The Art of the Foreclosure Deal

It may not be internationally recognized in the same stream of consciousness as a masterpiece by Renoir, Goya, Monet or Picasso, but a well-constructed foreclosure investment deal can be a thing of beauty to those who appreciate the effort that went into it.

 

For Chicago-based investor/educator Doug Crowe, president of real estate investment group Springboard Corp., not only was the bank-owned condo he recently purchased a turn-of-the-century work of art, but so was the deal he worked on both ends.

 

“I invested about 12 hours of my life and made $18,000 on it,” Crowe said (see “Anatomy of a Foreclosure Deal” on Page 5).

 

Envision the “Big Picture” Before Beginning

As investors are well aware, the business cycle switched over to a buyer’s market in 2006, which made determining whether a particular property is a worthwhile addition for one’s investment portfolio a much more difficult decision to make.

 

And there are many properties to choose from. Foreclosure data service RealtyTrac lists more than 1 million foreclosure filings in nearly 2,500 counties around the country. In the first half of 2007, the service reported more than 925,000 foreclosure filings nationwide, up 56 percent from the first half of 2006.

 

Many homeowners facing foreclosure today are upside-down financially for various reasons and can’t refinance their way out. Housing stocks around the country have growing inventories making it difficult for distressed homeowners to sell their way out. Prices continue to decline in many parts of the country and home sales volumes are dismal at best.

 

To Southern California-based investor and trainer Bruce Norris, president of The Norris Group, education and gaining firsthand experience are essential for the novice investor.

 

“Concentrate on education,” Norris said. “If I were a new investor I would run an ad that I buy properties, and have conversations 50 times a month with sellers. It’s good practice. You may get very fortunate and have a motivated seller. You could get lucky!”

 

Designing the Deal: A Real Work of Art

There are many books, seminars and workshops in the marketplace today addressing investing in real estate — particularly in foreclosures. Many of those education vehicles go through the same basic “Investor 101” essentials, such as selecting a geographic area to concentrate efforts, determining the type of real estate (single-family, condo, townhomes, coops, duplexes, etc.) to pursue, assembling an investment “team” (lawyer, accountant, contractors, real estate agent, etc.), and having a pre-approval letter from a lender in hand.

 

However, from Crowe’s perspective as a seasoned investor and long-time trainer in the business, the artistic freedom to design a deal that works best for each individual investor starts with establishing investment goals before focusing in on the real estate.

 

“Generally speaking, most people look at the real estate first. They should be looking at where they want to end up at five to seven years down the road,” he said.

 

Once investment goals have been established, designing a good investment deal is like a work of art — it all comes down to inspiration. What stage of the foreclosure process is the investor inspired to work in? How much wealth will inspire success? How many properties in should be in a portfolio? How long until retirement? Bottom line: what it takes to be properly inspired is individual to each investor.

 

Inspiration Depends on Information

Once the goals are in place, true inspiration can flow from proper information. At this point it comes down to the real estate and being realistic. In other words, as Crowe said, investors should take stock of ALL of their capital: human and financial, as well as their time and personality.

 

“Then go look at the properties,” Crowe said. “Look at those that have profit potential. We want an immediate profit. Only focus on deals where you have a motivated or flexible seller. We don’t care about the location, price or condition.”

 

Locating and properly analyzing a specific property for its investment potential takes access to competent and reliable sources of up-to-date foreclosure information. Looking at the RealtyTrac website, for example, an investor can dissect a property’s investment potential upfront through the combination of the property details, lien and loan history and comparable sales.

 

“You always make the profit when you buy it, not when you sell,” Crowe said.

 

Although Crowe and Norris have their own artistic styles for negotiating and closing a deal, both rely on similar mathematical formulas to help them determine whether the property in question will deliver that front end profit they’re seeking.

 

In today’s market, both investors recommend building at least a 30 percent margin into a deal to be assured of ending up with some profit. For new investors, that margin should probably be even higher (maybe 65 percent) to allow for underestimated costs, Crowe added.

 

In other words, an investor should calculate the market value of the property after repairs are made, multiply that value by 70 percent and then deduct the estimated cost of rehab to determine the maximum amount to offer for the property. The margin is quickly eaten up in real estate commissions, holding costs, closing costs, insurance costs, property taxes and the investor’s personal business overhead. The profit is what’s left over after all those bills are paid.

 

“I want to know what something is going to sell for. I have to decipher which ones have equity and which ones don’t,” Norris said. “About 95 percent of them don’t. I want to mail to the five percent who do have equity. When you have a list where 95 percent of them have no equity, it’s time to get back into short sales. If you’re in the short sale business then you can mail to the other 95 percent.”

 

Because so many people in foreclosure do not have equity to work with, Norris is hesitant to work with homeowners in foreclosure unless there is enough leverage in the deal to make sense. To work a deal like this he wants to structure the deal as “subject to” the existing loan so he can assume it. The “subject to” clause opens up the potential sales market for the property while allowing him to sell it without an agent, and thus reduce his holding and selling costs.

 

“There are only two reasons why I would buy a property in this market: if it has a margin of profit, or if it cashflowed from day one,” Norris said. “Some states don’t allow that. In California prices are too high to have cashflow from a rental. So investors are moving to other states and investments other than real estate. You have a lot of money exiting real estate right now.”

 

The last foreclosure Norris bought came as a result of a mailing campaign in the Moreno Valley area in Southern California. An owner in foreclosure called Norris in response. Norris bought the property for $332,000, spent $17,000 in repairs and sold it for $420,000.

 

“It was not a heavy fixer at all. We closed our purchase in September 2006 and closed the sale in February 2007. We had it for a little over five months and when all the dust settled I think we made about $35,000. It was just a phone call from someone in foreclosure,” he said.

 

Under present market conditions, both Norris and Crowe prefer to work with properties after they have gone back to the bank as REOs.

 

“Most of the wholesale deals are created by the foreclosures occurring, but we don’t buy the properties from the people who are in foreclosure. We let them go back to the bank, let the bank take the beating, and then buy from the brokers who get the REO listings,” Norris said. “Most of our effort now is not going to people in foreclosure. We are shifting to developing relationships with agents who are controlling the (REO) inventory. That’s going to be true for the next three to four years.”

 

Exit Strategies Complete the Masterpiece

An artist keeps his or her options open as to how and when the masterpiece is completed. In a similar way, real estate investors have to account for all contingencies and keep their options open in case the deal works out a way other than originally intended.

 

“There are only two ways to make money in real estate,” Crowe said. “Sell it or rent it. Sometimes you can buy something and make a profit and then take the money and buy something else and hold it. You have to have a Plan A and a Plan B. If you can’t sell it, then rent it. It you can’t rent it, then lease-option it. A basic guideline is to make sure you have multiple exit strategies on any deal you do.”

 

 

Foreclosure Deal Case Study

 

Courtesy Doug Crowe

 

The Property: a 2,200 square foot, three bedroom, two bathroom condo in a greystone building originally built in the Al Capone era of the 1920s. The property had been gutted by the previous owner, who had run out of money for the renovation. So the unit was down to the walls, plus the crown molding, cherry cabinets and hardwood floors — with the original gas lanterns still on the walls. “It was just beautiful,” Crowe said.

 

The Location: on the south side of Chicago in a changing neighborhood that became poverty stricken during the Johnson Administration back in the 1960s. Then in the early 2000s Crowe estimates that up to 40 percent of the neighborhood started cleaning up and changing over to a more livable area.

 

The Deal: the property had already gone back to the bank as an REO. Remodeled greystones in the neighborhood were fetching $260,000 to $280,000. Since the property had been gutted, however, conventional financing was out of the question, so the bank came to Crowe and sold it to him for $100,000. But the property still needed $60,000 worth of rehab, he estimated.

 

Crowe then proceeded with his “Plan A” to buy it, fix it up and then possibly rent the unit. That was until the regular contractor he was using on his team had to take a sudden and prolonged leave of absence due to a family illness. Having been burned so many times by contractors he did not know, and therefore couldn’t trust, Crowe switched over to his “Plan B” and decided to sell the property to another investor for a profit. So instead of making the $100,000 profit he was expecting to make on the deal, he settled for making more than $18,000, and was happy with the outcome nonetheless.

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