You may have heard about investing in foreclosed properties before — often it’s talked about as an easy strategy to make money flipping houses. But could it really be that simple? There’s a lot more to it than you might think, and if you go in underprepared and without considering certain factors, be prepared to lose money over and over again on these risky properties. Let’s discuss whether it’s a good strategy for you and if it is, how you might go about doing it.
What is a foreclosed home?
At its most basic, a foreclosed home is one that is no longer held by the owner, but instead by the bank or lender of the mortgage. This generally happens because the owner fails to meet their payments, but can also occur if the owner doesn’t keep the property insured or isn’t paying their property taxes. In these situations, the lender who issues the mortgage can repossess the home as collateral and resell it.
By reselling it, the lender recoups some of their investment in the property (the mortgage that the owner failed to pay). While they want to make back as much of their money as possible, the lender also doesn’t want to invest any more money into fixing up the property and is motivated to get rid of it quickly. Both of these factors mean that foreclosed properties are often sold at prices well below the average market value.
Pros & cons of buying a foreclosure
This takes us to the benefits and disadvantages of buying foreclosures. While the price alone may sound too good to pass up, there are also several other benefits (and some drawbacks) that you should consider before purchasing one.
There are a number of perks to buying a foreclosed home, most of them relating back to the finances of the initial investment.
1. Cheap Initial Investment
Starting with the most obvious advantage, you can buy a property at a fraction of the price tag as other properties in the area. It’s important to note that just because a foreclosed home is cheap, doesn’t necessarily mean it’s in rough shape. Because the lender wants to get their money as quickly as possible, they reduce the price to entice more buyers, and that goes for rundown properties as well as those that only need a little maintenance.
A lower initial investment also means you can diversify and buy multiple homes for the price of one. Be careful about buying up too many though, as they can quickly require more time than you have.
2. ROI Potential
Because of the lower-than-usual cost to buy the property, your potential for a great return on investment also increases. This is very dependent on the condition that the home is in, as those in worse shape will require more maintenance and secondary costs to get it back to a reasonable situation. However, if you know what you’re doing and do your research, these can be goldmines for improving the value well beyond the cost of repairs. They can also act as a foot in the door to a neighborhood or area that might typically be too expensive to invest in.
3. Better Financing Options
Another advantage of the lender wanting to get the property off their hands is that they will usually offer better financing. This could include lower closing costs or interest rates and are a great way to work towards an even better ROI and cash flow. If you purchase a foreclosure at an auction or other similar situation, you probably won’t be able to finance or see these benefits, so make sure you’re keeping that in mind when looking for places to buy.
However, there are downsides to foreclosure investing. Primarily, the risk you take on or the amount of research and time you need to put in to mitigate the risk.
The biggest mistake new foreclosure investors make is not doing as much research as they should. This is easy to accidentally do, as it’s not immediately obvious what you want to take into account before making a decision to purchase. However, you should actually be doing more investigation and analysis than a traditional property because finding foreclosed properties that are worth buying are fewer and further between. Investing in a bad property can also be a money pit that you never recover from, so you should thoroughly consider and research the following:
- Why the home was foreclosed
- Additional liens on the title (IRS, secondary mortgage, code enforcement, etc.)
- Inspections and valuations that will be required
- Estimates of the repairs required (including the grounds and landscaping)
- Research the neighborhood/area that the property is in
We’ll go into more detail later, but this is a high-level list of things you should be keeping in mind any time you look at a new foreclosure.
2. Maintenance & repairs
As mentioned in the research section, the maintenance required for most foreclosed properties can be widespread and extensive. To get to the point of foreclosure, it probably means that the owner didn’t have the means to keep the home and property in a state that it can be easily resold. Additionally, because the bank wants it sold as quickly as possible, foreclosures are usually sold as-is and the responsibilities of restoring are left to you, the buyer. As part of your research (or even before you begin), you should do a comprehensive inspection of the home, preferably with an expert. This will allow you to start a running list of items that you can estimate costs for and weigh with the price tag against the eventual value of the property.
3. Slow process
The final major drawback of foreclosure investing is that the closing process can take a long time. This is primarily due to dealing with a bank or other lender rather than an individual seller. Banks have a huge amount of transactions and other mortgages and foreclosures to process at the same time, which leads to a bottleneck for closing. While they might want to agree on a price as quickly as possible, they can’t do much to actually complete the transaction as quickly.
Foreclosure investing strategy
If you want to invest in a foreclosed property, you need to analyze not only whether the overall strategy is a good fit for your situation, but also each individual home. The key is finding a property that not just isn’t in bad shape, but plays to your strengths and knowledge. What makes or breaks a foreclosure strategy is finding the right property, not buying up a bunch because they’re cheap. Let’s expand on the research and due diligence sections to explain why each major factor is important and what to consider.
Circumstances of foreclosure
Knowing why the property was foreclosed in the first place can play a big role in understanding whether it’s worth your investment. Did it have to do with the former owners or was it something about the environment or market? Maybe the previous owners got laid off and weren’t able to pay their bills, or maybe there’s something about the location that makes no one want to rent. These both could be very important indications that you should pay attention to and analyze to determine if this could be a successful investment, even after renovating.
Research the market & location
As an extension of the previous example, the housing and job markets can have a huge impact on not only whether people want to move into the property you’re considering, but also how much they’re willing to pay. Researching statistics on the area such as disposable income growth, population trends, crime, and taxes will lay the groundwork for whether you even consider a property. Then, you can build off of this by assessing school districts, infrastructure development, local business growth (and support by the local government), and transportation options in the area.
When you look at the physical location of the property, is it close to important places like schools, grocery stores, and more? Is it next to a river or lake or at the bottom of a hill where flooding could be a concern? All of these factors and more will give you a better picture of the market and location’s overall quality and play a huge role in your decision whether to buy or not.
Estimate the costs
Once you have an idea of the surrounding market and it seems positive, you can really start digging into the property itself and determine what will be necessary to repair the home. This is important to do after researching the market and evaluating surrounding houses because doing so will give you an idea of expectations for amenities, style, and extravagance. Not every house needs to have expensive yard features, crown molding, or a gym if comparable properties don’t have them.
This will help you come up with a list of what does (and doesn’t) need to be repaired and renovated on the property, which you can then assign cost estimates to. Keep in mind there are things like plumbing and foundations that aren’t always visible but could cause serious expenses if not functioning properly. Once all the costs you think will need to go into the home are analyzed, you can begin estimating the cap rate or income that can be generated by the property. This could be in the form of rent if you decide to hold onto it, or the selling price if you don’t. These factors will also be informed by the surrounding area and housing market, but once you have estimates of cost and income, you can determine the approximate ROI.
Acquiring a foreclosed property
Once you’ve researched and analyzed the location, decided it has potential for growth, and calculated your estimated ROI that fits in your budget and plays to your strengths, you’ll have to acquire the property. This is often done by looking through publications that list assets going to auction and reaching out directly to the owner before it’s auctioned. However, there are also other ways to go about this, such as leveraging networking or purchasing the distressed loan at a discount from the lenders.
Owning a foreclosed property
Now that you’ve acquired a foreclosed property, you need to make sure you have a plan for what you’re going to do with it. The two most common strategies are flipping the property, or buying it and holding it for the long term.
If you don’t want to hold and manage the property once you’ve made repairs and renovations, you can simply sell it for a quicker source of income. We’ve covered how to fix and flip a home before, but it’s important to not “over-fix” the property to where it’s significantly more expensive than other surrounding options. This goes hand in hand with the market research step to decide whether you want to pursue a flip and where you should be looking to price it once completed.
2. Buy & hold
For those interested in a more long-term investment, you can keep ownership of the property once you’ve fixed it up. This way, you can rent it out or use it for continual, steady income rather than a one-time sale. Again, we’ve covered the buy and hold strategy in more detail previously, but it’s a great source of persistent revenue, as long as you have the time and resources to manage it.
Have an exit strategy
The last key consideration you should have before investing in a foreclosure is to have an exit strategy beforehand. Don’t wait to react in deciding when you’re going to sell the property. Beyond the basic fix and flip or buy and hold, you should have criteria and cutoffs for cumulative costs or deadlines that you will sell and cash out on. Carrying costs can build up quickly, and not having a set plan can lead you to keep the property and lose even more money when you should have just cut your losses.
Not for beginners
If you’ve learned one thing about foreclosure investing, we hope it’s that there’s a lot more that goes into a successful investment than immediately meets the eye. Buying and investing in foreclosed properties can be a profitable strategy, but it’s certainly not easy. You need to be experienced in the real estate market and do your research on a variety of factors that could impact whether you lose money or make money.
If you’re an experienced investor looking to get out of a hard money loan for your foreclosure flip, Visio Lending can help. Visio Lending is always in your corner to help you through the process of your buy and hold, rent-ready investments, so get in touch today.