Buying foreclosure properties is a creative way to add assets to your real estate investment portfolio. And since you can often buy foreclosures for below-market prices, this investment strategy can be lucrative. But before you rush out to purchase a foreclosure, there are a few things you need to know.
In this guide to buying foreclosure properties, we’ll:
- Explain how properties end up in foreclosure, and what the process means for real estate investors,
- Show you how to buy a foreclosure property, and
- Discuss the pros and cons of foreclosure investing.
What Is a Foreclosure Property?
A foreclosed property is a property that has been seized because the owner failed to meet their financial obligations. In most cases, the property owners have defaulted on the mortgage, so the lender has foreclosed on the home with the intention of selling it to recoup their investment. But it’s also fairly common for homes to be foreclosed on due to unpaid property taxes or even unpaid income taxes.
The exact foreclosure process varies by state and by foreclosure type. But the general mortgage loan foreclosure process is as follows:
- The owner fails to make their scheduled mortgage payments.
- The mortgage lender notifies the owner of the missed payments and outlines how the foreclosure will proceed if no attempt is made to bring the balance current. At this point, the property is said to be in pre-foreclosure.
- Lenders often try to work with property owners at this point. If the owner is struggling with temporary financial issues, the lender might offer a forbearance plan or even a refinance to help get the owner back on track.
- If a suitable agreement cannot be reached, the lender will seize ownership of the property.
- The property will then be offered for sale to the public, with the proceeds being used to help the lender recover their investment.
How to Buy a Foreclosure Property
In the same way that the foreclosure process depends on the type of foreclosure and your local laws, the process for buying a foreclosure property can also vary. But there are generally seven steps to buying a foreclosure.
1. Understand the Different Methods for Buying a Foreclosure Property
You might think of foreclosure auctions as the way to buy a foreclosure. But that’s only one of many different methods used to buy foreclosures. Let’s quickly look at some of the most summon ways to buy a foreclosed property.
Pre-foreclosures are properties for which payments have been missed and a notice of intent to foreclose has been served to the owner.
If the owner can sell during this time, they can avoid having the foreclosure hit their credit report. From a personal finance point of view, selling during pre-foreclosure is favorable to a foreclosure. While the owner still loses the property, at least their credit will be spared. And they can use the proceeds from the sale as needed to get back on track.
Buying pre-foreclosure property is generally a matter of reaching out to the owner directly to see if they are willing to sell rather than risk foreclosure.
Short sales typically refer to properties that are sold while they are underwater, meaning that the owner owes more to the lender than the house is currently worth. This was common during the Great Recession of 2007 when home values temporarily dropped following the housing bubble.
With a short sale, the owner can avoid having a foreclosure on their record, but all the proceeds will go to the lender. Lenders generally have to approve short sales since they won’t be fully recouping their investment. But the lender may be willing to take a small hit to avoid the hassle and expense of foreclosing on the property.
Short sales can be listed for sale on the MLS (Multiple Listing Service) along with all the other local homes that are for sale. But you might also reach out to distressed owners who are underwater on their mortgage to see if they intend to weather the downturn or if they are interested in selling at current market rates.
Sheriff’s Sales Auctions
Sheriff’s sale auctions are used to sell foreclosures quickly so the lender can collect as much as possible of the defaulted loan without waiting on the market and enduring a 30-day escrow period. Remember: lenders are not in the business of holding physical real estate. They want to collect their passive interest income; they don’t want to be responsible for the asset itself.
Foreclosure auctions are typically held on the steps of the local courthouse at regular intervals (typically quarterly or even monthly). Anyone is welcome to attend the auction, and the highest bidder wins the property.
If a lender cannot sell a foreclosure at auction, the property becomes bank-owned. Bank-owned assets are sometimes referred to as real estate-owned (REO) properties because of the line item they occupy in the standardized accounting system.
REO properties are generally sold the old-fashioned way. You can find them listed for sale on the MLS, and you can make an offer and navigate the escrow period as you would with any other home for sale.
It’s not just private lenders who foreclose on properties. Government-backed loans (like FHA, USDA, and VA loans) can be seized by the government agency backing the loan (the Federal Housing Administration, US Department of Agriculture, or Department of Veteran’s Affairs, respectively).
Unlike bank-owned properties, which are generally listed for sale on the open market, government-owned properties are only listed with government-registered brokers. To buy a government property, you need to work with one of these brokers, which you can find on the HUD (Housing and Urban Development) website.
2. Determine Your Budget
Setting your budget early in the process can keep you from spending more than you intended when buying a foreclosed home. This is especially true when purchasing at an auction, as it’s easy to get swept up in the excitement of potentially winning an auction.
Setting your budget requires an analysis of several factors, including
- Market rents. How much can you charge monthly for the property?
- Vacancy losses. How much of the year will the unit remain vacant?
- Your financial safety net. How prepared are you for large, unexpected expenses (like if the furnace goes out, for example)?
- Stability. Are you confident in the stability of your local rental market and your ability to continue earning income at your current rate?
There is no absolute rule when it comes to setting a budget. The important thing is to make sure you’re comfortable with the monthly mortgage payments (including property taxes and insurance) plus ongoing maintenance expenses.
3. Get Pre-Approved for Your Mortgage
Getting pre-approved for a home loan always tops the lists of first-time home buyer tips, and it’s critical for foreclosure investing as well.
If you’re planning to use a mortgage loan to finance some of the purchase, you want to get pre-approved for the loan before you even start looking at properties. Not only will your pre-approval confirm how much money you’re able to borrow, but it will also show sellers that you are a serious, qualified buyer. And this makes your offer stronger when you find a foreclosure that meets your goals.
4. Find a Trusted Real Estate Agent Who Specializes in Foreclosures
Real estate agents are invaluable when it comes to navigating the real estate market. And since real estate fees are typically paid by the seller, buyers generally have nothing to lose by hiring a well-qualified real estate agent to represent their interest in the purchase. If you’re interested in buying foreclosures for rental property, you need to find a foreclosure specialist. These agents have the specialized knowledge required to help you navigate the foreclosure market and all of its potential complications.
5. Find Foreclosed Properties
Finding properties in foreclosure is more difficult than searching listings on Zillow. After all, you may be dealing with reluctant sellers, faceless organizations, or offline auctions. But when you know where to look, there are opportunities everywhere.
- Start with your real estate agent. Foreclosure specialists have insider knowledge of potential deals and can notify you when a property meets your criteria.
- Visit government and government-affiliated websites like HUD, Fannie Mae, and Freddie Mac.
- Check with your local tax collector to find dates for tax foreclosure auctions.
- Ask your local court clerk about upcoming mortgage foreclosure actions.
- Invest in a subscription to property databases like Foreclosure.com or PropStream.
6. Make a Well-Researched Offer
If you’re bidding to purchase a foreclosure at an auction, you probably won’t have the traditional escrow period to complete your due diligence checks like inspections and appraisals. So you’ll need to do as much research as you’re allowed before making a bid. In some cases, the home will be open to investors for a quick tour before the auction. And in other cases, you’re buying without a true understanding of the condition of the property. Your bid price should reflect the uncertainty you face and the risk you’re taking.
In non-auction foreclosure sales, you’ll probably have access to the property for normal home tours. You should be able to view the home and see the condition for yourself before making an offer.
In either case, your real estate agent will have access to data from recent, comparable sales that can help you arrive at a fair offer price. Leverage your agent’s knowledge to make a competitive offer without offering more than necessary.
7. Get a Home Inspection
Foreclosed properties are typically sold as-is. The sellers are often not in a position to make repairs or renovations to the property before selling. So getting a home inspection is crucial. You need to make sure you know what kind of condition the property is in before you agree to buy it.
A licensed home inspector typically charges between $400 and $800 for a home inspection, but the expense is well worth the peace of mind when it comes to any real estate investment.
Benefits of Buying a Foreclosure Property
There are a few key benefits of buying a foreclosure property:
- Lower prices. In pre-foreclosures and short sales, sellers are highly motivated to sell quickly, which can mean they’ll let the property go for less than the market rate. Similarly, banks and government offices don’t want to act as landlords, so they won’t be trying to find tenants. And that means they’re losing money every day they own the property. So they are generally willing to accept less than the market rate to offload the foreclosure.
- Value-add potential. Many foreclosed homes come with some deferred maintenance because the owners weren’t in a financial position to make necessary repairs. While this can mean more work and expense for investors, it also gives investors the opportunity to quickly and easily add value to the property. And this can allow the investor to command higher rents or resell the property for a higher price.
- Possibility of favorable terms. Since the sellers are highly motivated, buyers of foreclosures can often negotiate favorable terms. Lenders might be willing to offer you a lower interest rate or waive some of the closing costs, for example.
- Potential quick close. Foreclosures sold at auction offer a quick close because they don’t require an escrow period.
What Makes Buying a Foreclosure Property Risky?
While real estate is a low-risk investment, investing in foreclosures carries a bit more risk than purchasing a traditional sale. So, is it safe to buy foreclosure properties? As long as you’re aware of the potential risks and are willing to accept them, foreclosures can be excellent investments.
The potential risks include
- As-is sales. Don’t expect the seller to make repairs prior to closing. You’ll need to be prepared to make repairs on your own. And you should expect some hidden costs as well for issues that aren’t immediately evident.
- Potentially slow process. While foreclosure auctions offer quick property transfers, other methods of acquiring foreclosed properties can all take longer than a normal transaction. With short sales, for example, additional time is needed for the lender to approve selling the property at a loss.
- Possibility of squatters. While not common, it is possible that the previous owners could refuse to leave the property. The lender is unlikely to spend the time and money to evict the prior owners. So the buyers of the foreclosure would need to follow the proper legal channels to evict the squatters.
- Competition from seasoned investors. While standard home buyers are less likely to be in the market for a foreclosure, you will likely be competing with experienced investors for foreclosure properties.
- Might require large cash investments. Some foreclosure auctions are cash-only. And then you need to make sure you have cash on hand for the renovations and repairs needed as well.
Foreclosure Alternative Real Estate Investing Options with Gatsby Investment
If you like the idea of building a real estate portfolio, but you’re not willing to assume the risks of buying a foreclosure, we have a clever alternative for you to consider: real estate syndication.
Real estate syndication is when investors pool their capital to purchase a property and share in the returns. The real estate project is managed by a sponsor, and all the investors own a share of the entity that purchases the property, as well as owning a stake in the underlying real estate.
Syndication comes with the same benefits as traditional real estate investing (flexible investment options, appreciation over time, rental income, tax benefits, and a hedge against inflation). But it offers additional benefits as well, including
- Low minimum investment amounts.
- Leveraging other investors’ capital to access larger deals than you could buy alone.
- The option to spread your investment funds across multiple projects for instant diversification.
- Professional management by a team of real estate experts.
- You can invest from anywhere. Since you won’t need to actively work on the property, you can access the best cities for real estate investing without living in the area.
Gatsby Investment is proud to offer real estate investment opportunities in the highly desirable Los Angeles housing market. Our local real estate analysts use many of the same strategies foreclosure investors use to buy properties below market value. We scout properties (both on and off the market), looking for distressed assets that we can negotiate a low price and favorable terms on. Then we determine the best ways to add value and create the greatest possible return potential for our investors.
With our wide range of investment opportunities, there’s an option to suit any real estate investor’s goals. We offer short-term flips and long-term rentals. You can even get in on the ground floor of a new multi-family development!
Unlike foreclosure investing, which comes with a steep learning curve and requires hands-on management, syndication investing is easy! Simply sign up for a free account with Gatsby Investment, get verified as an accredited investor, and choose your investment property (or properties). The hard work is done for you by our experienced project managers so you can kick back and enjoy the rewards!