One of the questions I often get during an initial buyer consultation is, “Do you handle foreclosures? My (insert Aunt, Uncle, Cousin here) bought one and got a killer deal!” While not always the case, you can sometimes pick up a property at up to a 40%-70% discount. These can be single-family homes or multifamily units—and both can become great rental units.
Two Types of Foreclosures
While hunting these properties down, you will be able to find them one of two ways: pre-foreclosure and foreclosure. Pre-foreclosures are properties in the beginning stages of being repossessed due to non-payment of mortgage payments, or tax obligations. You can identify pre-foreclosures in your area through a great service called RealtyTrac.
You can really hit a home run when buying pre-foreclosure properties, because oftentimes you are dealing directly with the owner/seller instead of the bank. Approaching the owner during pre-foreclosure also allows you to get a bid in before the property hits the open market, which is what you really want to try to do. Owners get foreclosed on for a variety of reasons (such as job loss, or victim of a sub-prime mortgage), so when you call on these owners, call from a position of wanting to help create a win-win situation. You, the investor, get a good deal, and the owner prevents a foreclosure and the ensuing credit nightmare. Pre-foreclosure properties offer the highest potential ROI, highest potential cap rates, and cash-on-cash returns for your money.
A property that has been foreclosed on has been assumed by the bank and goes to public auction to be sold, or is put on the fair market through a real estate broker. While you can still get a good buy, you have to keep in mind that the bank is a) much different from dealing with a distressed owner, and b) in the business of making money, not losing it. I wouldn’t expect as deep of a discount on buying bank-owned properties as buying them pre-foreclosure, but anything is possible!
Tenants Living in Foreclosed Properties
Another thing to keep in mind is that a significant percentage of foreclosures happen on properties that are already being rented. Oftentimes a rental agreement will survive a foreclosure, so you may inherit tenants along with the property. Your state and local landlord/tenant laws will dictate how to proceed, but certainly pay extra attention to what kind of tenants they are, how they’ve maintained the property, etc. Just because you’re able to score a property at a deep discount does not necessarily mean you want to be saddled with bad tenants.
The Importance of Due Diligence
So, how does this all work for you, the investor? The first and most important thing to keep in mind is to do your due diligence. A deal isn’t always as good as it seems. If you pick up a foreclosure for a buy-and-hold in a neighborhood of other foreclosed properties, rents typically will fall on the lower side. If you aren’t able to contact the prior owner personally, I would start talking to neighbors to get insight as to how the neighborhood is, and what they know about the property. Condition is often an issue with distressed properties, so always be aware and calculate that into your budget. Make sure your property will have positive cash flow from day 1.
Achieving Positive Cash Flow
If you haven’t read my prior post, What to Know Before Financing Rental Property, please do, and use it as a guide. Take some of these avenues whenever possible. Just imagine buying a $100,000 property for $50,000 in your own backyard. You’ll have positive cash flow from the beginning, plus have massive equity, plus appreciation—that’s called living the dream! You can use this same strategy to start doing rehab-and-resell, and absolutely crush it.
There are no shortage of ways to get creative with purchasing pre-foreclosure and foreclosure properties. Study all of your local laws, do your due diligence, partner with a great team of vendors, and get after it! Get great at the foreclosure business, and reap the benefits for as long as you want to!Read more on Scaling