iA complete guide to foreclosed properties.
Property is being sold; under market value and the transaction is being done by the bank as well; what could go wrong in such an investment? A lot actually, especially if you don’t know exactly what you’re getting into.
This is often the first and most impactful problem when it comes to any sort of foreclosure investment; the investor is usually blinded by the thought of a cheap investment from a trusted and credible institution and neglects to realize just how little they know about the foreclosure market.
This post is going to give a comprehensive guide through all things foreclosure with particular care to discuss the following:
- What is a foreclosed property?
- What causes a foreclosure?
- What happens in the event of foreclosure for the original owner?
- The investment opportunity and risks of a foreclosed property.
What Is A Foreclosed Property?
A property that has had its ownership stripped either willingly or legally from a property owner to a bank or legal lender is classified as a foreclosed property.
Why Do Foreclosures Happen?
Property owners will either go through foreclosure voluntarily by abandoning the property with no legitimate inheritor such as in the event of death or the property is seized from them through their inability to keep up with their mortgage or debt payments to the bank; in such events, ownership of the property is transferred to the bank as collateral.
There are also many advantageous reasons for property owners to willingly go into foreclosure such as the following:
- Having to quickly relocate due to family or job obligations.
- Divorce case disagreements
- Management of excessive debt
- Loss of income
- Uncontrollable home maintenance costs
In such cases, attempting to sell your home in a reasonable time to accommodate the above issues and cover your debt may not be a possible option. Admitting foreclosure may save the owner on more stress as well as potentially lead to small profit from the sale of the property without them having to invest in the necessary resources.
Talking About The Original Owner.
The bank and lenders, in most cases; don’t want the property given to them in foreclosure. What they most commonly want is the repayment of their loan. As such, foreclosed properties will be sold at auction by the deed sheriff to attempt to repay the original owners’ debt.
What happens when a foreclosed property is sold.
There are 2 possible outcomes when the inevitable sale of a foreclosure property happens:
- It’s sold for a loss (sold at a value the is equal to or bellow the remaining debt owed).
- It’s sold for a profit (sold at a value that covers and goes above the remaining debt owed).
In the event of a “loss” sale of a foreclosed property, the sale is said to result in a deficiency. All proceeds are used to pay off debtors with the lending bank as a priority to receive all funds. After which, depending on state law the bank is may plead for a deficiency judgment against the original owner.
This is when the bank files a lawsuit against the original owner to be repaid the deficiency amount (the amount owed to the bank, leftover after property sales proceeds).
In the event of a “profit” sale, The bank is only entitled to the money it is owned; no more and no less. That being said, the bank may be owed extra money as damages for the inconvenience of having to go through foreclosure procedures.
In this event, the bank is paid its original owed amount and then its extra money; this is unless the original owner had other debtors besides the bank, in such a case, those debtors get preference before the bank’s extra money.
In the event of a situation whereby the property was sold at an amount that covers all of the original owners’ debt and there are still proceeds leftover from the sale; the remaining proceeds will be given to the original owner.
The investment opportunity and risks of foreclosed properties.
Before I deep dive into the investment opportunity of foreclosed homes, I believe it is important that I let the cat out of the bag. Contrary to popular belief, the idea that foreclosed homes is a gold mine for cheap property investments that can secure you an incredible return on your investment is largely a huge misconception.
For one thing, as I stated above, banks do prefer to debt have a liquid repayment of their debt but rarely does this ever mean that banks are desperate enough to sell the property below its market value for a quick injection of money or to spite the original owner.
A more common case is that severely distressed properties are sold at their value which though not discounted, is significantly lower due to the state of the property; once typical repair costs are factored; the home may be closer to market value than most would expect.
The real opportunities for buying foreclosed property:
1. The Seller is more likely to carry out full repairs and renovations on the property.
Foreclosed property repairs and renovations are held to a higher standard than when your average individual decides to sell their home. If a bank decides to undertake to repair the home before sale; it almost guaranteed to be done so incomplete fashion.
This significantly reduces the risk of encountering any additional cost of repairs once a property is purchased as well as maintenance costs from wear and tear.
2. Sellers are by law, expected to provide a thorough and complete report on the condition of the property.
If the bank does not opt to conduct repairs on the property, it will be expected to undertake and provide a comprehensive report on the history of the property concerning repairs, condition, and occurring problems.
This can give a buyer increased leverage in negotiating the appropriate value of the property as there are no hidden cost factors that can lead to mispricing.
3. Renovation potential.
For old and severely unmanaged properties, the above benefit of being able to account for a comprehensive history of the property can be leveraged to assist in renovating the property to being more modern and attractive at a more reasonable price.
This can lead to premium revaluing that allows the new owner to gain an increased return on the property at later transactions.
4. Fewer concerns on ownership risks.
Title searches are never an issue with foreclosed properties as the bank would have already had to undertake and confirm all such procedures before foreclosing the property.
This results in a faster and smoother transaction for the property.
5. Cheaper than market value.
The unlikely, it is not impossible to come across a foreclosed property that may have been on the market for a long time, being sold below market value. This is a beneficial exception to the rule that cannot be expected to be a usual scenario. But it can happen.
The real risks of buying a foreclosed property:
1. As-is sales.
This is a particular disadvantage for buyers who have investment plans for the property as they would be forced to pay for the property as well as its repairs before being able to generate any form of return through rentals or flips.
2. Bank provision or purchase of the property.
Banks if they speculate that they are unlikely to earn back their owed amount from the sale of the property, may decide to take it completely as collateral or purchase it at auctions.
For prospective buyers, this adds a layer of competition at auction sales.
3. Auction format.
Foreclosure auctions are known to attract highly competitive real estate investors who like you, will be looking for a prospective good deal. The more prospective buyers auction for the same property; the higher its selling price becomes.
This for untrained buyers can lead to them making a purchase for a property at a disadvantageous- higher than market value price for a property.
4. Squatter rights.
In some states around the world, just because a property has been foreclosed; it does not mean no one is living there. If the property has been left unattended for long enough, it may have attracted squatters; who though they have no claim to the property may be protected from immediate eviction.
This can add months and additional costs of legal action for the buyer to even have access to their property.
5. Redemption periods.
A property labeled as “foreclosed” is never completely guaranteed to go to auction for sale. Owners are often provided periods of redemption to which they can repay a portion of the amount they have due to being able to continue normal mortgage payments and claim ownership of their property.
This period can last up to a year and for prospective buyers of the property, this can lead to investment delays that make the property unviable.
Conclusion – Is it a good idea to buy a foreclosed home?
The not so flattering answer to whether or not foreclosed homes are a good investment is that more often than not the investment opportunity of a foreclosed property is almost identical to that of buying a normal property on the market.
The idea that foreclosures = cheap properties is a blatant lie that can lead to the properties being huge bad investments if not just for the fact that buyers are going into the purchase unaware of what type of investment they are getting into.