We often get asked, what is the best way to buy foreclosure properties? And while it's a simple question, the answer is not quite as easy. Given the state of the real estate and mortgage markets in the U.S. and the increased rate of foreclosures, now is as good a time as any to address this.
First though, let's take a real quick look at the stages of foreclosure and perhaps we can discover where opportunities for investment arise in each stage. Remember though that each state his different laws and deadlines associated with each step, but in general - you'll find three stages:
Notice of Default
When a homeowner fails to make a mortgage payment and/or fails to contact the lender to make arrangements for repayment, notice of default is delivered. Typically this takes place after 90 days of non-payment.
Notice of Sale
Whether it's a foreclosure sale or a trustee's sale does have some nuances. Essentially it's the lender telling the homeowner their house is going to be sold. This takes place between 90 to 180 days after the Notice of Default, except in Texas.
Real Estate Owned (REO)
The home will either be sold at auction, or the lender will take it back and try to sell it themselves.
Lastly, we're going to add a fourth pseudo-stage that occurs in the time before the first payment is missed when homeowners realize that they're in trouble.
To address the issue of what is the best way to buy, you have to consider that there exists opportunities in each stage of foreclosure and you'll have to understand the process well, and have a competitive advantage to be successful. Trying to purchase foreclosures as an attempt at a cheaper primary residence will be difficult because of the heavy learning curve, but if you want to learn as an investment tool, it could be completely worth your while.
In order to make the best deals on foreclosures, you have to make those deals early, and quick. Signs of neglect and stress can present themselves well ahead of the Notice of Default which will bring an onslaught of offers from would be investors. Your competitive advantage in this instance is to know someone like a bankruptcy or divorce attorney who can refer you to people in those situations; you could even be referred by friends or family of the homeowners. This is the most lucrative, but obviously also the most difficult way to buy a home in pre-foreclosure.
A Notice o Default is a public record and as such can be searched by other investors who will write, call, and even show up on the homeowners doorstep tying to "help" them. These are the kind of deals that late night infomercials swear are your ticket to success. Deals can be had at this stage, particularly if the homeowner has equity in the home, but don't expect most of them to be friendly. Other tactics might include short sales from the lenders, where homeowners walk away while investors buy their properties below what is owed. Short sales rarely have the profit margin in them that they used to, because everyone is getting in on the game at this stage.
By the time a home makes it to the steps of the courthouse to be auctioned off, it's already had dozens, if not hundreds of investors, agents, and potential buyers look at it and pass on it. In many cases, homeowners have deliberately damaged the property, third party companies have put liens on them, or their could be clouds in the chain of title. Buying a home at public auction means you'll be bidding against of group of professional investors that know the system inside and out. Still want to buy a home at auction? A new foreclosure auction company, Vestus, estimates 25% of all homes scheduled for auction actually get sold there. Further, they calculate only 50% of those homes have profit potential. Essentially only 12% of homes sold at auction have profit potential. This is the riskiest time to buy a home in the foreclosure process.
If a home doesn't sell at auction, for whatever reasons, the lender adds it to their portfolio of real estate owned or REO homes. They may make minimal repairs if needed and market the home for sale. Since lenders are in the business of lending, they tend to do poorly at selling. For this reason, local REO specialists are hired to market and sell these homes in the communities in which they reside. Working directly with REO agents won't necessarily give you any benefit on price, but wouldn't you agree that knowing a house is 'coming up' for sale would give you the competitive advantage of first notice over those monitoring the local MLS? Many investors have developed relationships with REO agents and have seen foreclosure properties long before they ever hit the MLS. If you're depending solely on foreclosure listings in MLS for your business, you're behind the 8 ball.
One other option might be to look at HUD homes. HUD homes are foreclosure properties just like any other, the only difference being that their loans were secured with government financing, like an FHA or VA loan. HUD homes are purchased through sealed online bidding, and can often be picked up for a steal. The one disadvantage HUD homes present to investors though is that investors always take second billing to owner occupants - even if their bid is higher. Basically, HUD sets a minimum price that they will accept. You won't know what that number is, but if you bid over it, and are the highest bidder - you win the deal. BUT - if an owner occupant ALSO meets than minimum bid, he will win - even if your bid is higher. Finally - HUD homes must be purchased through a real estate agent.
As you can see, there is no one way to buy foreclosed properties. You'll need to figure out your financing far in advance. Some distressed properties can't be purchased using traditional financing because of the home's condition. The bottom line is every stage of the foreclosure process presents opportunities for investors that are prepared and have a competitive advantage of that stage. One investor I know only does pre-foreclosures. Others do quite well at auction. I personally look for REOs or other pre-foreclosure distressed properties. One can often find these properties on the MLS through driving neighborhoods or simply contacting lenders for REO lists. Make sure you are comfortable with whichever stage of the process you're looking at and figure out what your competitive advantage will be.