What is and How Do I Buy A Foreclosure Property?
/Why is real estate a good investment?
It’s more stable than the stock market and gives you a steady cash flow if you have enough rental properties. The tax breaks are significant, and most real estate appreciates over time.
Purchasing pre-foreclosures can be a great way to get started in the real estate investment business if you’re serious about learning how the process works and willing to follow some simple steps.
What exactly is a pre-foreclosure?
As the name implies, a pre-foreclosure is a house that the bank hasn’t foreclosed on yet, but that is in jeopardy of foreclosure. It hasn’t been put on the market and is still occupied by the owner, who has fallen behind on the mortgage payments. After a pre-foreclosure is listed, it becomes known as a short sale. The majority of pre-foreclosures are not listed.
Real estate investors love pre-foreclosures for several reasons:
They aren’t on the market yet, so they’re not listed on the Multiple Listing Service. This eliminates a lot of buyer competition.
Pre-foreclosures can be great deals because owners are anxious to sell and will often accept an offer that is significantly below market.
Experienced real estate investors target desperate owners and offer to pay the amount owed to the lender. They then buy the properties from the owners at a deep discount. Once you have decided you want to make this kind of investment, there are specific steps you need to take to ensure a successful transaction.
1. Assess the neighborhood
Landscaping and Curb Appeal.
If your goal is capitalizing on appreciation, you should focus on neighborhoods that are well-maintained. You want to see a variety of architectural styles and landscaping. Cookie-cutter neighborhoods are boring and don’t appeal to most home buyers. Homes in the best neighborhoods are the ones that appreciate most quickly in value.
Sidewalks.
Sidewalks say a lot about a neighborhood. They usually indicate convenience to parks and shopping. Sidewalks allow residents to walk their pets, jog and perform other outdoor activities. They are safer than neighborhoods without sidewalks.
Good Schools.
Private and public schools, kindergarten through twelfth grade, and even pre-schools can affect property values. Good schools should be a priority on your neighborhood analysis list because they are going to have a big impact on the resale of any pre-foreclosure you invest in.
Annoying Sounds.
Air traffic, trains, medical centers, and local bars all create noise that is an unattractive negative for many home buyers. Visiting a neighborhood at different times of the day and night will help you determine how much of a sound annoyance you are dealing with.
Purchasing in an area that is convenient to shopping, dining, and recreation is almost always a plus.
Property Taxes and Other Fees.
You need to know what the property taxes are on any real estate you purchase because it will affect your bottom line. In addition, you must factor in homeowner or condominium association fees and any other assessments that will affect your cost analysis.
Low crime rate.
It’s not hard to find out about crime rates in the neighborhoods you’re looking at. Most of them are just an internet search away. In addition to the information you get online, you can also discuss the matter with your real estate agent and local law enforcement.
Don’t be tempted to downplay the importance of a safe and secure neighborhood environment. It’s just as easy for home buyer’s to access the same information you have.
Appreciation.
The more vital a neighborhood is the more likely your property will increase in value quickly. Things to look for that tend to make areas appreciate include:
Millennial homeowners
Neighborhood art galleries and exclusive shops
Nearby juice bars and coffee shops
Airbnbs with five-star reviews and escalating rates
2. Generate leads
You can find pre-foreclosures the old-fashioned way or use modern technology to make your search quicker and more efficient. Generating leads the old school way includes:
Checking out neighborhoods.
You can spend hours driving around neighborhoods looking for signs that indicate financial distress. These include overgrown yards, overflowing mailboxes, and piled-up newspapers.
Cold calling.
Most real estate transactions are a matter of public record. You can find a wealth of information in the county assessor’s office. What should you look for? Absentee ownership, dissolved joint tenancies, senior citizen owners, and for-sale properties that aren’t moving are prime examples.
Once you have the information, you can start calling. This method is labor intensive and has about a one percent rate of success.
Emailing and direct mail.
You take the same steps as with cold calling. The only difference is that you have to find email and physical addresses. The success rate is about the same.
If you prefer to use a more twentieth-century approach, you can access your computer and type in specific keywords. These keywords will bring up listings that have pre-foreclosure issues associated with them. Examples include:
No FHA
As is
Investor opportunity
Owner will carry
Bring all offers
There are apps and websites you can subscribe to that will facilitate your property search. They can help you generate leads that include:
Off-market properties
Pre-foreclosures
Non-owner-occupied properties
Senior owners
Pre-probate
Divorce filings
You can also get important information to help you evaluate market rates by pulling up comparable sales from public records and local MLS listings. Search filters can help you with:
Property characteristics
Ownership information
Lien and foreclosure details
Tax Information
Mortgage Information
Once you find properties you are interested in, these apps will give you current phone numbers, email, and physical addresses so you can contact potential sellers quickly and easily.
3. Do your due diligence
Due diligence is a comprehensive appraisal of the property you are considering purchasing. You have to be thorough, especially when you are investing in pre-foreclosures. There is a reason these houses are in the foreclosure process. Skipping due diligence steps can put you in a worse position than the person being foreclosed on.
There are three general parts to due diligence:
Financial
First, you have to ensure you have sufficient funds to pay for the down payment, closing costs, and monthly payments.
A conventional loan may not be an option for your pre-foreclosure purchase. You may have to find a private, hard money lender willing to make you a loan.
Be sure to get a twelve-month breakdown of the property expenses, including utilities.
Get a copy of the lease or rental agreement, including the rent history.
Research property taxes.
Legal
Make sure there aren’t any outstanding liens or judgments against the property you are purchasing. If you buy a property with existing liens, they become your responsibility.
The easiest way to ensure you are buying a property free and clear is to hire a title company to do a title search for you. Not only will the company make sure there are no unresolved liens or judgments against the property but will check for any other title irregularities. A comprehensive title search is well worth the money it costs.
Legal due diligence is especially important when you are dealing with distressed properties.
Physical
This critical step includes a home inspection. Unless you are a contractor or home inspector, you will need the services of a professional. They will be able to uncover any potential problems that can become a financial nightmare down the road for you. Inspectors look for foundation issues, mold, leaky roofs, wiring and plumbing that isn’t up to code, and heating and air conditioning issues.
Cosmetic issues are to be expected. It’s the big ticket items you want to avoid because they will significantly affect your cash flow.
4. Obtain a loan
Before you even start looking at houses, you need to get pre-approved for a loan. This tells sellers you are a serious buyer, and it gives you purchase price parameters to work with.
Investing in pre-foreclosures usually means you are not just making a down payment on a loan, but paying off the loan balance including any liens against the property and unpaid homeowners and mortgage insurance. The easiest way to ensure a smooth transaction is to pay cash for the property. If you don’t have sufficient funds to pay cash, you will probably have to obtain a hard money loan.
What are hard money loans?
Hard money loans are different from conventional loans in that the lender is less interested in your credit score and income and more in the property’s potential profitability. The after-repair value (ARV) is used to determine how much the property will be worth after any renovations are completed.
A hard money loan is a lot easier to get than a conventional mortgage. Another advantage of a hard money loan is that it usually takes days rather than months to get approved for one.
The downside is that hard money loans are very expensive. You may have to pay as much as 18% interest on one, and you don’t have as long to pay back the money.
5. Make the offer
Once you have done your due diligence and obtained a loan, you are ready to make an offer. The easiest way to purchase a pre-foreclosed property is to pay off the mortgage and purchase the property directly from the seller.
Desperate sellers can be easy prey for seasoned investors. Many times these sellers don’t even know what the market value of their homes is. Investors come in and make lowball offers that sellers take because they don’t know what else to do.
Because of that, laws have been enacted allowing sellers to renege on sales even after all parties have agreed upon the deal. These laws vary from state to state. You need to know what the legal ramifications are in the state in which you are purchasing a property.
Steps to take after closing
Change all the locks.
It is not safe to assume you have the only keys to your property when they are handed over to you at closing. Friends, family, and neighbors may still have copies. The last thing you need is a stranger entering your house without your knowledge or permission and wreaking havoc.
Put the utilities in your name.
The utilities will be in the previous owner’s name until you change them into yours. You can be sure one of the first things the prior owner will do is to close out or transfer their utility account. To avoid disconnection, make transferring the utilities one of your top priorities.
Start renovations immediately.
If you have renovations or repairs planned, you should start on them as soon as possible. These issues won’t improve over time. Instead, they will get worse and cost you more money if you procrastinate.
In conclusion
If you want to invest in real estate, pre-foreclosures are a great way to start. You can purchase property at below market rates while facing less competition than you would bidding against other investors at a foreclosure auction.
Avoid the common mistakes novice real estate investors make by learning the ropes and doing your due diligence. Before you can be truly successful at investing in pre-foreclosures, you have to develop in-depth knowledge of the field, hone your negotiating skills, and have plenty of cash on hand.