More than a million foreclosed and "distressed" properties are expected to hit the market this year, from two-bedroom starter homes to 20-room mansions. But while the banks that own many of them are now preparing to sell them en masse at auction, most of the best properties will be sold long before the gavel comes down.
Homeowners unable to refinance—but still with plenty of equity—can simply put their houses on the market, while those underwater can plead with their banks to let them "short-sell" for less than they owe on the mortgage.
Those who can't sell before they're foreclosed on will be evicted and their houses auctioned off. Whether on the steps of the local courthouse or through private sales, bidding typically starts at or just below what's still outstanding on the mortgage, plus fees and court costs—which isn't a deal if the property's market value has sunk below that.
More often than not, the bank takes back the house and hires a real estate agent to sell it, sometimes at far less than what was owed on it. So which stage offers the best opportunity to buy on the cheap?
Here are the upsides and downsides of each:
Pre-foreclosures. This entry point offers both the best and worst of the often messy business of investing in foreclosed property. On the one hand, if you can contact a distressed homeowner as soon as or even before his troubles become public knowledge (usually in the form of a "notice of default" listing in the newspaper), you're ahead of the competition and in position to work out a deal. On the other hand, you're approaching the hapless homeowner when he's at his lowest, or even worse, still in denial of the reality he faces. Already on edge, many facing foreclosure are warned to be wary of strangers approaching them with quick fixes, and with good reason. "That's when the vultures show up," says real estate attorney Oliver Frascona, who notes that fraudsters posing as so-called foreclosure consultants often try to get involved at this stage in the process.
Anyone with misgivings about profiting from someone else's misery has plenty of reason to steer clear. The irony, however, is that this is the point when a would-be can actually do some good, helping an owner avoid the all but permanent taint of a foreclosure. Although involuntarily selling one's house is sure to be heart-wrenching, a fair offer can at the very least create a path to financial recovery. That said, foreclosure experts warn buyers to avoid getting entangled in the seller's personal affairs. "A reasonable offer is all you owe them," says real estate broker Ralph Roberts, author of the book Foreclosure Investing for Dummies.
Those who want to avoid direct contact with a distressed seller have another option: the short sale. Such homes, which are often put on the market with the help of a real estate agent, are priced below what the owner owes on the mortgage and must be approved by the bank. The advantage, of course, is that you have every opportunity to do your due diligence and make an offer without having to engage the seller directly. The disadvantage is that once the house is on the market, you're competing with everyone looking for a deal. Meanwhile, even if your offer is accepted, it could take weeks, even months, for the bank to respond.
To increase your chances of getting a thumbs up, be sure to do your homework, including a thorough market analysis of what comparable homes have sold for, and submit your research along with your offer. "If you come in with all the statistics and can make the case that yours is a fair price, they're more likely to take it," says Pat Lashinsky, chief executive of real estate brokerage ZipRealty. And whatever you do, "don't try to low-ball the bank because they won't go for it."
Public auctions. The very idea is irresistible. Find your dream house, head for the courthouse steps, and bid whatever you think the place is worth. Unfortunately, the public auction stage of the foreclosure process rarely presents easy pickings. Although the exact method of disposition varies widely by both state and county, the general process is that the homeowner is sent a "notice of default" and given a certain amount of time—usually about 90 days—to "cure" the loan and bring payments up to date. If the homeowner doesn't, the bank then sues to repossess the house, which the court or a trustee then auctions off to the highest bidder.
The caveat is that the highest bidder must offer at least $1 above what the bank is owed on the property, then make a nonrefundable deposit—usually between 10 and 15 percent—and arrange financing within 30 days. In most cases, however, even a bid that's just $1 over the outstanding mortgage is substantially more than the house is worth. The result is the exact opposite of the sort of auctions you read about in the arts pages: a short, utterly boring affair in which no one even bothers to make a bid.
In some places, the owner may then have one last chance to "redeem" the property, paying off the entire loan amount, plus fees and expenses. Such situations are exceedingly rare, however, as few can finagle a new loan at that point, let alone come up with enough cash to pay off the old one.
Equally rare are situations in which homeowners who still have equity are nonetheless foreclosed on and their properties auctioned off. "Some people who come to me are just in denial," attorney Frascona says of some who simply refuse to sell before they're evicted. "But they usually to come to their senses by the time I'm done with them."
Even if they don't, buyers lucky enough to ferret out a "found money" situation still face risks. First and foremost is that fact that publicly auctioned homes are sold "as is," and there's usually little or no opportunity to tour the house, let alone arrange for a full-blown home inspection. Fixing that leaky water heater or protecting the house from termites is usually low on a cash-strapped homeowner's priority list, which means such houses are often fixer-uppers.
Even worse are situations in which soon-to-be-evicted homeowners take out their frustrations through sabotage. "They were so angry that they poured cement into all the drains and blocked up all the plumbing," ZipRealty's Lashinsky recalls of the evicted owners of one property, which cost the new owner about $25,000 to fix.
Owners often leave behind other problems in the form of unpaid taxes and other liens against the property. Back taxes are considered "superliens" that must be paid off by whoever takes ownership of the property. In some states, a foreclosure extinguishes junior-level liens, such as second mortgages, credit card debt, and the like. Others, however, require the new owner to pay off mechanics' liens, such as the money still owed to the repairman who fixed the central air conditioning system last summer.
Information on such debts is usually available through the local county clerk and recorder and the local treasurer's office. Title companies, too, are often willing to do a free cursory "errors and omissions," or E&O, search for prospective customers, although they don't always pick up every outstanding debt.
Bank-owned sales. The last stage of the foreclosure process may offer the smallest upside over the short run but the surest investment over the longer run.
By the time a homeowner has been foreclosed on and evicted, plenty of would-be investors have already had and passed up their chance to buy the house, usually for good reason.
Unable to get what it's owed, the bank then hires an outside real estate agent to put the place on the market, usually for somewhat less than what was originally owed on the mortgage. Spying a potential deal, would-be investors then circle back. Free now to tour the home and do all the due diligence needed to make an informed decision, many nonetheless continue to low-ball the bank and get rebuffed in the process.
Abandoned and unkept, such houses often sit on the market for months — even a year or more — gathering weeds and dust until someone finally hits the bank's target price. As with buying houses during the pre-foreclosure "short sale" period, the best strategy for getting the bank to sell is to offer a fair price and back it up with hard copies of all the research you've done to get there.
Of course, good things may also come to those who wait. With few signs of a bottom to the market and inventories of unsold houses continuing to increase, some major banks are already engaging post-foreclosure auctioneers to sell off their properties en masse. Well publicized in advance, such sales can offer advantages over government-administered foreclosure auctions, allowing prospective bidders to tour the homes in advance, and can even offer help with financing.
Recent auctions in Southern California and Florida have disposed of hundreds of homes in a single day, at prices as much as 40 percent off what the houses previously sold for. Even then, however, "it remains to be seen how many of those people actually got a deal," broker Roberts says of home prices that continue to fall in many areas.