8 Steps to Making Money When Buying a Foreclosed Home (REO)

Foreclosures are not for the Timid or those on a budget. You need access to capital (cash!) to be successful. (More Here) But once you've got that conquered, here are some tips to make sure you're covered.

 

Base Valuation on the Foreclosure House

The first thing you should do is figure out if the home is cheap (1) . It should be priced cheap as an REO, or you should decide what cheap is if it is going to auction. This generally involves a quick Market Analysis for the age, style and location of the home. There's no point in buying a foreclosure if you have to pay market value: the goal is to get a discount. Generally, I try to get two baseline numbers on a home, the baseline I would pay for a "average" foreclosure, and the actual "retail" price if its fixed up (2). Based on that differential, you can decide if the numbers work.

 

Detailed Valuation on the Foreclosure Home

Now you've got to get as detailed as you can (3). A close inspection of the lot, the exterior, the roof, and the interior if you can. The goal here is to make adjustments to the baseline numbers to reflect reality. Perhaps on-line it looked cheap, but now, standing in the driveway, the highway noise makes you think that it's going to be valued much lower than you originally thought. Or, the neighborhood will quickly pull up the value on this home. Or, the roof is no good, and you have to adjust your first baseline, due to the work involved, but not the second.

 

Liens and Tenants when Purchasing Foreclosures

More research and math coming up. First stop, public records at your registry to see what liens have been placed on the property (4). This step is not necessary if the home is being marketed - a typical transaction will put clear title on the lender. Not so at Auction! At Auction, any outstanding liens/debts become your responsibility, so you should know what they are. There could be federal tax liens, state tax liens, town liens, contractor liens - you don't know, so you need to check.

 

Double check down at the local town hall, especially if there are any town services (5). The assessors will have outstanding tax bills (common), and the water/sewer department will have water bills (also common). Some towns have their own electric and cable services, and there could be outstanding bills here as well. Both trips are necessary, as not all liens are recorded where they should be.

 

For each lien or outstanding payment that will fall in your lap, deduct those from your baseline valuation number. So if you thought the property was worth 125K, but it has 15,000 in overdue taxes, it's now worth $110 to you at Auction.

 

Also note if there's anyone living at the property (6). If they are, they are going to be your tenants after the close, whether you want them or not. Better make a budget to buy them out, if at all possible before close. I don't recommend going through the courts - takes too long and isn't (usually) any cheaper. The sooner the better! They can cause more problems while you're waiting to for purchasing to be finalized.

 

Be Smart about Improvements to a Foreclosure Home

Assume that the home needs work. Typically a lot. Make sure you have a plan for what you plan to fix, how much you'll spend on that fix, and what the home will be worth when those fixes are done (7). This plan should be 80-90% complete BEFORE you bid. If you can't see the interior at auction time, make sure you are appropriately assuming the risk. It can't be said enough, the goal here is NOT to break even. The goal should be to make a profit. If you want to break even, just buy a regular home, and save yourself the trouble. Homes without clear Title V are a special risk in this area, and wells need special care as well when you're doing your number crunching. Either or both could significantly eat into your profits.

 

Also, make sure when looking at a properties problems, you're taking proper account of things that can't be fixed. If they can't be fixed, they'll be just a painful on the way out. For example, fixing up the interior of a 2800 sq foot home with only a 1 car garage is a problem - those homes often sell at steep discounts to comparable properties with a 2 car garage.

 

On a smaller property, you'll be looking to make a profit - after carrying costs and sales fees, of at lest 40K. That's a bare minimum. 75 would be better, and 100 is a good deal. As the properties get larger, and carrying costs grow, you can probably expand that to 100-200K for typical properties.

 

There will still be Risks in Buying Any Foreclosure

Even after you've done all your math, you'll likely find more competition at your number than you'd like to see. Auctions and REO sales are pretty competitive in this area, leaving little margin for error on desirable homes. Even with all the research and crunching, you may still lose money on that foreclosure. Be prepared for that outcome(8). Happy Hunting!

 

Do Good Things Today!

Matt Heisler