The 5 Biggest Risks of Buying Foreclosures at Auction
After the housing crash in 2008, home building was a dying business—one that my partners and I needed to replace with a new source of revenue. With our experience, flipping foreclosures seemed like a relatively easy way to make money. Considering how fast home values fell, we thought we'd be able to jump in and land some great deals right away.
We thought wrong.
Finally, thanks to a partner’s chance discovery of a foreclosure that wasn’t listed on the MLS, we realized we had been looking in the worst place for deals on foreclosures. We were competing with countless buyers when the real deals were closing much earlier in the process at auction.
It’s only the properties that fail to sell at auction for one reason or another that turn into REO foreclosure listings. If a bidder buys a foreclosure on the courthouse steps, that property will never hit the MLS—at least not until the buyer is ready to resell it.
Ultimately, we did buy the foreclosure my partner found the day it was auctioned off. After that, we bought several more. We sold these properties for significant profit and built a new business based on these successes.
The process seems somewhat simple now, but looking back, it definitely didn’t feel like it at the time; it was confusing, and I was constantly worried that we were just one costly mistake away from failure.
The Risks of Buying Foreclosures at Auction
If you’re a new investor or new to foreclosures, it’s important to remember that buying property at auction is risky. Things can go wrong, and when they do, they can cost you big.
But that’s not to say that you shouldn’t pursue foreclosure flips as an investment strategy. What I’m saying is that you should know what you’re doing first.
The best way to mitigate risk with foreclosure purchases is to hold off on buying until you truly understand the process. In our upcoming book, Bidding to Buy, we detail the foreclosure process and the pitfalls to avoid when bidding on distressed property.
Below, I highlight five of the biggest risks associated with buying foreclosures at auction and offer ways to mitigate these risks based on over a decade of experience and 700-plus successful foreclosure flips.
Risk #1: List Accuracy
Auction notices are typically printed on paper and posted at courthouses. While this low-tech approach to auctioning off foreclosures is slowly improving, most bidders still get information on properties from foreclosure list services. In most cases, the businesses offering these services resell information after gathering printed data and digitizing it.
The problem with this is that the process of digitizing property information is prone to human error. Prices may not be accurate. Addresses might be wrong. I know of people who have bought the wrong property due to list inaccuracies, so it’s crucial to scrub property information for mistakes before bidding at auction.
Risk #2: Property Condition
When buying a home at auction, it’s impossible to know the true state of the property. Unlike REO sales, you won’t have a chance to walk through the home or have it inspected. Plus, it’s not uncommon for owners to trash a place after defaulting, so there’s always a chance that properties bought at auction will need some serious work.
Since there’s no way to know the true condition of properties you bid on, you mitigate this risk by pricing the work they may need into your calculations. By doing this, you don’t need to worry as much about overpaying for a place that may need tens of thousands of dollars in work before it’s ready for resale.
Risk #3: Occupancy
Properties sold at auction may still be occupied. If you buy a property that’s occupied, you’ll need to have the occupants evicted before moving forward. Depending on state law and other factors, this can really slow things down. Previous owners may even file lawsuits against lenders. When this happens, houses can be tied up for years.
While there are potential upsides to buying a foreclosure with occupants, a less risky approach is to buy unoccupied properties. To determine occupancy with relative accuracy, you need to do a drive-by inspection.
When at the property, look for obvious signs of occupancy, like cars in the driveway. For additional assurance, try knocking on the door or speaking with neighbors. Another trick is to turn on an outdoor tap to help determine if the water has been shut off.
Even with no signs of occupancy, there’s always a chance that someone is living in a property. Still, with our drive-by process (which is detailed further in Bidding to Buy), we’re able to determine occupancy correctly about 90% of the time.
Risk #4: Clear Title
Remember earlier in the article when I said you should hold off on buying properties at auction until you understand the foreclosure process? Here’s why: It’s not always a simple process involving missed payments on a single mortgage. In other words, there can be more than one lien on a home.
While some liens are extinguished in foreclosure, others will need to be paid by the new owner. If you buy a property at auction without exploring its title and financial history, you may find yourself on the hook for unpaid property taxes, junior liens, and other unexpected fees. Always do a thorough title review on properties before bidding to avoid any nasty (i.e., expensive) surprises down the line.
Risk #5: Valuation
Bidding too much for foreclosures due to inaccurate valuations is one of the most common mistakes new investors make at auction. But since you never know the true condition of a property offered at auction, it’s hard to estimate value accurately with the same methods used for listings in the MLS.
Fortunately, there are ways to avoid overpaying for a foreclosure even without knowing its condition.
In an upcoming article, I’ll detail the tools and strategies we use to make educated guesses on the value of foreclosures sold at auction. While it’s impossible to know exactly how much to bid on a given property, getting close enough to secure profitability at resale is definitely doable.
Bidding to Buy: A Step-by-Step Guide to Investing in Real Estate Foreclosures by David Osborn and Aaron Amuchastegui is available now in the BiggerPockets Bookstore.
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