My friend, Mary, is like most real estate investors. She’s always looking for ways to improve her odds of finding cheap properties. Recently, she attended the Brooklyn foreclosure auction in the hopes of nabbing at least one of a few distressed houses she’d seen advertised on the Multiple Listing Service. She called me up after, frustrated that buying a foreclosure auction home was not as easy as she thought it would be. The only thing she left with, she said, was the sinking feeling that she and a lot of other investors had wasted their time.
Like Mary, I tried to buy foreclosed homes in Chicago, where I invest, by attending foreclosure auctions. Unlike Mary, I didn’t wise up to how much I’d been spinning my wheels until another friend stepped in and ran interference. I’m glad he did. When I was able to step back, I could clearly see the pros and cons of buying a foreclosure auction home and I didn’t like what I saw. So, I decided to take his advice, skip the auctions, and spend my investing time more wisely. Wanting to pay it forward, I passed this advice on to Mary. Here’s what I told her.
Pros and Cons of Buying a Foreclosure Auction Home
According to the latest U.S. Foreclosure Market Report released by ATTOM Data Solutions, foreclosure activity–which includes default notices, repossessions, and auctions–has dropped below pre-recession averages in more than half of U.S. housing markets. Across the country, foreclosure filings are down by 13% from 2017’s third quarter and 35% from just over one year ago. Additionally, most of the foreclosures that resulted from high-risk lending during the housing bubble have been removed from the pipeline–many of them likely bought, rehabbed, and sold by investors.
But, according to the same report, foreclosure starts are up in 24% of metro area housing markets and defaults on FHA loans issued in 2014 are at their highest in all markets since 2009. And, it’s possible that we’ll see an uptick in foreclosure activity once homeowners start to feel the pinch created by the changes in the federal tax code. Particularly in cities where property taxes are already high, the federal cutback in homeowner deductions could make the cost of owning a home prohibitively expensive and put existing homeowners in financial distress. For real estate investors looking for ways to find great investment properties, the possibility of an upsurge in foreclosed inventory is a welcome forecast, especially in markets where it may have flatlined.
Since the majority of foreclosed homes are sent to auction where the highest bidder can take ownership of a house at a potentially discounted price, auctions are a favorite with investors who want to buy and renovate property as cheaply as possible. There’s also very little competition with owner-occupiers at auctions since traditional sources of financing, like bank loans, can be difficult to get for these homes. The low price points and seemingly high odds of securing a fixer-upper that could produce good returns are the biggest pros that auctions have to offer.
But, because new foreclosure rates are currently uneven across the U.S., with no guarantee of when, or if, the inventory of foreclosed properties will increase, chasing auction homes right now might not be the right direction for finding the best deals. Of course, there are other reasons as well. Let me explain.
- Investor competition. Competition with buyers who want to purchase a distressed home they hope to live in after the rehab may be small at auctions, but competition amongst investors is big. A lot of real estate investors rely on foreclosure auctions as a way to find cheap property. So, investor attendance can get pretty high and, as a result, so can the bidding. If you’re not careful, you could get ensnared in the bidding frenzy and overpay for a property that you win. If you’re a savvy investor, you’ll walk away empty-handed, just as Mary did, glad to not have overpaid on a fixer-upper, but frustrated that you wasted your time.
- Property condition. When you buy a foreclosure auction home, you’re purchasing property that may be in such poor shape that a cost-effective renovation isn’t possible. By the time a house has been repossessed by the bank, the homeowners have had time to grab anything valuable–including fixtures, appliances, and copper pipes–in an effort to get what they can out of a financially and emotionally upsetting situation. It’s also likely that, before the foreclosure, they didn’t have the means to keep up with any normal maintenance or repair. Even if they left the house in the best possible condition considering the circumstances, foreclosed homes often sit vacant for long periods of time before going to auction. So, the condition of the property can still rapidly deteriorate due to neglect, weather, vandalism, and the presence of squatters. You’re not always allowed to schedule a home inspection before closing on an auction house either, which makes the possibility of buying a money pit that won’t earn you a profit after the rehab a real risk.
- Overall cost. The potential for buying a prohibitively-expensive rehab project isn’t the only high-cost risk you might encounter with a foreclosure auction home. There could be deed restrictions, easements, and encroachments that limit what you can do with the property and diminish its after repair value. You could also become responsible for any unresolved liens, eviction proceedings, or other encumbrances that are expensive to remedy and that impact the title transfer. Auctions referees don’t always disclose these added costs because the court doesn’t necessarily know they exist. And, because hefty cash deposits are required the day of the auction, your chances of discovering these problems before they consume your potential profits are remote.
With these issues in mind, I think buying foreclosure auction homes is the wrong way to go. Even if foreclosure rates escalate in the coming year and boost the inventory of these homes, buying from distressed homeowners before they lose their house is a better direction to take. You have a stronger chance of quickly finding a fixer-upper home at a significant discount and in a condition that can be rehabbed less expensively. You also have the opportunity to help a family get out of an ugly situation with more dignity, and even more cash, than they might otherwise hope for.
Helping Distressed Homeowners Before Foreclosure
Once I realized that the drawbacks of trying to buy foreclosure auction homes were too great compared to the benefits, I decided that helping distressed homeowners in the pre-foreclosure phase was the best route for me. All I needed to do next was find motivated sellers who wanted to sell their homes quickly, and cheaply, to make the best use of my time and theirs. So, my next decision was to become an independently owned and operated HomeVestors® franchisee. HomeVestors®’ franchisees have access to the nationally-known “We Buy Ugly Houses®” marketing campaign to help generate leads from distressed homeowners. It’s a more effective, and efficient, strategy for getting good deals than going to auctions–whether foreclosure rates are high or low. Mary was all-in for this real estate proven investing approach.
And, if that sounds like a good deal to you, you should call HomeVestors too.
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