Foreclosed houses not an easy investment

Published 9:37 pm Friday, December 28, 2007

Question: With all the news about the foreclosure rate skyrocketing, it seems like it would be a good time to pick up some good deals for rental properties. Where can I learn about investing in foreclosures?

D. E., Renton

Answer: There are some truly extraordinary bargains to be found in the foreclosure market. But even with the number of foreclosures rising, it’s much harder to find a real bargain than you might think. If you listen to the late-night TV real estate hucksters, you’d think that people in foreclosure are just waiting to give their house away for half of its fair market value. Nothing could be farther from the truth.

Think about it for a minute. If you lost your job and fell behind on your mortgage payments, are you going to hand me the keys to your house just because I’ve shown up on your doorstep to save you from foreclosure? Probably not. Most people want to keep their homes, and in the vast majority of cases, they find a way to come up with enough money to head off the foreclosure auction.

Or, if they can’t raise the money, they put their home up for sale through a real estate agent and attempt to recoup as much of their equity as possible before the house goes up for sale at a foreclosure auction.

Many years ago, I briefly dabbled in the foreclosure investing market. I found that some people would indeed offer to give me their houses for nothing down, but they were usually houses I didn’t want to own. Not because they were in poor shape, or in a poor neighborhood, but because they were over- encumbered with debt. For example, a house with a fair market value of $450,000 might have a first mortgage balance of $375,000 including back payments, plus home equity loans and other liens totaling another $125,000. That’s $500,000 of worth of debt on a $450,000 house.

That homeowner would love to hand that financial problem over to someone else, but it would be foolish for anyone to take title to the house prior to the foreclosure auction.

When the property comes up for auction “on the courthouse steps,” if no one else bids against you, you could pick up that same house for only the $375,000 owed to the foreclosing lender. Any loans or liens that had been recorded after the mortgage in foreclosure are automatically wiped out once the property is sold at auction.

Picking up a $450,000 house for $375,000 might be a good buy, but there’s a big catch: You have to pay cash at the auction. There’s no time to apply for a mortgage and wait 30 days until closing. You must have cashier’s checks in your pocket to cover the entire purchase price right there on the spot.

Needless to say, this weeds out a lot of competition. That’s why foreclosure auctions are primarily a game for full-time investors who have access to huge amounts of cash on a moment’s notice.

There are some bargains to be found in the three-month foreclosure period prior to the auction, but they are few and far between. You will probably have to analyze more than 100 properties before you find one that has enough equity left in it to make it a viable investment. Your individual investment goals will also play a large role in determining your success rate in this arena.

For example, investors looking for homes that can be purchased and resold for a quick profit must buy at least 30 percent to 40 percent below market value. Those deals are very tough to find, but it can be done if you have plenty of time and persistence. Investors looking for properties to hold as rentals may be willing to settle for buying only 10 percent to 20 percent below market value, which increases the odds that they will find a deal that makes sense. Most of the successful investors working in foreclosures do it as a full time occupation. It is very hard to analyze enough properties in your spare time to compete against them.

Finally, home buyers may be perfectly happy with a purchase price that is only 10 percent below market value because they are looking for a home to live in, not an investment. That greatly increases their chance of finding an acceptable house in the foreclosure market.

But be aware that foreclosure buying entails much more risk than buying retail. You must do a thorough title search to make sure there are no hidden loans or liens against the property that the seller has not disclosed to you. You also need to know all of the laws and regulations pertaining to the foreclosure process.

For novice investors, your best bet is to work with experienced investors who know the ropes. A few real estate agents in the Puget Sound area specialize in foreclosures.

If you want to learn the foreclosure market yourself, there are classes you can take locally at community colleges and adult education programs. You don’t have to pay hundreds of dollars to a get-rich-quick guru. In fact, that is the worst place to get information.

There are also many books on the subject that can be purchased or checked out of the library. Before you buy any foreclosure books or courses, be sure to check out this Web site: www.johntreed.com/Reedgururating.html. The site is operated by longtime real estate expert John Reed, who rates all the so-called “gurus” and tells you who is legit and who is a fraud.

It’s a great resource. As you will see on Reed’s Web site, most of the so-called experts who promote high priced foreclosure seminars are not what they claim to be.

The bottom line is, foreclosures offer great bargain opportunities for persistent and patient home buyers and investors, but they are much, much harder to find than the real estate seminar gurus would have you believe. You have to hunt and hunt and hunt some more.

We are entering a very strong buyer’s market for homes throughout the Puget Sound region, which means there are more sellers than buyers. You can drive a pretty hard bargain by just going through the normal process of buying a home listed for sale with a real estate agent. So you are probably better off shopping for a home that way rather than getting involved in the complex and risky game of foreclosure investors.

If you are not in a rush to buy a home, my advice is to wait until spring or summer, because there will be many more homes for sale at that time, and the sellers will be under more pressure to drop the price on their homes.

Mail your real estate questions to Steve Tytler, The Herald, P.O. Box 930, Everett, WA 98206 or e-mail him at economy@heraldnet.com.