Buying a Foreclosure Property

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Many of my regular readers have noticed that I haven’t posted in several weeks. What’s been keeping Dax so busy you ask? I’ve been helping to keep the real estate market balanced. Time and money are a delicate balance and unfortunately time has been scarce for me lately as I have been busy in the real estate game.

The market is a 0-sum game. Someone wins. Someone loses. In my August post “Why Our Financial Calamities are Good” I state my opinion that it is good to let nature take its course to bring things back to balance. I am a firm believer in the market. How does balance occur in housing? When houses get foreclosed who wins? Who loses? Well, the bank loses for sure. They probably underwrote some bad loan to begin with. They have the expense of filing the foreclosure process. They also have to carry the costs of mowing the lawn and property taxes until they can unload it. Who wins? Title companies, winterizers, and other services are employed by the banks so they are winners. So is the buyer (sometimes). The buyer of a foreclosure is afforded an opportunity to purchase a home below market. The difference is the bank’s loss or the government’s (if it is an FHA loan for example).

Lately home prices have seen downward pressure as the banks are now averse to “liar loans” or

no-doc loans. These were loans given out on “your word” about how much income you make. If that is not a bad practice I don’t know what is. It is more like optimistic risk-assessment in my opinion. The reduced bank lending has meant that fewer people can stretch for bigger houses. What this also means is a double-whammy for banks. Banks find themselves with bad liar loans and in turn find that they have less able buyers to purchase their inventory. This puts further downward pressure. In the long-run it balances out… eventually. In the short-run, well-heeled buyers with capital are in the driver’s seat with their pick of the crop in foreclosures. I find myself in that state. Interest rates are low. I am well-qualified, and now my wife has found a home that is priced 30% below what the last house sold for in a great upscale neighborhood that would have been out of our range just months ago.

I like buying homes that need a little work. This house needs a little updating, nothing major. The great thing about buying under market is that you can do the updates, furnish, and still come out under what it would cost to buy the same house when the market is stable. I live in Dallas, not a skyrocketing housing market by any means. This anomaly in this neighborhood will no doubt be fully valued in the next year or so giving me instant equity to leverage into investments. It will probably be sooner though. When we made our accepted offer, 2 other buyers made offers. Since then close to 10 people have shown interest from our realtor alone. While I was at the house making my short list of to do’s I even saw one of the persons that was looking at the house when I first saw it. He drove by slowly. It wasn’t till I stared him down that he left. I think he was hopeful our deal would fall through. I don’t have time for nay-wishers on my block.

REO - The Banker’s Dirty Word

REO stands for real estate owned, bank’s jargon for foreclosure. Banks hate them. They don’t want to own real estate. REO’s are drag on bank’s books and it prevents them from making profitable loans. Our banking system is a fractional reserve system so having $100K tied up in a house for example would prevent a bank from loaning out $1mm in loans (10% reserves). You can see how a foreclosure is an “ouch” situation for the bank.

The Deal

Banks want 1) an acceptable offer 2) fast 3) from a qualified buyer. We were more than happy to fulfill all 3 conditions. Our house was originally listed at $600K. The last house in the neighborhood that was similar in size sold for $680 so that is a discount already. The bank received an offer of $570K and $565K. The bank rejected the offers thinking they will surely get a higher offer. Well with lower liquidity in the market and buyers thinking we are going into recession, the pool of buyers dried up. Buyers were in a wait and see mode waiting for prices to drop. Remember I told you Dallas is not high-flying real estate market? Well the price drops didn’t come as aggressively as in other cities like Phoenix, Las Vegas, or Miami. After sitting on the house for 90 days they dropped the price to $499K. Quite a drastic cut. Now this put the house in a much larger pool of buyer’s price range.

We saw the house and within 2 days put an offer on it. When we went to see the house the first time 2 other people were already there looking. When we made our “official” appointment to see the house another person showed up asking me to let them in. I proceeded to lock all the doors thinking I had bought myself some time as they’d have to schedule a showing. A strange thing happened. I had to have this house. This was the one. We decided this was the house for us, pulled the trigger, and later found that we were in a multiple offer situation. The bank’s realtor notified us that we could raise our offer if we chose. We raised our offer to full price + $5K. My rational was that others may simply offer full or full + 1K. We got the house. I felt like I just won the name the price game on Price is Right!

We got our acceptance in 4 days. Thereafter the bank found out there was a gas leak outside. So we negotiated a credit of $8K at closing for the necessary repair, which most likely will be done under $6K.

Next we got the home inspected. It cost more because the house is so huge. That went as expected. The guy was so thorough I couldn’t believe it. I was mainly interested that there were no deal-breakers such as a bad foundation, or structural problems. There were none. There were some things noted such as the garage doors needed replacement eventually and faucets that leaked. These are minor in my opinion. They would eventually be replaced with updating of the bathrooms anyhow. I’ve already got my granite guy and carpet guy on my list of to do’s. By the looks of it the prior owner’s dogs had incontinence problems.

We’re going to close before April 18th and it has been an interesting experience to say the least. For one, we have access to the house since day 1. Banks are much more lax with access then individuals. This is the 2nd home I’m looking at and the first foreclosure was the same. In fact I need to remember to return the key.

FAQ: The Keys to a Successful Foreclosure Offer

Fast

If you’ve done your homework and you have a good idea that it is a good deal and you know you can move forward, pull the trigger. You can put in clauses and have 7 days to inspect for example with right to terminate. The key is that when you wait you allow others to come in before you and they may accept their offer first. You may offer $190K on the $200K house and they may accept it. They can just as easily accept someone’s $195K offer. The key is to be in FIRST with the acceptable offer. There always is the chance of multiple offers around the same time, but being FIRST won’t hurt you.

I did my market research including past sales, tax appraisal records, demographic, and even getting an insurance quote from my insurance agent. My agent told me this house would cost at the least $700K to build (not counting land value of $160K). It seems an unlikely source of research, but it is good to know replacement cost on a property even if it is just an estimate. Once I felt comfortable I pulled the trigger and was FIRST with the acceptable offer.

Acceptable

When a bank asks for $200K for a home in a $250K market, don’t expect to offer $100K. It just doesn’t work that way. Some individuals expect to get houses for pennies on the dollar. Unless you are in a mega-bubble place, that is hard to find for a good property that isn’t falling down. When banks put out their prices they are usually well within the market range and usually below. Banks will refuse your low-ball offer in most cases even if you have the only offer. As a last resort a bank would rather package many homes and sell them to an investment company than sell a one off home to you at half price.

Qualified

Sellers take pre-qualified buyers more seriously. Sellers may often see many “lookers”, but being prequalified shows that you are serious about buying a home. For foreclosure properties, it is a requirement. Banks won’t accept an offer unless it is accompanied by a pre-qualification letter from a bank for financing.

Luxury foreclosures offer the biggest bargains in my opinion. I find the situation similar to when I buy/sell businesses.

Our “foreclosure special”, hopefully not a Money Pit

Just like luxury homes, businesses that are bigger and are out of the range of the middle-tier of investors often sell at lower multiples when liquidity dries up. Mid-tier businesses have more competition (if they are genuinely good).

UPDATE 3/25/08 - Appraisal came back.  $830K replacement value (including lot) - $150K depreciation for a value of $680K.  Value according to comps is $677K.  My banker called and told me I got a hell of a deal.

Coming Soon - Vulture Investing 101

So what happens when liquidity dries up, business segments fall into a lull, and businesses are for sale? Vulture Investing… In my next blog post, I will detail my next venture - vulture investing, picking off the good from the bad and making a killing in the process.