When investing in foreclosures, understanding the lifecycles and different types of foreclosures—as well as knowing which type is hot at the moment and why—is crucial to choosing the right time to buy to maximize the potential of your investment and reduce risk. Within the circle of foreclosures there are three basic categories to recognize: buying before the foreclosure auction, buying homes directly at the auction and buying from the bank or auction after the auction is over. These bank-owned properties are referred to as real estate owned (REOs). Let us take a look at each of these types of foreclosure so that you can focus on the best segment of the foreclosure market.
Buying before the auction
When home owners are having trouble but are not yet foreclosed on, the property can be sold before auction. Such distressed properties include those from the multiple listing service (MLS), short sales, notice of defaults (NODs) and notice of trustee’s sales (NOTS). Because of the excess inventory of existing foreclosures on the market, the restriction of lending and the anxiety of home owners and investors willing to sit on the sidelines till something breaks, this could be one of the worst times ever to sell a house retail. Many sellers cannot compete against foreclosures, so unless they too enter foreclosure they have no viable way to sell their home for a fair price. This means that investors have no way to buy a home with equity in it at this stage of the foreclosure process. However, short sales are worth discussing.
In a short sale, the prospective buyer negotiates with the bank to let the home go for a value less than the amount owed on the home. This is but one solution for the home owner and a method for an investor to get a home at below market value. Note that home sellers may suffer tax consequences by selling their home in a short sale. In general, short sales take far too long to complete (4-6 months on average), the banks are too understaffed to handle the huge volume of short sales at this time (with many more coming in the future) and investors impatient for a good deal are dropping out of deals before they close. Some figures show that only 20% of short sales actually reach the closing stage. Though there are many companies, realtors and investors who are quite successful in short sales, it is a specialized niche in which most do not find the returns that they expect.
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Buying at auction
The second category of buying a foreclosure involves buying directly at the auction. Note that some states have judicial proceedings while others like California and Nevada have trustee’s sales that are held on the courthouse steps. Though there is little competition at these sales, the trust deed requires that the buyer have cash or the equivalent at the time of the auction to be the winning bidder. This eliminates a huge majority of potential buyers as most people do not have $100,000 or more in liquid assets. Because REO properties are now selling for less than the amounts owed on comparable properties in the notice of trustee’s sales (NOTS) stage, buying at the trustee’s sale is not as effective in most situations. Most properties are reverting back to the banks and becoming bank owned REO’s. Again, while there are professionals that are buying good properties at this stage, it is not an easy way for a beginner to break into the foreclosure arena and it is a very small segment of the market at this time.
Buying after the auction
By far, the best, easiest, safest, and most lucrative way to buy foreclosure properties at this time is at the third and final stage of the process: buying bank-owned properties (REOs) after auction. Because of the record volume of foreclosures now on the market and the huge number that will be coming in over the next 12-18 months, banks are lowering their prices daily just to move inventory. Banks are placing homes with listing realtors that specialize in listing REO homes. If homes do not sell in the 60-90 day period after being discounted, they return to the bank and are relisted with an auction company or sold in a bulk portfolio to much larger investors that can buy packages of $5 million and up. This secondary auction scenario has major issues that make it an undesirable way to buy real estate at this time. One should be very experienced before attempting to buy homes at any type of auction.
Markets like Southern California, Las Vegas, Phoenix and Florida are seeing prices that could drop to 50% from highs just 2 years ago. The new lower prices will once again result in positive cash flow for investors with 20% down fully amortized investments. As many first-timers are out of the market or sitting on the sidelines, the pros are preparing for tremendous appreciation on homes acquired in the slump.
Buying a bank-owned property is also much less risky than trying to buy at a trustee’s sale auction. The process is much faster than that of a short sale and negotiations are generally done within a week or two versus the 4-6 months required for a short sale. Bank-owned properties are almost always vacant so it is easy to get inside, inspect and run the numbers to see what amount of time or money the home may need to be brought up to speed. I would encourage every investor to get a good home inspection on any property they are looking to buy. Every good investor should gather as much information as possible before making a decision and always have an exit strategy in mind.
As an investor and licensed realtor that has bought homes in all stages of the foreclosure process, I am directing my clients to take full advantage of what could be one of the best foreclosure buying markets we will ever see. Based in the Las Vegas market for the last several years I have seen this market go from the number one hottest market in the nation in 2004, to one of the slowest in 2007, and back to one of the best and busiest markets in the U.S. this year. All because of something we call the foreclosure.