Foreclosures can be smart investment if you know how the system works
If you're considering buying a foreclosed home, it may be time to plan. Mortgage-industry experts expect foreclosure rates to rise in the...
Special to The Seattle Times
If you're considering buying a foreclosed home, it may be time to plan.
Mortgage-industry experts expect foreclosure rates to rise in the next couple years, meaning more properties in some stage of foreclosure will be available for buyers and investors.
But finding so-called distressed properties and buying them off the auction block isn't that easy, and most buyers aren't looking for a place to live. They are investors who buy foreclosures, fix them up and resell them.
"We find that our clients are primarily looking for investment property," said Alexis McGee, president of foreclosureS.com, a Web site for investors.
"They may search for a home to live in but then decide their 'wish list' of personal home needs and cannot wait for a foreclosure deal to come around," McGee said. "They buy 'retail' the old-fashioned way for the home they live in and make money doing foreclosure deals."
Foreclosures are sold by government agencies or by banks or auction companies at auction.
Stay focused: On average, there are about 200 foreclosure opportunities a week in Pierce, King, and Snohomish counties. "I used to try to look at them all," says foreclosure investor Mike Ballard. "Now I just focus on those that are within three miles of my home." This managed approach has paid off, he says.
Be prepared: Planning to buy a property at auction? Be sure to check with the home's trustee before making your bid. Every home has different sale terms and requirements, such as the type of cashier's check required for payment.
Avoid stinkers: Study up on the market and determine which houses have more resale potential than others. For instance, says Ballard, "I don't want to buy a house that will retail for more than $500,000 because it will likely linger too long on the market." The ideal foreclosure property? Ballard says he looks for "clean subdivision houses." "You know you can go in there and make them really shine," he says. "Those are the ones everyone wants."
Know your limit, and stick to it: For Ballard, knowing his limit means paying no more than 80 cents on the dollar for any given home. "My bidding always stops at 85 percent of the home's value," he says.
Be a savvy seller: To make money on your foreclosure investment, there must be a sale on the other end. "Really watch your pennies on the renovation," advises Ballard. Another way he keeps his costs down is by working with a real-estate agent who charges a reduced listing fee.
Don't go it alone: Get involved with a group of people who buy foreclosures as investments, Ballard says. By pooling knowledge, resources and capital, you'll be in a better position to succeed at foreclosure investing.
Sales handled by the federal government are generally easier for noninvestors to buy, because sealed bids are submitted over a period of time, financing exists and the properties are available for 45 days only to buyers who would live there.
Banks, auction houses, other private companies and sometimes local government agencies have different, more restrictive rules.
Investor Mike Ballard says those rules are not conducive to individual buyers looking for a bargain on a place to live.
"Based on the fact that one needs all of their funds with them at the auction for a house that they are not sure they will be able to obtain, traditional financing is impossible," he says.
"Banks do end up with repossessed property ... and they sell these on the open market, but not at any great discount that I have noticed," he says.
The number of foreclosures nationwide hit a record low last year, but they are rising this year — up 38 percent in the first quarter, data from property tracker RealtyTrac show.
That trend is expected to continue into 2007, mortgage-industry officials say, due largely to the dramatically higher payments homeowners face as rates jump on adjustable-rate mortgages.
These loans, known as ARMs, and newer nontraditional mortgages, such as interest-only and stated-income loans, have many homeowners in over their heads, says Grant Learned, assistant professor of business law at Seattle Pacific University and a real-estate investor and developer.
"[The loans have] allowed people to get larger loans and bigger houses with smaller payments," Learned says. "I call it the 'eBay mentality' — many people have got to get the house of their dreams no matter what it takes."
This year, rates will adjust for about $300 billion in mortgages; next year, that number is expected to hit $1 trillion, the Mortgage Bankers Association has said, dramatically increasing payments. Homeowners who can't afford those higher payments and who can't sell or refinance will face default and possibly foreclosure.
"Something's got to give," Learned says.
That something can mean foreclosure.
Bad news, good news
For some, mainly investors, those homeowners' misfortunes become opportunities.
Ballard, a real-estate investor in Edmonds, says he'll never forget the day he bought his first foreclosed home.
The entrepreneur, who sold his lighting business in 2003, had spent five months researching properties and learning about the foreclosure market. By early 2004, he and his business partner decided it was time to make their move.
"I had always wanted to be in real estate," says Ballard. "It really seemed like a way to make money, but I wasn't looking to get rich quick. I was interested in being self-employed."
So, with nearly $200,000 in assorted cashier's checks in hand, the two investors showed up at the King County Courthouse in Seattle, where several foreclosed homes were to be auctioned off.
Ballard, who had already received a list of the properties before the auction, had driven by several of the homes to check them out. He decided to focus his energies on an 800-square-foot fixer in the Bitter Lake neighborhood of North Seattle.
Ballard describes the scene on Fourth Avenue as "insanity." With more than 200 people crowded around five or six auctioneers, he says it was "loud, confusing and a little scary — truly capitalism at it's most raw."
But Ballard bid on the Bitter Lake house.
"The bidding was up to $170,000, and it looked like we had it," he says. "Then this guy showed up in a taxi and he started bidding against us."
Worried that the price had gotten too high, Ballard's gut told him to back out.
"But my business partner insisted that we stay in it."
A few minutes later, the property was theirs — for $181,000.
After investing $50,000 into the renovation, Ballard and his partner sold the property this year for $310,000. A good investment? Ballard says, you bet.
Breaking into market
Want to start investing in foreclosures? Alexis McGee of foreclosureS.com and has more than $100 million in transactions to her name, says it's not an industry for novices.
"It takes a certain amount of knowledge to do this," McGee says, who has 20 years of experience.
Foreclosure Web sites — such as ForeclosureS.com, RealtyTrac and foreclosure.com — give beginners a leg up in a complicated marketplace. Foreclosure information is a matter of public record, so anyone can access it, but sifting through government Web sites to find homes in foreclosure can be time-consuming and confusing.
McGee compiles weekly lists of foreclosure offerings and sends them to fee-paying customers who have specified a particular search criteria.
"These Web sites help break the info up for you and help you determine whether a home is a hot property or not," says Ballard, who has subscribed to such services for several years.
With the right knowledge, "anybody who has a little spare money and knows how to fix up a house can do well," Ballard says.
Before beginners take the plunge, however, McGee encourages them to spend a few months researching the market and reading up on foreclosure investing.
For $19, she also offers a monthly teleconference for would-be investors called "Kick-Start Foreclosure Investing." In it, she dispels common myths — like spending only $1,000 for the keys to a house — and encourages sensitivity when dealing with people who are about to lose their homes.
While buying a home on the auction block is one way to secure a foreclosed home, seasoned buyers say the best deals are made one-on-one, often across a kitchen table.
After a homeowner falls behind on their mortgage payments, they receive a "notice of default."
If they take no action to remedy the situation in 30 days, they receive a "notice of sale" — which is noted in court files the public can view — stating that if they can't pay within a 90-day period, their house will be sold at auction.
It's in this period, known as "pre-foreclosure," that investors prefer to make deals.
"Knock on doors," Ballard says. "Talk to the owner and prove that you are trustworthy. Reason with them. Their house may be worth $300,000, but maybe only if they put $50,000 into it.
"You don't want to sugar-coat things, but it pays to be nice. I'm a firm believer that everybody deserves to have dignity."
While most traditional real-estate transactions happen without the buyer and seller ever meeting, the opposite is generally true in foreclosure deals.
What a surprise
With the deed to his first foreclosure purchase in hand, Ballard drove to the house to introduce himself to the people who lived there. When he knocked on the door, he got the shock of his life.
"It turned out to be a guy I used to walk to school with from kindergarten to the 12th grade," he says. "But now I owned his house. That was awkward."
He likes to dispel the "big bad investor" stereotype. Sensitivity is a must, especially when dealing with residents.
"There's no reason to be mean," he says. "I say to people, 'Can we help you? Can we give you $1,000 and help you move out?' If you put a little money in their pocket, they can be on their way. I've never kicked anyone out, but sometimes you have to be firm."
Financial hardships aside, experts estimate that divorce and drug or alcohol abuse are among the top reasons for home foreclosures.
But whatever the reason, McGee says, "be conscious of the fact that you're talking to someone who is going through a really hard time."
While investors like Ballard may be the majority, there are those who prey on people who have fallen into hard times. Some advertise on telephone poles. Others knock on doors of elderly homeowners who may be out of touch with market values.
"I've heard about people offering ridiculously low amounts for houses, way below market value," Ballard says. "And sometimes people accept these offers because they are desperate.
" I just couldn't do that. You have to be able to look at yourself in the mirror."
Sarah Jio, firstname.lastname@example.org, is a Seattle-area freelance writer.