12 Things You Must Know Before Buying Foreclosures
Much attention, in some ways too much attention, in today’s market is focused upon Foreclosures, also known as REOs (Real Estate Owned). You can find some good deals in REOs, and they make sense for certain investors, however, don’t limit yourself just to shopping Foreclosures. Buyers should not overlook straight old-fashioned sales. Distressed property sets the bar, with the level of distress factored in, but if a homeowner needs to sell his house they cannot List it appreciably higher than the Foreclosure or Short Sale next door, on his block, in his neighborhood.
To compete successfully in the Foreclosure market you must understand the way things work, follow methods which are at this point established. Here’s a few things you should know, be prepared for:
1.) Remember Foreclosures by definition represent a home someone has walked away from. This is not an overnight process. It took months, probably over a year to get these people out. They occupied the premises for months and months not paying anything, waiting for the axe to fall. Very few care about or can afford to maintain these properties and many, in anger and resentment, pulled appliances and fixtures, perhaps even damaged the home before they left. After that the property might’ve been vacant for months before the Bank managed to list it for sale. If you are not in construction, if you’re not much of a Do-It-Yourselfer, if you don’t have a reliable and inexpensive source for remodeling, pay real close attention to how much it might cost to whip this property into shape and make sure you factor that into your P&L.
2.) Just because it’s a Foreclosure doesn’t necessarily mean it’s a good deal. With distressed properties a key component of the Listing price is how much the Bank or Lender has into the deal. I’ve had Clients submit offers on two almost identical villas in the same complex, owned by the same Lender, yet one sold for $20,000 more than the other. Why? Because one had a bigger mortgage.
3.) Don’t expect logic or intelligence. One fact becomes readily apparent when you delve into the Foreclosure market – the Banks and Lenders aren’t much smarter about getting OUT of the mess they created than they were getting into it. I had Clients renting a Townhouse that was getting Foreclosed upon. They approached the Bank, offered to buy it. They had good credit. They said they would sign a mortgage, so the Bank could make money on the property, recoup a bit of their losses. The Bank said no, they had to move out. The place sat vacant for months, sold for less than my Clients would have paid.
Buyers make offers on Foreclosures, they think they're dealing with a Banker – a guy in a suit and tie sitting in an office with a window and a secretary. Lower those expectations. In the basement of that building is a rat's nest of cubicles that needed new carpeting four years ago. The whole floor smells like B.O. In one cubicle is a broken down old desk piled with files, a bottle of Kaopectate, the large economy size Excedrin. Behind this sits a broken man in a rumpled shirt and an opened tie who stinks of stale coffee and cigarettes. This is the guy who handles the Foreclosures. He makes the same crappy salary whether you buy the place or not. And once a week he has to send a report up to the guy with the window office explaining how much he managed to get selling properties that were supposedly worth X-amount according to the BPO's they'd pulled.
4.) Don’t expect much from the “Listing Agent.” Most Realtors who specialize in Listing REOs are not going to be much help. They typically receive a very small commission for filling out some paperwork, putting a lockbox on the property. Their voice mailbox will be full. They will return emails days later, if at all. I have submitted offers to Agents and they don’t even take my call, never return my message. You would think you make an offer on a Realtor’s Listing, they would pick up the phone. Don’t bet on it. Sometimes they take days to submit offers to the banks. This is usually done by email. Often the Listing Agents don’t even have a phone number to the person they are dealing with at the bank. A week later you call up, ask what’s happening with your offer, they say they haven’t seen any emails yet.
5.) Know the neighborhood. Drive by, look at the property. Check the surrounding area. The more intrinsic value a property possesses the less likely somebody is to walk away from it. See what general state the property is in before you start getting excited, expend any time or resources, whether the neighborhood will ever appreciate even once the market starts coming back. There's always a reason a property is Listed for a low price, even by the Banks. Buying a 3 Bedroom house for $35-40,000 may sound intriguing, but fact of the matter it's liable to be within a Police perimeter at least 3 nights a week.
6.) Be prepared to move fast. Have all your ducks in a row. Some REOs stay on the market because they are simply not good deals. The good deals go quick. Some banks leave their Foreclosures on the market 7 to 10 working days. Have an Agent ready to move. Have money in Escrow. Have Proof of Funds set up.
7.) Pay Cash. The vast majority of the good Foreclosure deals go to Buyers who are paying cash. Think about it. Why is that property on the market to begin with? The bank’s already gotten burned. Now they just want cash. A logical person might presume the bank would want to finance the new owner, recoup some of the money they’ve lost. Well, that’s another department. These guys want cash. If you are not prepared to pay cash, then you are operating at a distinct disadvantage, especially for the exceptional deals. Be Pre-Qualified, at least, and make sure your Real Estate Agent has that as well. Frankly, however, if you want to finance you will probably have a better chance getting a deal going after Short Sales.
8.) Low Ball is No Ball. Don’t even think about low-balling. Especially on really good deals. Got 3 hours? I could tell you 10% of the stories I know about buyers who had to get cute. The Bank sets a price, you’ve got to be relatively close to that to stand a chance. The really good Foreclosure deals there are usually multiple offers. I counsel clients to offer MORE than the Listing Price. If it’s an unbelievable deal at $125,000, offer $132,000 and finish ahead of the clowns who are trying to nickel and dime them. We’ve done this, still not gotten the deal. It went to somebody outbidding us. If the house was selling for 300-something 4-5 years ago, now the bank’s asking $160k, it’s still a great deal at $165k. I’ve seen buyers thinking they can get it for 120-130k; the place goes for $170-180k. And in 3-5 years, the guy who bought it’s going to get $250-260k, make a $100,000 profit.
9.) Proof of Funds. Set up a system that can generate a quick Proof of Funds letter for your Agent. This must be a letter from a financial institution, on their letterhead, with a legitimate contact person, stating that you have sufficient resources to purchase the property in question at such-and-such a price. If you are offering $60,000, this letter must say $60,000. You can show them account statements, too, or give you agent a number of letters already filled out with pre-determined amounts, however, think how it will look to the bank if you are offering $55,000 for a property they have listed at $60,000 and they see a Proof of Funds letter or an account statement showing you can afford more. I try to have my REO investors set up some email communication between myself and the contact at their financial institution. We start putting a deal together, I email the contact, copying the Client, requesting the POF, and I can usually have the letter by the time we’re submitting the offer.
10.) Highest and Best. When a Foreclosure represents an extremely good deal the bank will receive multiple offers. I have gone after properties where there were 8 or 9 offers. I did a deal on a great house in Coral Ridge; it was on the market 2 days and they got 6 or 7 offers, many for more than the Listing Price. Many time the bank will go back to the parties who have submitted the better offers and ask for their “Highest and Best Price,” trying to get Buyers to up their bids. Be prepared for this, though I cannot offer much in the way of advice how to handle it.
11.) Be prepared to sign their “Act of God” Addendum. If you prevail, win the deal, the bank sends you an Addendum to sign which pretty much supersedes all the terms of the offer contract you submitted, and protects them (the bank) from anything up to and/or including nuclear war and an asteroid collision. You have to sign this. If not they simply give the deal to the next guy in line. READ IT FIRST, however. Most times these Act of God Addendums pretty much reflect the terms of the deal you submitted with only minor, if any, modifications. But MAKE SURE.
12.) Check the Utilities. Many times you find notices from the Water or Electric Company hanging on the front door of these Foreclosures. Make sure you check with the Utility companies, find out if there are any outstanding balances, include them in the Closing. Otherwise you could be on the hook for a couple extra hundred dollars which you will never be able to collect afterwards.
These are the basic rules to survive in the REO market. Still, if there’s one thing we hope you remember from this article it’s what we said above – don’t restrict your shopping to just Foreclosures. Short Sales are a royal pain in the you know what, but you can get good deals if you weather the storm, but a regular Homeowner who’s trying to sell his house cannot price it significantly higher than the REOs and/or Short Sales in his neighborhood. I’ve had a number of Clients come to me, interested in distressed properties, and after putting up with the ridiculous rigamarole through a few frustrating failures I bring them a regular old-fashioned sale, where you have Listing Agent who actually works, and you can make an offer, negotiate a deal between human beings, and come away with a property which doesn’t need work and an immediate infusion of capital to become liveable.