying to get through to the homeowner is virtually impossible,"
If the homeowner is contacted, the buyer could be
in for a surprise, Reed adds. Homeowners in default might not have
phones or electricity, and they might have a variety of personal
and legal problems. What's more, they probably need somewhere to
live before they can move out of the property the buyer wants.
This is a high-risk, high-reward proposition, and
it's not for first-time foreclosure buyers, Beitler says. Most auctions
take place at the county courthouse steps, and they pose disadvantages:
Buyers might not be able to inspect the property, and they'll have
to put up the entire purchase price the same day.
The U.S. Department of Housing and Urban Development
also runs auctions to unload homes it has acquired through defaults
on federally backed mortgages. There aren't a lot of steals in this
process, according to a study by Tim Allen, a real estate professor
at Florida Atlantic University.
Allen tracked sales at a HUD auction in Florida
in 1998; he found that buyers paid prices very close to assessed
value. Beitler agrees that there's a "frenzy" at HUD auctions
that can push prices to unreasonable levels.
The cost of getting started
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.