Although you’ll find plenty of articles online geared toward homebuyers who want to know how to buy a foreclosed home, fewer are written with a real estate investor specifically in mind. This is probably because there are so many homebuyers who think they want to get into a foreclosure, not realizing just how much there is to know before they make such a leap. So, while this is all about buying a foreclosed property, a lot of what I’m about to write is going to be specifically pointed at those flippers, landlords, and other sorts of investors who are considering jumping into foreclosure properties for the first time.
Back in the 2000s, I had an investor client who loved single-family homes, but he was also extremely tight-fisted and consumed with the idea of foreclosure properties. The market was different then, but not as different as you might imagine. Although we didn’t have the inventory shortage that’s currently plaguing the industry, we did have a monumental valuation crisis on our hands, especially in my local market. For the first time any of my fellow Realtors could remember, we were dealing with offers above asking price and aggressive bidding wars. So, you couldn’t really blame the guy for trying to get in on the cheap.
But, the problem then, as it is now, is that not every foreclosed house is a bargain -- in fact, many will turn out to not be -- so, if you’re banking your investment strategy on foreclosures alone, it’s a long-term gamble at very best. You will have to put additional money into your foreclosure purchases, as my client learned time and time again, and they absolutely are never guaranteed to turn a profit. That being said, they can be incredible vehicles to help you build up a property portfolio (my first real estate purchase was actually a foreclosure!) if you have a good idea of what could go wrong and prepare for it.
Buying a foreclosed property in seven simple steps
The truth is that buying any sort of property isn’t simple, especially if it’s an investment property of pretty much any flavor. However, there are better ways to approach a foreclosure-as-investment than others.
Step 1: Do your homework
Before you dive into the stack of foreclosures in your local markets of choice, really get to know what the property market looks like. If you intend to rent your purchase, make sure you understand what it takes to make a rental in that area attract the best tenants and the highest rents, as well as what you can afford to put into one to make that happen. For a flip property, consider the comps on the market (and go see a few if you have the time) and what they’re bringing.
If you’re not sure what you plan to do with the foreclosure home when it appears, you should not be looking at it. Plain and simple. This is an investment, and as such, you need a plan to get the most out of it. Just because it’s a distressed property, it doesn’t make the transaction a slam dunk, nor does it guarantee it’ll be a winner no matter what route you choose, rent or sell.
Step 2: Talk to your loan officer
Although you should be doing Steps 1 and 2 pretty much simultaneously, if you have to do one first, the research should be the thing. Especially if you’ll be using a commercial loan to secure the property, in which case you’ll need to be prepared with a plan to rehab (for a construction or construction-to-permanent loan) any seriously distressed property you may choose to pursue.
Because many, many foreclosure properties sit empty for long periods of time during the foreclosure process, are sometimes damaged by former owners or tenants out of anger and frustration, and frequently have massive failings that prevented them from being sold as short sales prior to foreclosure, your bank will be understandably wary. No matter how good your credit score, the revitalization plan is important to moving forward with your financing.
Unless you intend to occupy the foreclosure home yourself for an extended period of time, the likelihood of being able to secure it with a 203(k) FHA loan, USDA loan, or other type of loan primarily used for homeowner-occupied properties is extremely low. The FHA, in particular, is very aggressive about ensuring the buyer is planning to live in the property they’re involved in long term.
Talk to your lender as soon as possible. You need to know exactly what their terms will be for a commercial loan of this type, as well as how much of your own money you’ll need to invest and what kinds of documents they’ll need to see regarding your investment plan. Having a preapproval prior to making an offer, even with a commercial loan, gives your offer a better chance to be accepted.
Step 3: Take a look
One of the benefits of purchasing a bank-owned property is that you get to see it first, unlike what sometimes happens with a sheriff's sale or other type of auction. There’s a lot of risk removed by simply waiting for this stage, since your and your real estate agent’s combined experience should make a good base for assessing just what will be required to get the property up to snuff.
Keep in mind that the seller will almost certainly do no more with the property than has already been done, and start working the figures. (That said, if, for example, the roof was collapsing or otherwise in seriously bad condition, a foreclosure property might get a new roof.) Make detailed notes while you’re on the premises; every hole punched through a door or missing light fixture is another line item you’ll have to deal with after closing.
Because it is often a serious holdup, make sure you take detailed photos of the electrical panel or fuse box. Fuse-based systems can be problematic for securing insurance, even with a bank-owned foreclosure, but so can low-amperage electrical services (generally under 100 amps), regardless of the presence of a breaker box. This is one of those major expenses you should be aware of before making an offer, so call your electrician for advice before proceeding if time allows.
Step 4: Make your offer
Once you have a rough estimate as to how much money you’ll need to sink into the property, you can make an offer to the owner of the bank-owned home. Consider things like inventory surplus, neighborhood desirability, potential for other investors or brave homebuyers to make an offer at the same time, and the amount you’ve calculated the property to be worth as an investment before you put your offer together.
Negotiating with banks has never been the fantasy a lot of people make it out to be. You won’t be buying this (or any) house for $100. The property owner knows the value of the property on the foreclosure market, and while they may offer it at a discount, it won’t be so significant that a ridiculous lowball offer will get you very far. Additionally, with a bank foreclosure you may only have one chance, especially in the current real estate environment, so make your highest and best offer off the bat and don’t deviate from it (or, as the kids say these days, don't "shoot your shot").
Even with a strong offer, it can sometimes take up to 90 days to hear back from a bank owner. They have a lot going on and dealing with foreclosures is not their primary business. This is simply not a high priority for them, even if they have a dedicated real estate agent or department for these repossessed properties.
Step 5: Home inspection, home inspection, home inspection
Assuming your offer was accepted by the property’s owner, your next big hurdle is the home inspection. Absolutely do not skip this step on any property that has been abandoned for any amount of time. Structures tend to go downhill quickly without human intervention, and problems you may have never anticipated can be hiding in the most unlikely places.
You will need to specify your desired home inspection period and actions that you’re allowed to take should the inspection not be favorable within your offer. For example, it’s reasonable to void the contract if an inspection shows serious structural damage that wasn’t obvious or visible during your viewing of the property, but you may still need to spell it out.
You can do your own inspections, but it’s really not a great idea. If you have a second set of eyes on things, you may find things that you may have not caught on your own; plus, a home inspector sees so many more houses than you probably do in a day. They already know what issues are endemic to specific neighborhoods and types of structures. You can also call in specialists, like electricians, to assess specific systems like the electrical box, but you may have to pay extra for the additional inspection.
Remember that whatever your inspection turns up, you’re unlikely to get the seller to fix it. In certain situations, they may be willing to give you a credit at closing, but if there are lots of buyers lined up behind you, this, too, is unlikely. Ask your real estate agent for specific advice on handling any serious issues that are uncovered, but generally any bank-owned property is sold "as is" -- and you should be operating under that assumption.
Step 6: Meet with your insurance agent and other experts
You’ve had your inspection and you’ve decided to move forward with the property, even though it has a punch list of repairs the length of your arm. (Don’t worry, most are small things like that door you already knew had to be replaced). Don’t wait until the day before closing to call the utility company or your insurance agent about your upcoming acquisition.
This is kind of the last major hurdle to overcome, because you may find that your insurance agent won’t insure that 60 amp breaker box, or that the utility company has red-flagged the property and won’t turn the utilities on until you’ve corrected a specific issue. Problems you find at this stage tend to be smaller, and can be overcome, but they can also take extra time. If you get everything lined up prior to closing, you can have these issues cleared up the day you take possession of the property, speeding up the income stage of your investment.
Step 7: Closing day!
It might seem obvious that the last step would be closing, but because you’re dealing with an entity and not a home seller, and likely a commercial loan and not a residential home loan and mortgage lender, closing may not look quite like what you expect. The bank’s representatives will have already signed their portion of the paperwork, which you and your agent both should check very carefully, and you’ll be presented with documents for your investment loan (unless you’re paying cash, of course).
Make sure you get any and all keys and door openers, even though you plan to rekey immediately, and that any credits that were agreed upon in the contract are applied properly. If an escrow was to be established, you’ll need to check that the escrow amount is correct as well. Basically, closing on any sort of investment property should be a long series of "hold on, let me make sure this matches what I’ve got in my file" moments. When it comes to investment property, it’s extremely important that all the I's are dotted and the T's are crossed.
The Millionacres bottom line
Buying foreclosed homes can help an investor build a solid base for their real estate rental portfolio or give a flipper ample opportunity to create more value from a house that has seen a few decades. Either way, proceed with caution, since you’ll be buying the house in an as-is condition at minimum, or sight unseen in the most dramatic of cases.
Be sure to consider the costs of rehabilitation when you make your offer, but if your local market is active, bring your best offer to the table if you really want to be considered a serious buyer. And, above all else, don’t forget to consult with construction professionals throughout your purchase to ensure that the house you buy will be a good investment, not just a deep black pit in which to throw money.