I was involved in real estate investing for years before the foreclosure explosion that began in 2007. It was a time where a glut of foreclosures came onto the market, and more and more people got into this business. Since then, people starting out in real estate investing have been looking for foreclosures as a way to make money.
This makes some sense. Finding a foreclosure, fixing it up, and selling it is the classic way to run this business. But there’s one thing to consider: Finding foreclosures isn’t always easy, and, in turn, neither is selling them.
Don’t get me wrong. It can be done, and many people have made a great living doing so. That’s why a lot of people want to start a real estate business during tough economic times. But you have to know how to buy real estate foreclosures the right way, understand the pitfalls involved in doing so, and see if you can find better ways to improve your business.
Starting Point: What Constitutes a Foreclosure?
This may seem basic. But, “foreclosure” is one of the real estate investing terms you need to know so that you also know what it isn’t.
Simply put, a foreclosure is when the bank (or another financial entity) has taken control of a property from an owner who couldn’t pay the mortgage or taxes.
Foreclosure is triggered when a borrower misses a certain number of payments, as defined in the lease. There could be other specifications in the lease that would allow for a foreclosure, but the classic way for it to be triggered is by missed payments.
One missed mortgage payment starts the process. Two payments usually result in a demand letter. After 90 days, the foreclosure process really starts.
So, Are Foreclosure Laws the Same in Every State?
No. There are 22 states that have what is called “judicial foreclosure”, where the lending agency has to go through the court in order to foreclose on a borrower. The other 28 states have nonjudicial foreclosure, which is generally faster.
Beyond that, different states have to grant different rights to borrowers. In some states (such as Oregon) the borrower can reclaim their home in some cases even after it is sold.
Why Does That Matter?
It matters what the laws are because they can impact the real estate investor. It is possible to buy a home in foreclosure, pay its taxes and bills, and still lose it if the owner is able to repay their loans in the time the statutes (or the court) determines. Knowing the laws of your state is crucial to avoid a red-tape nightmare.
Pre-foreclosure and Zombie Foreclosures
There are two other terms you might hear when talking about foreclosures: pre-foreclosure and zombie foreclosure.
A pre-foreclosure is when a house has begun to enter the foreclosure process but the bank has yet to take control. At this point, many real estate investors try to make a deal between the borrower and the lender to take control of the house. In theory, this deal is a win-win-win for everyone (or less of a loss for the borrower). But buying preforeclosures is a hard thing to do, because you are relying on bureaucratic flexibility from a large lending institution.
A zombie foreclosure is not as exciting as it sounds. It is when a house is in the foreclosure process and is abandoned by the borrower. They might want to start over, avoid notices, or just get away. This adds complications to the investor, as finding a homeowner of a distressed property can be difficult. It also adds another layer of complexity to the foreclosure process.
But, whether the process is normal or there are twists, at some point the lender takes control. And that’s where you can come in.
How to Buy Real Estate Foreclosures
When a bank or other financial institution takes control of the home, they likely want to sell it as quickly as possible. After all, they are the ones on the hook for bills, taxes, insurance, and even upkeep so it doesn’t fall into disrepair. That’s why they use auctions.
Buying foreclosures from an auction is a very common way of obtaining properties, but there are a lot of downsides to searching for foreclosures—higher costs, less visibility into the condition of the house, and a ton of competition. It is better to buy directly from distressed homeowners if possible.
Types of Foreclosures
There are two other types of foreclosures:
- Real-estate owned: when the bank works through a real estate agency to sell the house, which for you is no different than buying any house from an agent
- Government-owned: when someone defaults on a government-backed mortgage. Usually, these can also be purchased at an auction.
How a Real Estate Auction Works
With the obvious caveat that every county does things a little bit differently (and with the further caveat that social distancing changes things), most auctions work in a fairly similar way.
- The auctioning agency (whether Sheriff or another third party) releases a list of houses up for sale in an upcoming auction. These lists can be as basic as addresses or as descriptive as full home descriptions.
- The auction is held on a designated day. This can vary from weekly in big cities to monthly in smaller areas to “whenever there are enough houses” in the least-populated counties.
- The auction will be in-person or online. There is sometimes the classic “do I hear $50,000, $52,000” auction businesses, but it is more often a set time where people can enter bids.
- The winner of the auction has to make an immediate down payment of a certain percentage (again, this varies by county and even house) in order to actually take possession.
It should be noted that “possession” here can be defined extremely loosely. In many jurisdictions, you don’t actually have possession, but the right to have possession in case it passes through all the red tape (including the rights of the foreclosees we discussed above).
Easy, right? You’ve got a house? Well, yes, in theory. But describing it this simply isn’t the whole picture. There are reasons why these are so popular but also some reasons why they are so challenging.
The Pros and Cons of a Foreclosure Auction
Let’s take a look at the pros and cons of buying a foreclosure from an auction.
Pros of the foreclosure auction
- There are a lot of houses. Especially in bigger jurisdictions, there can be a ton of houses on the list every week or month. This is great if you are looking for something extremely specific for your business, or if you are looking to cast a wide net.
- Houses start out at a lower price. The banks want to sell and just get a little bit of profit out of it. So the prices start out pretty low.
- You don’t have to go all around looking for houses. There are a lot of leads, on a piece of paper, or right in front of your face. That makes it easier than doing your own marketing or finding leads in different ways.
Cons of the foreclosure auction
- You don’t really get to inspect the houses. This is a big one. After all, it is super important to add up the cost of flipping a house so you determine if it’s a good investment. Not knowing if the property is in good shape or needs a whole new foundation makes buying it a gamble.
- Oftentimes, you will be responsible for all liens and taxes associated with the property.
- There is a lot of competition. You’re not the only real estate investor watching the properties on the list. No matter where you are, every investor in the area is going to sniff out the auctions. They know there are a lot of houses there.
- Some of that competition has deep pockets. Auctions are a great place for institutions or larger investment groups to acquire real estate in bulk, making it harder for a mom-and-pop business to get the house they want.
- Competition drives up prices. Once the bidding starts, prices go up. What may have started out inexpensive suddenly became pretty pricey.
You can probably guess what happens here. It’s really easy to go into an auction thinking you need to buy a property. You start to get outbid, and get desperate. You raise your bid. You bid on houses you didn’t want. You start to get really competitive and just want to win (this was always my problem). And then you end up with a money pit for which you’ve overpaid.
It’s not great. But there are ways to avoid losing your shirt.
How to Avoid Losing Money When Buying Foreclosures at an Auction
To be clear, there is no guaranteed way to avoid losing money in any aspect of this business. But there are precautions you can make to protect yourself before an auction.
- Budget: Go in with an upper limit for what you will spend. This is so crucial. Don’t get caught up in the moment and blow your budget.
- Plan: Go in sticking to your business plan. Do you want single-family, one-story homes in an up-and-coming neighborhood? Is your model looking at the “worst” neighborhoods? Stick to that! Don’t let your eyes get huge seeing all sorts of houses. Once you deviate from your plan, you start to get in trouble.
- Research: Do as much inspection/research as you can. At the very least, know which houses fit your plan. If you can inspect them, even with a drive-by, you’re ahead of the game. At the worst, you can see if a house’s roof is collapsing or not. You can get hints from the outside of the house as to how well the house has been maintained and give an idea of the scope of potential repairs on the inside.
- Know the After Repaired Value of the house: What will this house sell for once it is fixed up? From this number, you will need to subtract your costs for repairs, holding costs, etc., and the profit you hope to make to determine that upper limit you can pay.
- Ask questions: Ask around about houses. If you are in a real estate network, ask if people know about the house on Elm Street. Get all the information you can.
- Have a limit: Stick to a limited number of houses. If you have your eye on 20, you might get a bit confused or unfocused. Some people can handle a huge amount. I can’t. Stick within your mental limits.
- Be willing to walk away: You might not get a house. The four or five houses you have your eye on might get overbid. That’s ok. Don’t think you absolutely need a house. At the very worst, you’ve wasted time. That’s not great, but it is much better than blowing your budget and getting a house you can’t sell.
Again, the best way to avoid losing money when buying a foreclosure at an auction is to have a plan and stick to it—even if that means walking away empty-handed. Your plan for purchasing a foreclosure at an auction needs to be a seamless part of your business plan. It has to fit in with your exit strategy. And, you must be focused.
That’s true when it comes to any business plan that depends on foreclosures. This is the most common way of doing business. That’s why it is hard to find one with little competition, at a good price, that fits your model.
For some people, there is a better way.
Stressing the Distressed: How to Avoid Depending on Foreclosures
Foreclosures can be part of your business plan. But given their shortcomings, it isn’t always wise to make them the entirety of your business plan. What’s often better is to be able to buy houses directly from owners before they enter the legal nightmare of foreclosure. In this case, both the homeowner and property are referred to as “distressed”.
A distressed homeowner is someone who may be facing foreclosure, taxes that they can’t pay, or any number of difficult circumstances that make them want to sell quickly. Marketing to distressed homeowners is about building trust and treating them fairly. These are the homeowners from whom you’ll be buying most of your property, so understanding who they are and what they are going through is key to your business.
The houses owned by distressed homeowners are called distressed properties. They may or may not need a lot of repair, and may or may not be swarming with liens and debts. Sometimes, these properties can be bought as-is, quickly, without a lot of red tape. The key is being able to present the right solution for the distress.
Knowing how to find and buy distressed properties is crucial to your real estate investing business. By definition, distressed homeowners are in a hurry, and want to sell. They’ll likely go for the quickest offer that seems fair. So you have to be able to be in contact with them when they are ready to sell.
That means having a great way to get leads.
Diversify Your Investment Business By Getting Better Leads
I’ve bought a lot of foreclosures. And, I’ve bought a lot of distressed houses. Since becoming an independently owned and operated HomeVestors® franchisee, I’ve focused almost entirely on the latter. That’s because HomeVestors a great way to get leads before a house enters the foreclosure process.
As a franchisee, I benefit from the nationally-known “We Buy Ugly Houses®” marketing campaign. Homeowners contact HomeVestors before they have to deal with foreclosure, or before abandoning the house. These highly motivated leads come to me. I can get these leads while circumventing competition.
Foreclosures are a great way to find houses. But getting quality leads before dealing with banks or auctions is the real dream. Maximizing your opportunities while minimizing your risks is the actual classic way to run your business. If you’re interested in this model, request information about becoming a franchisee today. I think doing so should be a foregone conclusion.
Each franchise office is independently owned and operated.