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Investing In Foreclosures: The Risks And Rewards

Investing In Foreclosures: The Risks And Rewards

If one word can be considered a symbol of today's market turbulence, that word is foreclosure. Over the last year, foreclosures have accelerated at a sometimes head-spinning pace as homeowners continue to default on their mortgage loans.

This in turn creates an investment opportunity as foreclosed homes as well as short sales flow onto the market. Like any other opportunity, investing in foreclosures has its advantages as well as its risks.

Risks and Rewards of Foreslosures

Carrie Blair, a broker associate and foreclosure specialist with Denver-based Modern Real Estate, breaks the idea of foreclosure investment into three categories: short sales, public trustee/sheriff auction, and bank-owned/Real Estate Owned properties.

Blair says the three carry differing risk, but offer a similar reward: "You are able to buy a property below market value and have instant equity immediately following your purchase," she says.

She says short sales carry less risk, but also less reward. "In a short sale, the lien holders are willing to take a short payoff," she says. "The buyer can then buy the property slightly below market value."

However, short sales will typically take several months to complete, so investors in this category must be patient and willing to risk the possibility that the bank may not issue approval.

Blair estimates that only one of every three short-sale transactions ever close, with the remainder ending up at a county auction, known in Colorado as a public trustee sale or in all other states as a sheriff sale. Investors at these sales must arrive with certified funds - cash - for the total purchase amount. With lien holder bids posted the day before the auction, investors have a limited amount of time to evaluate the property's exterior and it is bought as-is at auction, with liens and taxes attached.

"There is much higher risk (with these transactions) but potentially high reward if you can get the property with a big deficiency, since the bank bids substantially less than what it is owed," Blair says. "Many times I will see investors buy properties at auction and successfully flip them with high profit margins. Then this successful investor buys a property with structural problems, has to then resell the property at a loss, and then all of his profit from his previous several deals get eaten up by one mistake. Buying at foreclosure sale is high-risk and is not for the casual investor."

The third and most common category of foreclosure investment outlined by Blair involves buying bank-owned or Real Estate Owned (REO) properties. She says this type of investment holds the least risk in that the buyer is entitled to a inspection period and inspection objection, meaning that he or she can terminate the contract should the property not be found to be in satisfactory condition. These transactions also allow buyers to receive a clear and free title from the seller, provided all liens, property taxes, or anything else encumbering the property have been cleared.

"Buying an REO is very similar to buying a "normal" property and has the lowest risk," Blair says. "Many times the banks will put their inventory of properties on the market at highly discounted prices, below market value, because the properties are being sold as-is. You can buy an REO and have instant equity in your property. In 2008, I closed 39 transactions and about 80 percent of my business involved bank-owned properties."

Foreclosure Investment Strategies

When first starting out with foreclosure investments, Blair says, it's important to accumulate a wealth of knowledge about how to research available properties. Investors need to know where to find pertinent information along with making sure they're paying the right price for a given property. She advocates finding a foreclosure specialist or mentor to help throughout the process.

"You need someone who is quick and reliable, accurate and knowledgeable, to help you get started," she says. "There are certain strategies that work better than others. There is a lot of research to be done in a short amount of time. Most importantly, you have to be fast in buying the property. Speed is the key to success in buying a bank-owned property, and having an agent who is an expert in buying REOs is extremely important."

Blair says good investors share a number of qualities. They understand the financials behind potential purchases and projected neighborhood appreciation and are not afraid to collaborate with trustworthy friends and colleagues who are experts in the field. They double- and triple-check their figures and are prepared to buy in transitional neighborhoods.

"Those who invest intelligently will continue to do well and find the good deals. As the fad of foreclosures loses steam, and the bad investors are weeded out, then the number of investors will shrink," she says. "The future of foreclosure investing will remain strong for those who have the right skills."

Image by: Photo Dean