More than 1.2 million properties had foreclosure filings in 2007, a nearly 75 percent increase from 2006 and a nearly 150 percent increase from 2005, according to a recent RealtyTrac report. The record numbers could represent a prime opportunity for foreclosure investors.
“Two years ago, talking to a seller would mean [that you would hear], ‘I don’t need an investor, I’ll just list it on the market and get full market value from a homebuyer.’ Now all of [a] sudden there’s a strong demand for investors, and sellers are much more willing to sell at a discount….There’s more value in having cash than in having a house if you’re in need of money,” Alexis McGee, president of Foreclosures.com, said.
McGee makes purchase decisions based on a profit formula. “I recommend you budget a 15 percent profit on the current resale value….You’re going to budget based on how long your hold is going to be, so that way it doesn’t come out of your profit,” she said. “I estimate my quick resale value for today’s market, and then deduct my cost to acquire, repair, hold, sell and profit. What is left is what I pay for the house. In a slow market, those deducted costs average 35 to 50 percent of the resale value.”
![filekey=|1570| align=|left| caption=|Repair expenses can turn profit into loss for investors in foreclosures| alt=|Renovating a foreclosed property|]Investors can easily underestimate their expenses when first starting out in foreclosures, and would be wise to allow a margin of error, according to McGee. “I had a deal that I thought the repairs were going to be $15,000 and it worked out to be more like $35,000, and that was a big difference,” she said. “There are a lot of clients that make a mistake and don’t have a big enough profit margin spread and end up losing money.”
Knowing where to look for foreclosures is also key to an investor’s approach.
Though most foreclosure markets are—by nature—struggling, certain areas are more ripe for investment than others. Any market that is suffering employment losses is likely better left alone, as a lack of jobs typically also means a lack of buyers.
“Even though California has depreciating values, we still have people moving in and we still have employment growth, so you know it’ll balance out. Versus Detroit, which is losing 10 percent of [its] employment. People are leaving the state because [there are] no jobs,” McGee said.
There are several different types of foreclosure purchases that investors can pursue, particularly in the today’s soft market. Some possibilities include pre-foreclosures, REOs—also known as bank-owned properties—trustee sale auctions and short sales.
Investors can buy pre-foreclosures with equity before the bank takes possession of the home, effectively bailing out the homeowner before the actual foreclosure occurs. McGee recommends that investors purchasing pre-foreclosure properties stay within driving distance. “If your seller wants to meet with you, and it’s two days before they lose their home, you need to be able to see them and not have to go on an airplane,” she said.
![filekey=|1571| align=|right| caption=|Banks will offer discounts on foreclosures they have held for a while| alt=|A foreclosed property discounted by the holding bank|]On the other hand, when buying REOs, proximity isn’t important. “You can buy [bank-owned properties] in any city. Because one relationship with a bank could lead you to deals anywhere in the country,” she said. After the lender has foreclosed on the property and held it for a while, they will be more likely to accept a more discounted offer from an investor, according to McGee.
It is also possible to purchase foreclosure properties through a trustee’s sale. When a homeowner defaults on a mortgage, the designated trustee is able to foreclose on the property and sell the home through a trustee’s sale. These homes are auctioned off to the highest bidder after the foreclosure has taken place. Investors can purchase these homes with less outstanding debt on the property because junior liens—liens placed on the property after earlier liens—will be wiped out, according to McGee. “[Investors] need to have all cash and no title insurance, and [the property is sold] as is with no inspections—so this is senior class investing only,” McGee said.
A fourth possibility for foreclosure investors is to purchase property through a short sale. These are homes that have not yet gone into foreclosure. The homeowner is unable to continue making payments, but the home is not worth the outstanding amount on the mortgage. The homeowner makes a deal with the lender to sell the home at a loss. McGee does not recommend short sales to investors because they typically take a long time to complete and often fall apart at the end of the deal. Additionally, less than 10 percent of lenders approve short sales at the discounts she requires, she said.
Ultimately, investors should remember that the foreclosure business is a people business. It’s important that investors know, or learn, how to interact with people if they want to get involved in this market.