How to Make Money Buying Foreclosures

As I mentioned in another article, How to Still Make Money in Real Estate, real estate investors are bailing out on the real estate market left and right. Literally fleeing, with their hair on fire. That leaves the rest of us here to laugh and collect the profits. So, what am I saying? I’m saying it’s good news, people. Great news. More foreclosures, better deals, and less people buying them. The perfect storm. 

Investing in foreclosures has been a profitable business for decades. Only a few years ago it was so popular among real estate investors that foreclosures were only selling at a 5-10% discount. No longer is that the case. Why is that? It’s due to a combination of things. I mentioned the smaller number of real estate investors, so that decreases the pool of potential buyers and thus decreases demand. On top of that, the glut of housing inventory extends the time it takes to sell a property. Why is this important? Because when a bank forecloses on a mortgage, it becomes the owner of the house. Banks are not in the business of owning real estate. They don’t want to own the house. When they own the house, that means that their money is tied up in the physical asset of the home, and is therefore not available to lend to someone else. Lending money is a bank’s business. Not real estate. So, the longer it takes to sell a property, the more likely it is that a bank will take a low and lower price. They want to get rid of it – off their books. This, again, is a very good thing for us. More properties, better deals; even lower prices, even better deals.

The Process

Ok, so now we know why it’s a great time to invest in foreclosures. More importantly, though, is how. There are a multitude of ways, and they really differ from state to state, depending upon your state’s foreclosure laws. I suggest step one in the foreclosure process for you is to contact an attorney in your area and inquire into the foreclosure laws and requirements in your state. You can also easily google your state’s foreclosure laws, and if you’re extra savvy, look up your State’s statutes (just google those as well – i.e. Wisconsin Statutes), then just search within the statutes for “foreclosure”. This is important because each state has a different way of treating the foreclosure process, and more importantly, the rights of the owner whose home is going into foreclosure. As an example, some states include a 6 month “redemption” period. This means that anytime within 6 months of the foreclosure sale the previous owner can come back and pay off the entire amount owed, plus all expenses and legal fees the bank incurred via the foreclosure process, and legally take back the home. If you bought the property via foreclosure, you get your money back, but you’re out the property, and each state treats the improvements you may have already done differently as well. Now, is this a very real concern? Yes. Is it probable? Not really. If a homeowner couldn’t pay their monthly mortgage before, how are they going to pay all of their outstanding debt PLUS costs and fees now? Maybe if they win the lottery this might be possible, but then again, they’d probably be just buying a bigger house anyway.

Once you’ve learned your state’s foreclosure laws, you can move ahead with the process. I’m suggesting something entirely different, however, and it’s a growing aspect of investing in real estate foreclosures. It’s called investing in “pre-foreclosures”. A pre-foreclosure exists in a very small window of time between when the homeowner gets a Default notice (or Notice of Sheriff’s Sale, in some states) and when the sale actually occurs. This information is readily available on a multitude of different pay sites (none of which I am affiliated with, but one that is quite popular, and that my company uses, is foreclosures.com). Once you receive this information, you can contact the homeowner directly (some States require that you go through the homeowner’s attorney, again, something you should look into) and try to work a deal out with them before the actual foreclosure sale. This is better for many reasons. An important one is that, in some cases, when someone is foreclosed upon, they trash their place. They’re emotional about it. They’re pissed off at being kicked out. You name it, they feel it. So they take it out on the house. Additionally, before the foreclosure sale, you are not granted access into the home, so you have no idea what they did to it. You might buy what you think is a great property, only to find out that they plugged the toilet on the top floor then flushed it and let it flood the entire house. Or ripped out all of the copper plumbing and sold it. Or tore out the electrical. If you think about it, there’s an amazing amount of vandalizing someone could do to a home if unchecked. It’s sad, really.

Another reason why it’s better to deal directly with the homeowner before the actual sheriff’s sale is because you can get a great deal on the property while potentially giving the homeowner something in return. Let’s use an example to illustrate. Say an individual owns a home that appraises for $200,000. The problem is that the inside is trashed and dirty, the unfinished basement floods in the spring, and it’s in serious need of a new roof. Then, the homeowner starts falling behind on payments. Maybe they only owe $130,000 on it. They go and try to sell it, but because of all I just listed, no one will touch it for more than $100,000. So there they are, stuck in a house they can’t afford, that no one else wants either. They receive their default notice, the home goes into foreclosure and gets sold at a sheriff’s sale. Because it’s sold at a sheriff’s sale, and the buyers at the sale can’t look inside the home itself, it goes at an even further discount to account for such potential risk as I mentioned earlier. It’s a sad story, and why foreclosures are ripping through our nation at a harried pace. But here’s why this route is better. You find out from whatever resource you use that a homeowner has just received their default notice. You go and visit them. If they let you in (that all depends on your ability to persuade them – our company uses our real estate agents for this process. It’s a lot easier that way), you get a chance to check out the property.

After walking through the property, you notice the things I mentioned earlier. It’s dirty, run down, has a wet basement, and needs a new roof. Additionally, through your “flip” scouting abilities (see How to Find a Potential “Flip” Property), you’ve discovered that after fixing the wet basement problem (a lot easier than you might think – it could be as easy as simply re-grading the exterior landscaping, or as extensive as installing drain tile throughout – either way, wet basements can be fixed, and for a lot less money that people actually know) you can finish the basement and add a bedroom and a bathroom. Additionally, maybe it’s a story and a half, and you can finish the attic and add yet another bedroom (see How to Maximize "Flip" Profits Through Smart Renovations). After some quick calculations, a little shopping, and maybe a quick bid or two, you discover you can fix the problems in that property, and renovate it completely, for $35,000. After adding another bedroom or two, and a bathroom, it will sell for much more than $200,000. Enter all of this information into your investment decision equation (halfway down the article), and come up with a number (your NPP – negotiated purchase price). One important note – you’re going to be required to pay off the deficiency on the mortgage, and the bank’s costs to date, when you purchase the property. Do your best to estimate that amount (with the homeowner’s cooperation if possible), and make sure to build that in to your investment decision equation (maybe include it as renovation costs).

More than likely, your bottom line (NPP) will be higher than what they owe on the house. Let’s say, in this example, it’s $145,000. Therefore, you can offer the homeowner $15,000 more than they owe on it, and you get a phenomenal deal in return. Most importantly, they not only avoid foreclosure, but they actually get to take some of their hard earned equity with them, and hopefully move on and use it to right their lives. You make money and help a person in need. It’s so beautiful, it’s almost humanitarian! =) Additionally, since you bought the property straight from the owner, there’s no redemption period to worry about. It’s yours, free and clear. Another positive, especially for investors just getting started, is that you can fund the purchase just like any other investment property. At a foreclosure sale, however, you will be required to pay in full within a very short period of time (usually less than a week, sometimes even a day), and put down a large cash deposit. This can be a definite barrier to many otherwise able investors. While the time period in gathering the funds and closing on a pre-foreclosure is tight (there’s usually less than a month between the default notice and the actual sale), it’s a lot more reasonable than the one day you typically have at a sheriff’s sale.

Conclusion

Investing in foreclosures is always risky business, due to the many unknowns, and the varying degrees of legal hurdles to jump through. However, with a solid plan, a good real estate agent to rely upon, and a good attorney to fill you in on the legal aspects, it can be a very, very profitable venture. Additionally, a lot of the hassles involved in foreclosures can be avoided by the pre-foreclosure avenue. It requires a lot of work, and a lot of searching, but especially in today’s market, it can turn out excellent for you. GOOD LUCK!!