Foreclosure Properties: A Good Investment?

By Katie Wethman

The nation’s housing market is bracing for another wave of foreclosures. The past few years saw waves driven by subprime loans, but inventory was partially mitigated by the temporary demand created by the first time buyer credits. Now experts are concerned about the ‘shadow inventory’ that banks allegedly have been holding back, and new waves are potentially on the horizon, this time driven by option ARM loans and owners making the decision to ‘strategically default’ on their severely underwater homes by simply walking away.

There’s no better time to buy a house than now. If you’re in the market for a new house, you should look at foreclosed homes being held by banks. Here’s why:

1. Foreclosures can be an opportunity for home buyers to get a steal of a deal on a home that simply needs some TLC…but they can also be a stressful transaction that only ends in a big money pit if you’re not careful.

There are many risks that are unique to a buying a foreclosed property, but the risk can be mitigated if buyers and their agents take certain precautions.

It’s important to look at the neighborhood you’re buying in though: if there are a tremendous number of foreclosures, you may not be getting much of a deal…foreclosures and short sales will drag down the value of the entire neighborhood. Ideally you want to find a foreclosure in a neighborhood that doesn’t have very many of them.

2. There are risks that are unique to foreclosure transactions.

Some of them can be mitigated and some can’t. It’s vitally important that you assemble a real estate team—an agent, a title company, an inspector, and a settlement attorney—that are very familiar with the risks you’ll be facing and know how to structure a transaction to protect you as a buyer.

3. Be careful of the pitfalls when buying a foreclosure home.

Property condition is the most common surprise for buyers—having a home inspection contingency WITH a right to void the contract if you don’t like the results is critical. Home inspectors aren’t all-knowing though…you need to be prepared to come across some issues even after the transaction closes and have some cash in reserve to deal with them.

Foreclosed properties frequently have a host of title issues, or “clouds on title” as they are known. If a buyer isn’t paying their mortgage, chances are high they aren’t paying other bills either—things like condo or HOA fees, property taxes, or other items—which may result in additional liens on the property that need to be paid in order for a buyer to have clean and marketable title. Oftentimes the bank selling the property will require the use of a specific title or settlement company but buyers would be well advised to hire their own attorney to conduct a title search when purchasing a foreclosure.

4. Buying a foreclosure home as an investment property.

Foreclosures can be excellent investment properties, but obtaining financing for an investment property is a very different process than getting a loan from an owner-occupied property. Typically it will require a much higher down payment and carry an above-market interest rate. Managing an investment property isn’t easy, either—you need to be prepared for the middle-of-the-night phone calls from tenants when there’s a problem with the property.

5. Financing a foreclosure home.

Generally, financing for buying a foreclosure home is the same as in a traditional sale. The exception is if the property has severe damage and will not serve as adequate collateral for the loan. In that case, a lender may require certain repairs to be made prior to approving your loan. The problem comes in when the selling (owner) bank refuses to make those repairs, effectively creating a stand off and bringing the transaction to a halt.

If a property is in need of serious repair, a buyer could consider special rehab loan programs, like FHA’s 203(k) program.

6. Determining the fair market value of a foreclosure home.

A buyer should be looking at comparable properties in the same general area that sold recently, and then make adjustments for property condition—the same as with any transaction. Banks often look at some ‘qualitative’ factors in an offer, though: a quick settlement, taking a property in ‘as is’ condition, and cash financing are all very attractive to a selling bank and they will take that into account when considering your offer.

7. Foreclosure homes on the MLS.

Most foreclosures ARE listed in the MLS, and the mechanics of the process are very similar to a traditional sale, with the exception of the additional risks to a buyer noted above. Banks hire listing agents to put their Real Estate Owned (REOs) into the multiple listing service to maximize the exposure of the property.

The real estate outlook for 2010

I wish I had a crystal ball for this one. There has been talk for several years about the pending ‘shadow inventory’ that may flood the market in 2010 or 2011. The key to the real estate market isn’t just supply vs. demand. Because so much of the purchase price is typically borrowed, we need to look at interest rates vs. prices for a true measure of affordability. Right now, interest rates are still at historical lows which, combined with lower prices, is putting us in the middle of one of the most affordable housing periods in recent history.

The best piece of advice for a single woman purchasing a foreclosure home is to work with a team of professionals familiar with the unique risks in a transaction like this who can serve as an independent sounding board when you find yourself getting caught up in the excitement of buying a home.

Katie Wethman, CPA, MBA, Realtor is the Managing Director of the Wethman Group with Keller Williams Realty in Northern Virginia. Katie is licensed to practice real estate in Virginia, Maryland, and the District of Columbia. She issues market commentary and real estate advice at her blog at http://blog.wethmangroup.com

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