Are foreclosed properties an excellent funding technique?
For the average real estate investor, foreclosed properties are a mixed bag. If you’ve spent time looking for an investment property, you’ve likely noticed some foreclosures on sale. You’ve probably also noticed that they’re usually cheaper than other, similar properties on the market.
Foreclosures often point to a good reason for their lower price – they may look poorly maintained, or there may be a major repair needed that may not be as obvious.
While foreclosures may require a little more work, they can also offer a much higher return on investment.
So should you invest in a foreclosed property? Perhaps. Before you think about it, it is important to be clear about exactly what you are getting yourself into.
After the Great Recession of 2008, we saw a significant number of foreclosed properties. Many experts predict that we’ll see a good number of them again sometime in 2021.
What is an excluded property?
You’re probably already familiar with the concept, but as a quick refresher, a foreclosed property is one that has become property of a bank after the owner failed to meet their payment agreement.
Of course, the lender is more interested in getting their money back quickly and they are very motivated to get rid of the property. For this reason, the foreclosed property is often offered well below the market value.
The downside is that these properties are usually sold as they are. No repairs are made as part of the store. So, as a buyer, you are taking a reasonable risk (this is why research is key).
The condition of the property can vary widely. From rundown homes that are barely worth more than the land they were built on to well-kept properties that are just as good as anyone else on the market. Most of the time, however, they fall somewhere in between.
Benefits of buying an foreclosed property
The first and most obvious benefit of foreclosure is the lower selling price. The lender is highly motivated to sell quickly and is willing to cut the cost of the property in order to achieve it.
Because of this, foreclosure does not necessarily mean that the property is in poor condition. It may need updating and maintenance, but sometimes the seller just wants to get rid of the property. This is a great opportunity to own a decent property at a great price.
Another benefit of buying a property at this lower cost is that you can diversify a little. You could potentially buy two foreclosures for roughly the same cost as a traditional property to help spread the risk. Of course, this is only beneficial if you are willing to accept the work that may need to be done on the property.
Potential for a higher ROI
As I mentioned earlier, foreclosures are often in a “state of emergency,” which means they have not been well maintained and need to be fixed. However, depending on the magnitude of the problems, this can be a great opportunity.
If the purchase price is reasonably low and the repairs needed are not inordinately high, even bringing a few thousand into the property can add significantly to its value – well beyond the cost of the repairs.
Not only does foreclosure add value to the home itself, it also gives you the opportunity to invest in a market or neighborhood that would otherwise be beyond your budget.
A few repairs can potentially match the value of houses in a good market and charge higher rents accordingly. And of course, higher rent means more passive income.
If you don’t have a lot of capital, the lower cost of a foreclosure is a huge benefit. In addition to the purchase price, buyers of foreclosed properties can often achieve better financing deals.
Because the bank / lender is motivated to sell quickly, they may also offer lower closing costs and lower interest rates. If you have funding planned anyway, this is a huge benefit as it will increase your positive cash flow.
Of course, there are times when you cannot finance at all. For example, if you buy a foreclosure at auction, the terms of purchase may require you to pay in cash. However, this is less common.
Disadvantages of buying an foreclosed property
Of course, the biggest downside to buying a foreclosure is that the previous owner likely didn’t look after the property very well and the bank / lender almost always sells the house as it is. They are also unlikely to offer repairs as part of the business.
In short, it means that you are taking a reasonable risk. After all, the repairs can be extensive.
That is why a home inspection is vital. You will get an idea of how much you would have to spend to get the property in good condition and ultimately how much you could benefit from the investment.
The fact that the property needs repairs isn’t a bad thing in itself, but it’s important to weigh the cost before making a decision.
Because of the nature of a foreclosure, you will need to do more thorough due diligence than a more traditional purchase.
You need to find out why the house was foreclosed and get as much information as possible about the previous owner. You’ll also need to look out for additional mortgages on the title (IRS, secondary mortgage, code enforcement, etc.).
Then there is the aforementioned home inspection that should take into account the repairs needed.
You should also look into the neighborhood itself. If there are a lot of foreclosures going on in this area, it can be a bad sign for the market in general.
When buying a traditional property, the seller is usually motivated to complete the transaction quickly. This is usually because they want the capital from the sale.
However, when buying from the bank they have to deal with a significant backlog of transactions and it can take a while to get to you. In short, while you may be motivated to agree on a price, the closing process can take a while (especially now).
This is not always the case, of course, but it is still worth noting.
Buying a foreclosed property can be a very lucrative investment. On the other hand, there is real estate that can make you lose money. Basically there is more risk, but possibly more reward.
Ultimately, I believe that investing in a foreclosure is not ideal for beginners. If you’re just starting out, it’s probably better to start with one turnkey property or even some form of Crowdfunded real estate.
However, if you are willing to do extra work, foreclosure can produce a high return and allow you to invest in a market that otherwise might not have been accessible.
Whether or not a foreclosure will work for you simply depends on the level of risk you’re comfortable with. With enough research, you can reduce that risk and potentially find a gemstone that is worth your time.