Wednesday, February 14, 2007

Buying Foreclosure Properties Has Its Rewards, but Also Risks

By Jeff D. Opdyke
Wall Street Journal

The bidding on home number 546527 -- a moss-colored brick house in Baton Rouge, La. -- began at $103,333.33. Less than a minute later, Ray Williams owned a home he had never set foot in. His winning bid was $130,000. The appraised value: $155,000.

After looking it over, Mr. Williams figured he would spend $20,000 repairing rotted wood and other defects. Then he will put it up for sale -- at $205,000.

Seven months ago, Mr. Williams joined a legion of investors who buy and sell foreclosure properties. So far, he has bought seven.

"If I'm not confident I'll make $30,000 per property, I don't bid," says Mr. Williams, 42, who used to own and run Domino's Pizza outlets. He has hit his goal on the first five.

As interest rates rise, more homeowners are falling into foreclosure. That is what is prompting the wave of bargain-hunting investors now descending on courthouse auctions across the country.

"It's just crazy. We have 100 houses [at auction] each week, when we used to have 10 or so," says Elaine Began, a deed clerk in Macomb County, Mich. Three years ago, the Montgomery County (Ohio) Sheriff's Office was "lucky to get 50 people to an auction," says Laura Wright, a foreclosure clerk there. Today, 120 often show up.

Some may be sorry they did. Novices face a host of risks. Foreclosed homes can come with hidden debts. Homeowners generally won't let you inspect the home before you try to buy it out from under them. Not knowing the local rules, which vary from state to state, can also cost you big.

The notion that $250,000 homes can be had for a few thousand dollars "is largely a myth," says Peter O'Connell, a former banker who has invested in foreclosures for years, including near his home in the Florida Keys. "If there is any equity in a house, you're generally not going to get it cheaply."

Here's a primer:

The Process
The process usually begins when a mortgage fall three months behind on payments. The lender sends a default notice to the homeowner and to the county. If the homeowner can't pay up, a foreclosure date is set. County officials handle the auction and use the proceeds to pay off the mortgage and any other debts secured by the house. Leftover money goes to the foreclosed homeowner; leftover debt, in some cases, is the new owner's responsibility.

The mortgage lenders typically bid up to the remaining principal amount plus any foreclosure fees. Their goal is to recoup what they are owed, either from investors bidding more or by buying the home and reselling it. Foreclosed homeowners sometimes join the bidding and win the auction, even though they don't have the money, effectively delaying their eviction until another auction is held.Investors can get in the game before or after auctions, too. They can try to buy directly from homeowners beforehand or from lenders who win the auction.

What's Available?

Just about every type of home ends up at auctions: wood-frame houses in downtrodden neighborhoods, high-end homes in gated communities, condominiums, mobile homes, partially built residences and vacant land.

To find them, get free foreclosure listings from county court clerks or sheriff's departments; some counties post them online. Commercial services provide access to local and national listings. Foreclosurenet.net provides information on bank-owned real estate for about $30 a month. RealtyTrac.com has nationwide listings of homes in foreclosure and offers geographically tailored email alerts for $50 a month.

Professionals specialize in niches, such as low-income housing or condominiums. Less-seasoned investors should stick with single-family homes in lower-middle- to middle-class neighborhoods, where resale likely will be easier.

Legal Issues

Hidden liens can be a big problem. If a homeowner had two mortgages and defaulted only on the second, the first is still binding. Auction officials aren't obligated to tell you about debts outstanding, so unwary investors could be saddled with having to pay off that first mortgage, generally immediately.

A full-blown title search on a house can cost $400 or more. But for as little as $25, some title companies will do quickie "pencil searches" that detail existing liens -- raw data that you weed through yourself.

In many cases, it is the property's first mortgage in default, in which case subordinate liens are eliminated in foreclosure. But watch out for exceptions: Internal Revenue Service liens and some utility bills will need to be paid off.

Here is another pitfall: Some states give foreclosed homeowners time to reclaim their property by paying the auction price, often plus an additional percentage. In Colorado, they have 75 days (though the state is set to eliminate that grace period). So you could spend tens of thousands of dollars remodeling a house, only to have the original owner grab back the newly improved home.

Investment Stages

Many investors scour default notices in search of homeowners willing to sell cheap before auction. The competition is stiff, given the many services that report new filings to subscribers.

"There are a million investors looking to contact that homeowner with letters and phone calls and drive-bys," says Todd Beitler, president of Real Estate Library, an online provider of foreclosure information (http://www.trel.com/). What's more, homeowners in preforeclosure know their home's value, so don't expect a big bargain.

Preforeclosure investing is medium-risk, medium-return. Executed successfully, an investor could make a 20% to 30% profit, longtime foreclosure investors say.Buying at auction is riskier. You are typically buying "a mystery box" seen only from the outside, says Ken Kulpa, a real-estate agent specializing in foreclosures around San Jose, Calif. Sometimes, the house is a gem, but other times, there are big, costly problems -- faulty plumbing, a 1950s-era kitchen or a leaky roof.

Then there is the belligerent homeowner who trashes the place on the way out or refuses to vacate, requiring a costly eviction process.

Another risk: In the excitement of bidding, many novices overpay. If you are careful, auction investors can expect to notch gains of 40% to 50% or more, professional investors say.

Most bankers won't finance a foreclosure bid, in part because current owners aren't likely to let them inspect the house to appraise it.

The lowest-risk option is buying foreclosed homes from banks that acquired them at auction. Most major banks list properties they own on their Web sites, and some will provide financing.

Banks often list homes in good condition near market value, so there isn't much upside there. But banks also end up with mediocre properties and some real dogs. You can try to negotiate these houses' prices down to less than the outstanding principal, rehab them and then resell quickly at market value or just below.

Profits on such properties can be in the 15%-to-20% range, experts say. Real Estate Library's Mr. Beitler says this is a good place for novices to start. You won't have title worries, because banks do that work, and you can inspect the house beforehand.

That "will help you gain confidence and experience buying and selling a property, negotiating and closing a deal, and doing the rehab work," he says.

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