If you are new to real estate investing and considering buying foreclosure properties, you need to be realistic about what you are facing. If you feel more sober about foreclosure investing after reading what I have written below, I will have accomplished my goal.
Foreclosure investing is not a good investment approach for beginners. I recommend that you have at least a couple of years' experience with more traditional real estate investing first.
The profits from foreclosure investing can be huge. That makes foreclosures attractive. There is an awful lot to know in order to avoid the problems that can occur. If you don't know what you are doing, one disastrous foreclosure investment can wipe out your capital and your enthusiasm for all real estate investing.
Three ways to buy a foreclosure property
There are three basic approaches to buying properties in foreclosure depending on the stage of the foreclosure process: buying pre-foreclosures, buying at the foreclosure auction, and buying from lender after the foreclosure sale.
If you buy from the delinquent property owner before it goes to auction, you have bought a pre-foreclosure deal. Buying at the auction is self-explanatory. If nobody bids, the lender ends up with the property.
Buying from the lender after the auction is called buying REOs (real estate owned) or Repos, (repossessions). Sometimes you will see them referred to as "corporation owned" or, my favored term, "lender owned."
REOs are the least risky way to buy foreclosures
You may have more risk than you would in a regular real estate transaction, but REOs are less risky than in buying at the auction. Since REOs are somewhat similar to a regular sale, they can be pretty safe. You might not get a seller's disclosure.
In California, a lender who acquires a property through foreclosure does not have to offer a disclosure to you as a buyer. But, if there are problems after you buy the property, you might be able to sue the lender who sold you the property, or at least threaten to sue them, and they might make things right or pay part of the cost. There's a good chance they will still be around after the sale.
The risks of buying pre-foreclosure real estate
The next riskiest foreclosure purchase is the pre-foreclosure. If an owner of a pre-foreclosure disappears, you risk not getting anything from him after the sale. A pre-foreclosure seller might be desperate and lie to you about the condition of the property and the neighborhood.
There might be liens on the property that the seller "forgot" to mention. The big utility bills become the buyer's responsibility if the pre-foreclosure investor failed to check them out. Ditto for unpaid property taxes. There may be another person on title who did not sign the deed, and so on.
In California and, I believe, some other states, there are special laws related to dealing with and buying a property from a homeowner occupant who is in default on a loan.
If the contracts and the sale are not done according to the law, the seller has the right to rescind the sale and could, long after the sale, sue to have the sale reversed. There are extreme penalties for violating the law. Remember, "Ignorance of the law is no excuse." You need to know the state law when you do pre-foreclosure investing.
Can the seller can legally deed the property to you? What if the seller is already in bankruptcy? The deed is likely not valid unless it has gone through the bankruptcy court. You have to call the local bankruptcy court to check for a possible filing. And, of course, the seller could have filed bankruptcy in another bankruptcy court that you did not call.
And, even if the seller does not file bankruptcy until after your purchase, you may have to deed the property back to the seller up to three years after you bought it.
If selling the property made the seller destitute, and the seller sold for much below market value--which you hope he did so you could make a good profit--the bankruptcy trustee can require you to deed the property into the bankruptcy estate on the grounds that the sale was a "fraudulent transfer," wherein the seller deprived his creditors of an asset which could help pay the debts.
At that point, you become a creditor of the bankruptcy estate. Is this really what you planned when you bought the "great pre-foreclosure deal"? A lot of pre-foreclosure buyers may forego some of the inspections because they are hurrying to buy before the foreclosure auction.
Sometimes the buyers will give money to the owner, get a deed, and record the deed themselves in the land records office of the county. The pre-foreclosure buyer has to be very alert to a lot of possibilities and check them out. You must have superior knowledge of real estate investing before you start doing pre-foreclosure investing.
But, if you sign a proper sales contract with the owner, get appropriate inspections, go through an escrow with a knowledgeable escrow agent, and look at the property yourself, you probably will not be at great risk. If you use the safeguards above, you are going to have less risk than in most foreclosure auction buys.
The risk of buying at the foreclosure auction
Buying at the auction is the riskiest foreclosure purchase. At the auction you have no real estate agent to lead you through the process. You have no escrow and no title report let alone title insurance.
In most jurisdictions it is an all cash sale. In some states you may have a week to a month to come up with the full purchase price. If you do not raise the money, you lose your deposit.
At the auction the people conducting the sale will announce that the successful bidder will receive NO WARRANTY OF ANY KIND. You have no assurance that there are not other liens or loans on the property.
You do not have any inspections by contractors, roofers, pest inspectors, building inspections, water well, or septic system experts. You get no disclosure from the seller as to the condition of the building or what is happening in the neighborhood.
Usually you cannot see the inside of the building; perhaps not even the back of the outside. You know nothing about the electrical system, the plumbing, the heating, or air conditioning.
If you buy an occupied property, you have to do an eviction, which, in some states, can drag out for a while, preventing you from getting into the property quickly to prepare for resale. Sometimes the occupants, if they are former owners, will vandalize the properties before leaving or steal items, such as cabinets, doors, fixtures, lamps, etc.
If you are buying to resell the property quickly for a profit, you had better know if your buyer can readily get title insurance when buying your foreclosed-upon property.
When you get a very good deal at a foreclosure auction, you may find that the former owner files a lawsuit to attempt to overturn the sale. So be prepared to hire an attorney and fight for your profit.
Experience and knowledge build your foundation
Now do you begin to understand why I recommend that beginners not start investing in foreclosures? Start with simpler buying approaches and get some experience with properties, laws, ordinances, deeds, and loans, and so on to provide a foundation.
Learn to do title searches as fast as the professionals. Get to know intimately the government offices that have property records and tax assessment rolls. Get to know the property values in an area where you invest.
Learn about the problems with properties in different neighborhoods, such as bad soil, poor construction in certain subdivisions, problems with septic systems and wells, and soil contamination.
When you have learned all that, start studying up on foreclosures. Study the foreclosure laws in your state. Study law books on the priority of liens, bidding at auctions, title insurance, and bankruptcy. When you fully understand foreclosures, start buying them.
I am not trying to stop you from investing in foreclosures. They can be profitable for those who can practice it well. But, few beginners can do it well. I'm telling you to be realistic and get the background that will allow you to be successful in foreclosure investing.
The field is rife with risk. You can easily lose your whole investment if you make a single mistake. Please believe me, even with all my years of real estate investing experience, it has happened to me.