Question: I enjoyed your article last week on real estate investing. I was wondering about foreclosures, and how to buy these? Are there potential deals here?
Answer: This question has been coming up a lot with all the news about record foreclosure rates across the country and here in the Puget Sound region.
The short answer is yes, there are potential deals out there, but they are much harder to find than you might imagine.
For one thing, many homes in foreclosure are upside down or underwater, which means the owner owes more than the home is worth in today’s housing market. This is a very common problem because back mortgage payments, penalties and accrued interest charges are added to the mortgage loan balance; and there are often second mortgages and other liens. And to make matters worse, average home values have dropped about 20 percent from the peak of the housing market in 2007.
That’s why it is very, very difficult to find a good deal on a home during the 90-day pre-foreclosure period that takes place after the homeowner receives a notice of trustee sale and before the foreclosure auction on the courthouse steps.
You might have to look at more than 100 more homes in pre-foreclosure before you find one that has enough equity left to make sense as a buying opportunity.
The real deals are found at the foreclosure auction. But that’s pretty much a game for professional real estate investors only. Here’s how it works:
When a home is sold at the foreclosure auction, the liens are paid off in the order that they are recorded. For example, let’s assume a house that has a fair market value of $300,000 goes into foreclosure. The house has a $250,000 first mortgage balance due (including late payments, fees and interest), a $75,000 second mortgage balance, and $25,000 in other liens. That’s a total of $350,000 in liens on a house that is worth only $300,000.
At the foreclosure auction, the lender holding the first mortgage makes an opening bid equal to the total amount it is owed. In the example above, that would be $250,000. If nobody else makes a bid on the house, the lender gets the house for the total balance owed and the junior lien holders get nothing. Their liens are wiped off the property records.
If somebody bid the price up to $300,000 then the first mortgage holder would be paid in full, and the second mortgage holder would receive a partial pay-off of $50,000 and the third lien holder would be out of luck.
Now, let’s say you are the only bidder at the foreclosure auction. You bid $1 over the minimum bid put in the bank foreclosing on the $250,000 first mortgage and you get a $300,000 house for $250,001.
Not bad.
But keep in mind that is only 16.6 percent below the fair market value of the home so you probably would not make any profit if you resold the home after paying fix-up costs and real estate sales commissions. A deal like that might make sense if you were going to live in the house as your personal residence, but it would not be a good investment. Most professional investors want to buy at least 35 percent to 40 percent below market value to leave enough room to make a profit on a resale.
And the really bad news is that if you want to buy a home at the foreclosure auction, you have to pay cash on the spot. There’s no time to run out and get a new mortgage to buy the home. That’s another reason why the auctions are typically attended by professional investors only.
There are a few real estate agents and companies in the area that specialize in helping private investors finance and buy homes at the foreclosure auctions, but be very, very careful. You need to make sure you know exactly what the expected resale value of the home is before you place a bid and make sure you are buying well below market value. Otherwise, you will probably ending up making very little if any profit when you sell the home.
Don’t even think about trying to buy homes in foreclosure as rentals. Even with today’s depressed home values, you can’t get enough rental income to even come close to breaking even on a cash-flow basis, so you would be losing money every month on a home that will probably not appreciate for many years to come.
The bottom line is that you can find good deals in the foreclosure market, but it takes a lot of knowledge and a lot of hard work and it’s probably not a good place to start out as a novice real estate investor.
Mail your real estate questions to Steve Tytler, The Herald, P.O. Box, Everett, WA 98206, or e-mail him at economy@heraldnet.com.
Talk to us
> Give us your news tips.
> Send us a letter to the editor.
> More Herald contact information.
