Is Buying a Foreclosed Property Risky?
Many investors and real estate buyers inquire about whether they should purchase a foreclosed property and what kind of foreclosed property they should purchase.
A property becomes foreclosed when an owner who has debt outstanding on the property defaults on their debt. When a borrower defaults on their debt, the property that is used as collateral on their debt moves into a pre-foreclosure stage where the borrower may be able to short sell their property to cover the outstanding mortgage balance.
If the borrower fails to sell the property during the pre-foreclosure process, the property moves into a foreclosure process where the lender takes over the property and tries to sell it using their resources.
Pre-Foreclosure VS Foreclosure
A buyer who is looking for a bargain deal may be able to purchase a property in pre-foreclosure or to purchase a foreclosed property. Both of these investments are risky because both types of properties tend to be sold “as-is”, meaning that the property sold may be inhabitable due to the damages and flaws a property has. It is expected that a foreclosed property has some flaws because if an owner cannot pay off their debt, it is unlikely that they have enough funds to keep the property maintained.
Another factor that contributes to the risk of buying these types of properties is the short time frame between the initial inquiry and the purchase. Usually, the owners of foreclosed and pre-foreclosed properties want to sell the property as soon as possible. This means that an investor may not be able to conduct a proper inspection and an appraisal of the property before purchasing it. Without an appraisal, the buyer may not be able to estimate the value of the property and the cost of repairs needed to bring the property into a habitable condition.
Even though both types of properties are risky, there are some ways to minimize the risk taken by the buyer. Regardless of whether an investor is buying a foreclosed property or a property in pre-foreclosure, the risks vary depending on the property. Instead of searching for a specific type of foreclosure, it is much more beneficial to look at a set of metrics and see how they may affect the deal and future expenses associated with the rehabilitation of the property.
Relative House Price
One of the most important metrics to look at is the price a buyer can get for the property. Most of the time, both pre-foreclosure and foreclosure properties are sold at a discount. More precisely, the lenders and the financially distressed owners may be willing to sell the property to cover the debt outstanding on the loan. This means that if the value of the property is $300,000, but the debt outstanding on the mortgage is $50,000, it might be possible to purchase the property for $50,000 if, and a big if, there are no other bidders. The lower the price of the property, the lower the bottom line expenses associated with that property.
Of course, the price of the property must be considered relative to other comparable properties in the area. For example, it might be a bargain to purchase a house for $50,000 that is expected to cost $300,000.
On the other hand, buying a foreclosed property for $40,000 that is expected to cost $50,000 may not be a great investment. It is important to expect a certain amount of money to be spent on the rehab of the property, so if the value of the property is very similar to the price of the property, then an investor may be realizing a loss on the property considering the expenses associated with the repairs.
Plus, there might be outstanding liens on the foreclosed property that would fall on the new owner. So if the property is worth $300,000, needs $150,000 of renovations/repairs, and has $50,000 in liens purchasing the property for $100,00 could be a break-even point, maybe even a loss.
Number of Bidders
Another important factor to consider is the number of bidders on the property or generally the number of real estate investors in the area. The more investors in the area looking for bargain deals, the more likely it is that the price will be increased through bidding. On one hand, a large number of investors signals that there is a potential to make money off the real estate market in the long term. On the other hand, a large number of investors will contribute to increased prices for these types of properties. As discussed above, the higher the price relative to market value, the riskier the investment is.
If an investor has experience working with foreclosed properties and they have enough cash on hand, then they may be able to handle the competition and make some profit off the deal. Usually, experienced investors are willing to pay extra because they see a long-term value in the deal.
On the other hand, if an investor does not have a lot of cash on hand or they do not have enough experience working with foreclosed properties, then they may prefer markets with a small number of real estate investors. In this case, the inexperienced investor may not look for long-term growth, but instead a short-term capital gain. One way to make a short-term gain on a property is to flip the property, which means buying a damaged property, repairing it, and selling it at a premium.
Condition of the Property
A buyer may not be able to have an opportunity to conduct a formal inspection of the property before purchasing it, but they may still be able to look at the property and talk to the owner if they still reside in the property. Sometimes, owners may be honest about the condition of the property, and they may provide information on all the flaws the property has.
If the owner does not share any material information about the property, they may still let a potential buyer look inside and around the property. Even though some flaws may be hidden, many issues that require large investments may be spotted. For example, there may be cracks in the foundation or leaks that have not been repaired. These problems may be spotted without a formal inspection because they usually lead to clear consequences such as pest infestations or water damage.
As a rule of thumb, the better the property looks inside and outside, the less likely it may have serious problems that require a large investment. Common sense may also help a buyer to identify any flaws a house may have.
Uninhabitable properties usually feel like properties where a person may not be able to live comfortably. A buyer may walk around the property and imagine whether the property has all the necessary structures to support the life of the buyer. If the house is comfortable and does not have any obvious issues, then it might not be as risky as an average foreclosed property.
Buying a Foreclosed Property Is Risky
Regardless of the condition and the price of the property, there are still risks involved when dealing with foreclosed homes. An inexperienced buyer should avoid purchasing foreclosed or pre-foreclosed properties because apart from physical damages, the property may have outstanding legal claims. Lastly, it is very hard to receive a loan for a foreclosed property, so it might be more beneficial to look for regular properties on the market that can be bought on a mortgage with a low-interest rate.
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About the Author
Top Wellington Realtor, Michelle Gibson, wrote: “Is Buying a Foreclosed Property Risky?”
Michelle has been specializing in residential real estate since 2001 throughout Wellington Florida and the surrounding area. Whether you’re looking to buy, sell or rent she will guide you through the entire real estate transaction. If you’re ready to put Michelle’s knowledge and expertise to work for you call or e-mail her today.
Areas of service include Wellington, Lake Worth, Royal Palm Beach, Boynton Beach, West Palm Beach, Loxahatchee, Greenacres, and more.
