One question I’m often asked by people new to real estate investing is “how can I find foreclosed houses?” They generally think that foreclosures are the best way to get houses for cheap to fix and flip, wholesale, or use as investment properties. They’re surprised when I tell them that buying foreclosures may not be the best real estate investment strategy, especially for someone just starting out.
Sure, there’s often an abundance of foreclosures on a market at any given time, but there are also a lot of risks to buying a foreclosed house—risks that could impact your bottom line and potentially result in losses. Luckily, there are better ways to find properties that don’t come with such risks.
Let’s discuss the top 10 risks of buying a foreclosed house and the best ways to avoid them.
The Top 10 Risks of Buying a Foreclosed House
In a perfect world, buying a foreclosed house would be a worthwhile investment. You’d be able to purchase it at a decent price, fix it up, and place it back on the market. Unfortunately, it’s not that simple.
Foreclosures can present a number of potential risks, here are 10, listed in no particular order:
1. Competition at the Auction
The huge majority of foreclosed houses are sold through auctions, generally through a county sheriff’s auction (working on behalf of financial institutions). These auctions might be in-person or virtual and could be akin to a silent auction or a live bidding battle.
In general, auctions can be exciting, especially when there are people bidding on the same item. But when you’re trying to purchase a foreclosed home at a low price point, competition isn’t a good thing. When other real estate investors participate in foreclosure auctions, that usually means two things: (1) you are less likely to get the house you want, and (2) the foreclosed home you had your eye on is probably going to go for more than you expected to spend.
When it comes to an investment property, you need to be able to budget for how much it costs to buy and have the capital for any improvements that need to be made. Buying a foreclosure at an auction can make budgeting difficult.
2. You Aren’t Able To Inspect the Property
Most foreclosed properties are off-limits for potential buyers to inspect. Some counties will have detailed listings, others just provide an address and a starting bid. That means, at best, all you can do is drive by to eyeball the property.
This is great if you can visibly see damage such as a collapsed roof. But it can be difficult to see serious plumbing or foundational issues from the outside. When you can’t inspect the property before purchasing it, you have no way of knowing how much work you are going to have to put into it before you can sell or rent it. If you have a house where the upkeep is going to cost more than you planned, you put your ROI at risk.
3. You’re Buying the House “As Is”
Buying a foreclosure often means that there isn’t a homeowner or seller trying to spruce it up and make it appealing to a buyer. When a home goes into foreclosure, the homeowner may take all of their belongings or they could leave a lot behind—leaving you, as the new owner, to deal with it. There’s also the chance that they may have vandalized the house before vacating.
Another thing to consider is that when a house is vacant for a long period of time, there’s a chance that it’s been looted for wires, vandalized, or even taken over by squatters. And, if there were any foundational or structural issues, they may have worsened over time.
Not being able to inspect a house when you’re purchasing it as-is is a risk that you probably don’t want to take.
4. You Might Underestimate the Cost of Repairs
Because you can’t inspect a house that you’re purchasing as-is, you’re likely to underestimate the costs of repairs. You have no idea if the light switches are going to work fine or if you’re going to have to run all new wiring throughout the house. You don’t even know if you’ll have to pay a crew to clean it up just to make it safe to work in.
Every dollar you spend on upkeep is a dollar you lose toward your bottom line. You probably have a number budgeted for costs. But if you spend that budget having to get the house in condition to safely conduct repairs, your plans might be thrown for a loop.
5. It Can Take a Long Time To Close
Banks and other financial institutions don’t always work on your time. If the bank has possession of a foreclosure, it’s not going to want to hold on to it forever. But if you aren’t buying from an auction, the bank might take a long time to approve a loan that you’ll need to close the deal.
Another thing to consider is that not every house at an auction is fully foreclosed. Some places have auctions during the window where an owner still has a chance to reclaim the house. You could end up in a situation where you put down a (rarely refundable) deposit, and then not be able to close on the house for a long time.
6. There’s a Chance You Could Still Lose the House
There are a lot of jurisdictions that give an owner a long time to reclaim their house. Even after they have been foreclosed upon, the owner can still reclaim the house if they’re able to cover their missed payments. That means you can buy the house, and lose it.
This isn’t always an issue, but when it is, it can be really frustrating. Multnomah County, in Oregon, gives foreclosed owners a whole year to get their home back. In that time you are likely paying bills, taxes, and other associated costs—all of which can be lost.
7. You Are Responsible for Liens
If you purchase a property at a foreclosure auction and later find that there is a lien that survives the auction, you will be responsible for that debt. You’ll likely have to pay off the lien. And, not all liens will be apparent at the time of purchase. Lienholders are typically notified after property ownership is transferred. They may reach out by sending bills that you hadn’t accounted for.
8. You Are Responsible for Taxes
Liens aren’t the only debts you may have to pay when you purchase a foreclosure. As long as you own the house, you’ll have to pay property taxes, for example. When a foreclosed property is sold at auction, the back property taxes are transferred directly to the buyer and become your financial responsibility.
9. It’s Harder to Get Financing
In real estate, financing is your lifeline. Most investors don’t have enough liquidity to purchase a property without needing a loan. Banks are a lot warier of lending money for foreclosure purchases, adducing that they are high-risk.
Hard money lenders are generally more amenable but, given the risks, their rates tend to be much more significant. Higher interest rates and stricter terms eat into your bottom line.
10. It’s a Much More Regulated Market
You might have caught on that there are a lot of rules and regulations governing foreclosure auctions. They vary within each county and across the country. I can’t tell you the set rules of purchasing a foreclosure because what’s true in one place may not be in another.
This is an even bigger challenge if you are starting a wholesaling business. There are a lot of regulations for wholesalers, specifically for buying foreclosures. And if you don’t abide by them, you could face steep fines and penalties.
Now that you know the risk of buying a foreclosed house. Let’s discuss how to avoid them.
The Best Way to Avoid the Risks of Buying a Foreclosure House
There are a couple of steps before a house goes into foreclosure. There is pre-foreclosure, which is a legal state that has its own complexities. You won’t be buying from an auction, but still have a lot of rules to observe.
There are also properties that are underwater with an owner looking to sell fast for cash. They’re behind on their bills. They might be going through a divorce. They might be getting pestering phone calls about money owed and just want to get rid of the house. These are called distressed properties.
Investing in distressed properties can be a great model for your real estate business. These properties are sometimes off-the-market, meaning there’s less competition trying to buy. You may be able to talk to the seller and inspect the house. You don’t have to wait for an auction, and you don’t have to deal with the complications involved. You just have to value the house, make a fair offer, and acquire the property.
These houses may not be in great shape—and you are buying them as-is—but you can probably avoid homeowner vandalism, since they are getting cash and not having to vacate due to eviction. Most importantly, you know what you are getting into, and can make your calculations based on the condition of the property.
Now, you’re probably wondering how to access off-market properties. I’ll tell you what worked for me.
The Best Way to Access Off-Market Properties
In order to avoid the risks of buying a foreclosed house, don’t. That’s right. Don’t wait until a house goes into foreclosure, instead, purchase a distressed property directly from a homeowner looking to sell to avoid foreclosure.
By working directly with distressed homeowners, you can avoid the hassle of foreclosure auctions, competition, and issues with obtaining financing. Finding off-market properties is easier when you are associated with a well-known brand. Investing in an independently owned and operated HomeVestors® franchise gave me the tools I needed to find distressed homeowners looking to sell fast.
Once I became an independently owned and operated HomeVestors® franchisee, I could participate in the nationally recognized We Buy Ugly Houses® marketing campaign. I’ve found that many distressed homeowners are familiar with the slogan. They call HomeVestors, often before listing their property, and I can receive their call in real-time. I now have a lead who is ready and motivated to sell.
Of course, I still have to do research, build trust, and make a fair offer before I can close the deal. But I am able to access an off-market real estate deal before the competition and without the risks associated with buying a foreclosed house.
If you’re considering getting into real estate and want to avoid the risks of buying a foreclosed house, request information about becoming a franchisee today.
Each franchise office is independently owned and operated.