Warning: We cannot print today’s pieces without a frank discussion of the “f” word. Yes, the “f” word.
Foreclosure. It’s a fate we all hope to avoid personally. But as real estate investors, we also know that foreclosed homes may offer us tremendous opportunities for profit, incredible deals, and epic upselling after appreciation works its magic.
Acquiring properties that have been foreclosed, are owned by banks, or are otherwise underpriced because of related issues is a smart investing strategy for many REIs. If you’re thinking about going this route, you can’t afford not to know the following information about why and how to buy these discounted properties. Read on to learn more about REO investments, foreclosure, and how to make these assets into your next profitable investment properties.
What is an REO Investment?
An “REO” is a term for a bank-owned property. “REO” just stands for “Real Estate Owned”–meaning someone already owns the property. In the case of REO properties, that someone is always a lender. These lenders are, more often than not, banks. So all “REO investment” really means is just that the property is purchased straight from a lender, not a person.
Another thing to understand is that these aren’t “short sale” homes. “Short sales” are usually where investors can find major steals. In these sales, a homeowner is selling their home for less than they currently owe on the mortgage. Foreclosed homes have essentially been sold in this fashion back to a bank.
At that point, most banks mark the price way up–back to what the asset’s original value was, most of the time. After all, even banks want to make their money back. By the time the foreclosure is complete, the bank becomes the owner and seller. They can make any demand they like. Smaller banks may offer great deals on their homes.
What are Some Benefits of Buying Foreclosed Homes as Real Estate Investments?
The foreclosure auction can be the deal-hunting real estate investor’s best friend in this department. This is just one of your options for shopping around, but first, let’s get into why you might want to:
- Easier negotiations. Some find institutions simpler to handle than people–and often, they’re much more transparent. The banks with tons of stock are going to be more highly motivated, and therefore the most amenable to compromise during the negotiations process. Others may staunchly and adamantly demand sticker price for a given property. Your mileage will vary.
- Below market price opportunities. Some banks are incredibly motivated sellers and will accept offers if their “inventory” of homes is massive or overstocked. Bonus points if you’re interested in an extremely unpopular or traditionally difficult-to-sell asset class.
- Sellers are legally obligated to disclose full property records. Anything the bank knows about repairs, the property’s condition, appraisals, changes in ownership, and much more is actually information you have a legal right to. This is great for due diligence purposes.
- Repairs and closing cost credit opportunities. Many institutions are all too happy to complete the necessary repairs to get your property habitable, and therefore sold. Some even will offer closing cost credits to expedite getting the property off their laundry list and into your hands.
- You can buy with ordinary mortgage financing. With foreclosed properties, mortgage opportunities for you as an investor abound. Buy the property in your own name, but only one you’ve already set up your asset protection structure. Have everything you need from a legal standpoint ready to go so you can minimize the amount of time the property, and all of its liabilities, are directly attached to your personal name.
Note: You can still protect your property, even if you choose to buy in your own name to obtain financing. All you have to do is use an anonymous land trust to take the property’s title after purchase. From there, leave it in your land trust or move it into your asset protection structure. Whatever you do, your mortgage will stay the same assuming you execute these transfers appropriately and legally. An experienced real estate or asset protection attorney can ensure you do.
This is just the shortlist of some of our favorite perks of these properties. Of course, you may reap additional benefits we can’t list because they honestly warrant an entire article of their own. But these are some of the very basic reasons why people love hunting for REO or foreclosed homes. They can be a dealmaker’s delight.
The REI’s Guide to Buying Foreclosed Homes
If the auction isn’t your scene, of course you can also buy a foreclosed-upon home directly. You’ll generally follow the same basic steps, but of course, check with your own real estate attorney before you purchase any major assets. That said, this is the basic outline of what you have to do to legally and safely acquire one of these properties:
- Assemble your team of qualified professionals. Most folks like to have at least an attorney and a real estate agent on their dream team.
- Defend your offer. Even a verbal promise is better than nothing, but ideally you’ll be protecting yourself down the line with real estate contingencies that allow you to back out at no cost if the property “fails” any of the next steps. See our previous pieces on crafting real estate contingencies to your advantage for more information.
- Have the property thoroughly inspected. This will help immensely with the next steps.
- Weigh the pros and cons of purchasing this investment. Consider your portfolio, return expectations, the amount of time you have (if any) to put into renovating this property, property management costs, and of course, a good 20% buffer never hurts a pro forma. You can also ask your team of advisors their opinion on your investment opportunity.
- Get the property professionally appraised. Only a real-deal appraisal will give you the true value of the home. This is vital for determining whether your deal is worth the amount of time and effort (as well as money) that you have to invest in this new acquisition. It can also become enormous leverage at the negotiating table. Getting additional discounts on these homes is easy for the deft negotiator.
- Bring in experts if necessary. Should any special issues arise during inspection around local law, water, ground coverage, or any other impediment to your ideal use of this property, don’t be afraid to have an expert in whatever subject come on down. You can usually secure experts quickly and easily on most common real estate problems, assuming both buyer and seller have a desire to fix the issue. While you get obvious negotiation power in such situations, you can simply ask to have the problem fixed. It’s best in our opinion to invest more in due diligence and addressing all potential issues prior to purchase than to buy on a whim and handle everything “later.”
- Make your offer. If you’re buying a bank-owned property, understand you’re likely to pay sticker price for foreclosures. If you know ahead of time sticker price is well within your budget, make the exact offer if you wish to expedite things. You can try to bargain, but frankly your odds of success may vary wildly between institutions.
- Close. Grab your keys and get to work. You’ve either got some remodeling to do. some tenants to find, or some property management contracts to sign. Get any third parties you may need to run your real estate business.
Don’t Forget to Cover Your Assets
Buying a foreclosed or bank-owned property is no different than making any other investment from an asset protection standpoint. Ensure you handle this property exactly as you would any other REI asset from a legal standpoint. If you normally buy with your Traditional LLC, do that. If you secured financing in your own name and have a land trust ready to go, proceed with your plan. If you don’t have an asset protection plan at all, it’s time to start learning about asset protection at the very least. Ideally, real estate investors should have a trustworthy attorney who can answer asset protection questions.
Of course, asset protection experts and firms exist for a reason as well. You’ve got options for protecting your new asset, so get a plan that’s customized to maximize your business’s profits, tax savings, scalability, and success. You can find an expert on any budget to help you out, but above all, don’t hold any real estate assets in your own name over the long term. You’ve got so many alternatives that there’s no excuse, so start planning before you even think about buying.
Bottom Line: The Savvy Investor Can Win on Good REO and Foreclosed Properties
If you take nothing else away from this article, simply understand that making deals with the bank is a bit different than making deals with a person. This basic truth is the root of most of the confusion around foreclosed and REO properties. But since you’re no longer confused, you can start considering whether such investments have a place in your portfolio. Your answer will likely depend on many factors, including your age, sex, location, main career, investment class preferences, investment strategies, aspirations for your portfolio, and other highly personal details.
But for now, at least you know the basics of how to intelligently vet and purchase these properties. Your team of advisors and even your personal investing network is likely full of insight on the foreclosure opportunities in their respective local markets. Asking around can often be the beginning of a beautiful learning experience. So don’t be afraid to ask around about how foreclosure and REO deals have gone for others in your personal and professional network.