Considering today’s real estate climate, many people are looking to purchase distressed properties, like short sales, REO’s or bank-owned properties and foreclosures, as a means of minimizing their monthly payments or bolstering their financial portfolio. While properties in each of these categories may represent an opportunity for instant equity, that “opportunity” must be weighed against the potential risk of acquiring such an asset. And, in many cases, that risk can be substantial.

Foreclosures

Foreclosure laws in Texas do not require the lender to go to court in order to re-possess the property.  Once the lender has provided notice to the homeowner of its intent to foreclose, the property goes to auction on the courthouse steps on the first Tuesday of the following month.

Considering the types of loans utilized over the past few years (little or no equity), the bidding on these properties will typically fall short of the amount owed on the property, at which point, the lender will step in and bid the loan amount and retain possession.  The property will then be marketed through the realtor community as an REO.

IF, through your research, you find a property with a potentially high equity position, there are still other risk factors that need to be considered such as federal tax liens and insurance claims.

The insurance industry maintains a central database of all homeowner’s insurance claims by property called C.L.U.E. If there are an unusually high number of claims on a particular property, it may not be insurable…or only at a prohibitively high rate.

In the case of federal tax liens, the IRS has 120 days (from the auction date) to redeem the property in order to settle the debt.  Let’s say you purchase a home at auction with the intent of fixing up the home for sale.  The IRS can step in at any time during that 120 day window and seize the property.  All you would get back is your investment…the IRS would realize the profit…been there, done that and I still have the T-shirt!

Now, I’m not saying there are not good “buy” opportunities in the foreclosure market.  What I am saying is that there are not as many as you might think.  If you know of a property that is going to auction that represents a good opportunity buy, hire a realtor who has a relationship with a good title company that can provide data on potential liens and insurance issues and can steer you through the other “landmines” of the transaction in order to minimize your risk.

REO’s (Real Estate Owned)

If the property is not sold at the auction, the lender will then hire a real estate firm to do a Broker Price Opinion on the value of the property and to take bids on repairs to make the property “saleable”.  PLEASE NOTE:  These repairs will NOT be done.  The bids are taken strictly to discount the BPO in order to arrive at a fair market price for the property.  So, although the price of the property may LOOK to be low, compared to the market, it may not be as low as you think once repairs are factored in.

Two things to look for in a good REO buy:  1) They will be in poor condition and 2) They will have been on the market a long time.  The reason for this is that most buyers want a home that is “move-in ready” and do not want to take on a project like this.  Plus, the lenders only discount the price in small increments over time to minimize their loss on the property.  The longer a property is on the market the more discounts will have been applied to the listed price,  which will continue until they hit a price that motivates someone to buy it.  This may seem to be counter-intuitive (which it is) but that is how they think.

In summary, good buys on REO properties will be in poor condition and on the market an extended period of time and to maximize your profit opportunity you will need to do the repairs yourself or have the contacts to complete the repairs in a very efficient manner.

Short Sales

In many cases, properties can be sold prior to foreclosure.  When a property is sold for LESS than what is owed it is called a “short” sale and the lender must approve of the sale prior to it being consummated.  There are a number of these types of transactions taking place in our market today.

In short sale transactions, the listing agent submits to the bank a BPO on the property, minus any and all costs associated with closing the sale which would also include any outstanding liens on the property such as property taxes, mechanic’s liens etc.  If the net proceeds from the sale fall below a set percentage of the market price, established by the BPO, the bank will reject the sale and take the home to foreclosure.

So, what you will see in the multiple listing service is a price on the property that is pretty close to the minimum the bank will accept plus all the costs associated with closing the sale (NOTE:  An astute listing agent will add 2-3% for negotiating purposes but that is about it).  Why is that?  Because typically these properties are within 60 days of being foreclosed and require an offer be submitted quickly, which is why the properties are priced aggressively.

Please also note that just because a property is listed for sale DOES NOT mean the short sale has been approved by the lender.  Lenders will not even review a file for approval until an offer is submitted.  THIS is where the really sticky part of buying a short sale comes into play.

A typical real estate transaction takes approximately 30 days to execute from contract to close giving you time to close on the sale of your own home, give notice to your landlord and make arrangements for moving, etc.

It has been my experience that closing a short sale can take 90 days or more which can be a logistical nightmare in moving into your new home.

In summary, since there is not much room to negotiate on price in short sale transactions there needs to be other specific criteria used to decide if the property represents a good value (i.e. a home in poor condition in a highly desirable neighborhood) plus, the flexibility to move when necessary and close quickly.

Once again, it is not my intent to discount the pursuit of distressed properties like short sales, REO’s and foreclosures.  It is my intention to provide you, the reader, with information to make a more informed decision.

Good Luck and Good Hunting!