The Three Faces of Foreclosure Investing
By Andy Heller and Scott Frank
So you want to invest in residential foreclosures? Not sure quite where to start? It is helpful to understand first that there are three faces to foreclosure investing, each with very different characteristics.
The first face of foreclosure investing is "pre-foreclosure." The pre-foreclosure period begins when a homeowner gets behind on his or her loan, and ends with the foreclosure sale. The pre-foreclosure phase itself is divided into two stages.
The first stage covers the period of time beginning when the homeowner misses his or her first mortgage payment, and ends in the final month preceding the impending foreclosure sale. During this time if a homeowner is not already marketing his or her home, it will be up to the investor to reach out to and find these distressed homeowners through mailings, ads ("We buy homes fast" and "We have CASH for homes") and networking.
The second stage of pre-foreclosure occurs during the final month leading up to foreclosure. The precise laws differ from state to state, but most states require some form of public notification of a pending foreclosure. Investors can seek out these notifications, and many have ample contact information for the investors to approach the distressed homeowner. RealtyTrac is a great resource for finding these pending foreclosure notifications in your area.
The pre-foreclosure face offers wonderful wealth-generating potential to investors. Investors can approach distressed homeowners, and give them some quick cash when there is ample equity in the homes. There are also opportunities to work with some of the foreclosing lenders directly (with the distressed homeowner's approval of course), as it is in the lender's interest to avoid costly foreclosures.
Pre-foreclosures may be arguably the most written about method of finding discount property. It is amazing how many distressed homeowners wait to the last minute with their properties, always thinking they would be able to bail themselves out. It is then, with little time left on the clock, that some of these distressed homeowners realize that the only viable remaining option is an investor in a position to move quickly to buy their home.
On the plus side, pre-foreclosures can be very, very lucrative. A typical pre-foreclosure might have an investor paying off a distressed homeowner's $220,000 loan, giving the distressed homeowner $25,000 in cash to walk away with, and taking over the $350,000 property. The primary negative associated with pre-foreclosures is the taxing emotional element that can come with constantly dealing with homeowners involved in a downward spiral. Simply put, this will not be feasible for every investor.
Almost 20 years ago we were fresh out of one of those "get-rich-quick" seminars. Our model was to focus on pre-foreclosures, and we went to only one home. The family we visited was the most likeable family. The husband was a veteran, and both he and his wife lost their jobs within a short time of each other. When visiting the home their little girl took my hand and showed me the "doggie window," the hole in the kitchen door for their family dog to go in and out of the house. I left this visit emotionally drained and with a sour feeling in my stomach. This was the last pre-foreclosure we ever visited.
The second face of foreclosures is the "foreclosure sale." This occurs when the loan on the home is not brought current by the distressed seller or the home is not sold.
Again, the procedures and processes have slight differences from state to state, and prospective investors will need to educate themselves as to the foreclosure sale process in their respective state. For many states, the sale of the property takes the form of an old-fashioned auction on the courthouse steps (in several states this occurs on the first Tuesday of every month).
Like pre-foreclosures, the foreclosure sale also can be a quite lucrative way to purchase property. However, unlike pre-foreclosures, there is no emotional element other than controlling your adrenalin at the foreclosure sale. The main drawbacks: investors are often bidding on property they have not been able to access (this makes assessing repairs and improvements quite challenging); an investor may need to quickly assess the title and any liens (this can lead to mistakes and can be costly); and many states require certified funds at sale or within a very short timeframe (such as 24 hours). While investors can make a lot of money with foreclosure sales, having access to large sums of cash or fast financing limits these to a subset of experienced and well-financed investors. If you're interested in this face, we suggest you go to a foreclosure sale and see how one works firsthand.
The third face of the foreclosure process is the "post-foreclosure." If the property is not sold in pre-foreclosure and not purchased by an investor at the foreclosure sale, then it goes back to the bank or other lien holder who secured the loan.
With interest only, 100 percent financing, and other loans offered today requiring little down payment, record numbers of properties are going through the foreclosure process without attracting investor interest in the pre-foreclosure or foreclosure sale stage. These properties eventually land on the desk of someone within a financial institution (bank, mortgage company, etc) who has the responsibility of disposing of these properties. Many institutional lenders carry so many properties that they have entire departments dedicated to this task. Oftentimes, these departments are referred to as REO (real estate owned) or Post-Foreclosure Departments.
When contacted by investors, institutional sellers will generally fall into one of three categories.
The first category is those institutional sellers that will be happy to work with an investor directly, bypassing listing the property with a real estate agent. The second category is institutional sellers that will at first indicate plans to list their REO property, but can be persuaded by the skillful investor to delay the listing until the investor has a chance to see the property and make an offer. The third category is those institutional sellers that will not consider working with an investor directly, but will instead list their properties with selected real estate agents.
One of the key benefits of purchasing post-foreclosure is that the sellers have no emotional ties to the property. For financial institutions, this is a simple business transaction.
Further, investors seeking post-foreclosures should remind themselves that institutional sellers are in the business of lending money, not managing real estate. At some point, if a bank or lender has too many properties on their books, the number of REO properties will need to be reduced, sometimes quickly, and oftentimes at a discount to investors. It is not as common to acquire post-foreclosures at 30 percent discounts — as is possible with some pre-foreclosures (and even some foreclosure sales). But the available pool of properties at investor discounts of 10 percent to 20 percent is plentiful.
If the investor's sale or rental model minimizes the marketing time and holding costs associated with each purchase, the investor will find post-foreclosures to be a good source of discount real estate. Many predict this source will increase significantly in the coming years due to record numbers of new loans today offered with little or no down payment required. Our model allows us to minimize holding costs and marketing time, so we have elected to focus on post-foreclosures as our primary source of finding discount real estate.
Foreclosures "is a buzz word that attracts the interest of many new real estate investors. It is helpful to understand from the start that there are actually three very different "faces" to foreclosure investing. Most established investors that buy foreclosures are actually focusing primarily on one of these three "faces." Therefore, for new investors who are just getting started, take a look at the characteristics (time, money, risk, emotional element, potential profits) of each of these "faces" of foreclosure investing and select the one that is the best fit for you.
Whichever one you select, implemented properly, the three faces of foreclosure investing all have the potential of putting a smile on your face as an investor.
Andy Heller and Scott Frank are co-authors of the Fortune Magazine recommended book "Buy Low, Rent Smart, Sell High." Combined, they have been investing in residential real estate for over 40 years and have purchased and sold approximately 100 residential properties on a part – time basis. Visit them at www.regularriches.com