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Foreclosures . . .
What, When, Where, Why and How
The Foreclosure Myth - Just like we were hearing all the stories about flipping properties back in 2003-2005, we are now hearing similar "hype" about the money to made in buying foreclosures. In fact, I'm hearing it from the little guy that is buying a single foreclosure to flip to the bigshot buying up dozens or hundreds of properties to manage or sell. The little guy is clueless. He's just shooting in the dark. The bigshot is a different story.
The bigshots are from two groups. The first is the 25-35 year old portfolio manager with more risk hormones than brains. The second is the wealthy high net worth individual that thinks he is smarter than the market. From what I have seen, both of these groups are getting their butts handed to them . . . but they don't know it yet. Moreover, the kid with the portfolio doesn't really care. He just wants to make deals. I'm not saying that that to be funny. That's exactly what I hear. If they make deals, they get bonuses. If they don't make deals, they get fired. It doesn't matter if the deal falls apart three years from now, because junior will be long gone, and there is no accountability in this game.
Mr. Bigshot doesn't realize he is in trouble, because he has surrounded himself with putzolas. These are folks that are giving Mr. B.S. the real B.S. Once again, I'm not making this up. The putzolas tell Mr. B.S. he made a great buy and they are going to fix these up and rent them out and sell them for profits and yada yada yada. The putzolas and their friends will milk Mr. B.S. until his accountants put a stop to it.
I hope you're still reading, and I hope you're smiling. If you're not smiling, you're probably in one of the two groups described above. If you need help, call me.
If you are interested in buying a foreclosure property to live in, fine. If you are looking to buy foreclosures as an investment, think very hard. There are tremendous opportunities, but there are a hundred landmines in the way.
I am writing this in April 2008, so please consider any changes that have taken place in the markets. As of now, I don't see at bottom for at least another 12 months . . . maybe longer.
The basics still apply . . . buy at the right price and the right location. Actually, you only need to know the first rule, because even lousy locations have a price. It might be a very low price, but there is a price and a market for everything.
Foreclosure Myth #1 - Flip - I can flip these properties and make a bundle. - Response: Don't count on it. If it were that easy, an end user would have already bought the property, or one of the lenders buddies would have been in line ahead of you. Yes, there are some flip opportunities, but more traps than opportunities. The only way to flip these properties consistently for a profit, is when you are a bulk buyer getting this stuff at a deep discount.
Foreclosure Myth #2 - Clear Title - I am buying this free and clear. - Response: Unless you have done your homework, you might be buying with a tax lien, a mortgage, a squatter or any variety of legal glitches that have not been totally cleared. Do your homework and make sure you know where to look and how to look.
Foreclosure Myth #3 - Rental Income - I can rent these out and have positive cash flow. Response: We've yet to see positive cash flow, with the exception of some unique areas. These include very depressed and very low income areas, and college town rentals. Both of these markets come with major headaches, but they are positive. Other than these two markets, purchase prices are still too high and rentals are still too low. Keep this in mind . . . there are a flood of rentals on the market from all of the inventory the flippers are stuck in.
Foreclosure Myth #4 - Great Price - I saved this one for last, because this is the saddest myth of all. I hear from buyers that purchased homes at foreclosure, thinking they got a great deal. Unfortunately, three months later they realize they overpaid . . . and now they are realizing one or more of the three preceding myths. When it comes to price, you really need to know what you're doing. You can't buy something simply because it is half of what it sold for three years ago. Here is a great example. A buyer picks up a house for $260,000 in foreclosure. Two years prior a flipper paid $504,000. The buyer thought he "stole it," as boasted to me. When I asked him why he thought that, he responded that he bought it at 50 cents on the dollar. He was obviously not thinking clearly, because the original price had nothing to do with what this property was worth today. He didn't pay 50 cents on the dollar. He actually paid about $1.20 for a $1.00.
Here's how this played out . . . The buyer had to put more than $20,000 into repairs after not being able to sell it "As Is" for two months . . . plus the expense of taxes, insurance, HOA fees and maintenance for the two months. But let's go back to square one.
When he bought this for $260,000, he paid $35,000 more than market price . . . but he got caught up in the bidding. He was bidding against a couple that wanted to buy and live in this home. It was their dream house, so the only way he was going to outbid them, was to pay a stupid price. And he did. How does this end?
After a few months of wallowing in this lousy deal, and writing a lot of checks, he comes to me and we wind up selling it to the couple he was bidding against for $220,000. Even though he put $20,000 in repairs into the home, the market had gone down, and the buyers were looking at other properties. His total loss on this $260,000 "bargain" was $82,473. That includes closing costs for both ends, a $40,000 hit on the price, $20,000 in repairs, and the balance in expenses and legal fees.
How To Do Foreclosures - My best advice is NOT to do foreclosures, unless you really, really, really know what you're doing . . . really. If you must buy foreclosures, then follow the steps below. My very best advice is to get in touch with the owner and/or the lender prior to the foreclosure. The earlier you find pre-foreclosure properties or properties in the early stages of foreclosure, the better chance you have of buying it right.
If you're not an end user, you'd better be a very savvy investor or have a very savvy broker advising you. There are no exceptions. By the way, if you are an end user, I suggest retaining a very savvy broker or "real estate" attorney to walk you through the steps. There are too many pitfalls and too many opportunities for emotions and hype to interfere with our thought process.
First Step - Fact Gathering - Get the facts. All the facts! And then more facts. You'll want to run a title search on the property in addition to requesting the property details from the party foreclosing. If the property was listed, get the listing . . . and get your hands on the Agent Details as well as the Client Details. There are two parts to all MLS listings. Run a property tax search and a county records search. Even with the tax and county records in hand, you still want to run a title search with a company that is going to stand behind it with a title policy.
Second Step - Inspection - Go see the house AND the neighborhood. Find out how to get access and do a walk through. If you're still serious, spend the money and get it inspected. And be very careful here. You can get a "check the boxes" inspection for as little as $250. But if you want a very thorough inspection, be prepared to be shocked by what they find. I've yet to see my primary inspector come back with anything less than a 25 page report of problems . . . and that's it brand new homes. If you think the local building official actually inspects homes before issuing a Certificate of Occupancy, you are dead wrong. Most municipalities do a very basic "walk through" and other do "drive-bys" (if the house is there and the builder said it is OK, the building official issues a CO). Once you have walked the property and you have a solid inspection report in hand, reevaluate the price.
Third Step - Assessing a Value - Evaluate your basic research. What issues are hanging over this property. Once you have them identified, and you still want to continue, you need an appraisal or a broker price opinion. If you're dealing with a savvy broker, the BPO will be even better than an appraisal. A comprehensive BPO will include information about what has sold and what is on the market, as well as market conditions, property condition inside and out, neighborhood details and enough additional info for you to come up with a price. Yes, you. You're either going to live in it or rent it out. If you are a flipper, forgettaboutit.
Fourth Step - Area Scouting - If you are still interested, scout the area. Talk to some brokers, but get out there and drive around. Make sure there are no surprises. If you are still interested, make sure you visit the home site on a weekend and maybe a Friday night and maybe early in the morning before everyone leaves for work. Get a feel for what's going on. In this market, you have foreclosure neighborhoods that are full of homes with multiple occupants. You have homes that are being trashed by renters that couldn't care less. You have entire neighborhoods that are being trashed by a cycle that can catch you off guard. If you are an investor that is buying the property sight-unseen, because some guy in the Internet told you he is going to find foreclosures for you and rent them out with positive cash flow . . . you are nuts.
Fifth Step - Buy It - Why wait for the foreclosure auction. Work with the bank and the owner. The owner may be completely out of the picture, but if not, talk to both of them. Remember . . . you have already set your price. If you go to auction, chances are you will get caught up in the emotions and bid higher. That's the eBay syndrome. There are enough properties out there for you to find and buy before the final auction.
If you must go to the auction, make sure you visit the property the day of the auction. And whatever you do . . . stick to your price.
Comments: The basic information I am providing above does not apply to everyone, and it is very basic. I tried to put together some general information to give you a flavor for what is involved. If you are serious about foreclosures in Florida, call me. There is much more to this, and it really depends on your particular circumstances.
Foreclosures can be very profitable, but you need to have a team on the ground doing all the field work. If you think you can rely on a portfolio manager, risk manager at a bank, or someone sitting in an office, you are better off buying a vacation home in the islands. At least you will have something to show for the money.
If you have questions, please feel free to call me at 772-260-5448 or email me at Mike@MorganFlorida.com
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