Real Estate Investing Basics

Buying Foreclosures at Auction: How to Avoid Overpaying

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Close up view of bookkeeper or financial inspector hands making report, calculating or checking balance. Home finances, investment, economy, saving money or insurance concept

Overpaying for property is one of the biggest risks of buying foreclosures at auction—and it’s also one of the most common mistakes made by new investors. That’s why it’s important to have a solid system for valuating potential purchases in place before making bids.

For years, my partners and I have profited on foreclosure flips with a system based on the following simple equation:

Resale Price – Cost = Max Bid

While the system itself has evolved over time, the foundation (the equation above) has not and will not change. If you’re able to accurately estimate a property’s resale price and the costs associated with getting it ready for resale, you can get some great deals at auction while avoiding most of the bad.

Below, I’ll cover the basics of what it takes to determine a property’s resale price and outline the costs you’ll need to consider in order to come up with the right figure for a max bid.

Related: The 5 Biggest Risks of Buying Foreclosures at Auction

Estimating a Property’s Resale Price

Estimating resale price is a good place to start with any potential property flip. Resale price is what you believe you’ll be able to sell a home for after you’ve completed any necessary work. In other words, it’s what the property should sell for on the open market once it’s in salable condition.

That’s easy enough to understand, but estimating resale price isn’t always easy because it’s dependent on a variety of factors, some of which are ever-changing.

Location, for one, will have a considerable impact on price, as will surrounding properties and the current economy. Fortunately, in most cases, it’s possible to come close with market-value calculations fairly easily as long as similar homes in the same area have sold recently. Sales of similar homes are called comparables, and they’re the key to estimating resale figures quickly.

To find comparables, real estate data sites like Realtor.com and Zillow can be used to search for sales data. Recent sales are always best but not always available. Comparables should also be near the home you're looking to buy (in the same neighborhood if possible) and similar in size, style, and amenities for best accuracy.

Unfortunately, finding these ideal comparables isn’t always possible, but that doesn’t mean you can’t work with what you’ve got to estimate resale price. In our upcoming book Bidding to Buy, we detail the system we use to adjust comparables to account for differences between them and the subject property.

couple on laptop, on holding gavel, online auction concept

Calculating Costs for Foreclosure Flips

Even if you’re able to calculate resale value accurately, you’ll make very little (or lose money) when the time comes to resell unless you’ve considered costs and capped your max bid accordingly. Here are the most common costs encountered on the road to resale.

Realtor Commissions

If you opt to have a Realtor list your property, you’ll pay a commission. Typically, this will be between 3-4% of the sale price.

Closing Costs

In order to finalize the deal, legal fees and closing costs will need to be paid. We generally assume these will add up to about 2% of the resale price.

Past-Due Taxes

Back taxes are common with foreclosures. If the previous owner owed property taxes, you'll need to pay these after taking ownership. Fortunately, a title search will tell you how much is owed, so you won't need to estimate.

Liens

While many liens expire after foreclosure, some will still need to be paid by the new owner. These can include mechanic’s liens, federal tax liens, and city utility liens. Again, a thorough title search should tell you what, if any, liens need to be paid and how much it’ll cost you.

Related: Rapid Spike in Foreclosures Right Around the Corner

Occupancy Costs

In general, we prefer to buy unoccupied foreclosures to avoid additional costs and headaches. However, you’ll miss out on some great buys if you elect to overlook all occupied foreclosures. When working out our max bid on an occupied property, we add an additional 5% to account for costs associated with getting occupants out.

Foreclosure Sold For Sale Real Estate Sign in Front of House.

Miscellaneous Expenses

There are certain expenses associated with researching potential property buys. Title research and drive-by inspections, for instance, will require an investment of time (if you opt to do it yourself) or money.

Also, as with any home, you’ll need to cover expenses like insurance and security until the property sells. These expenses tend to be fairly consistent from one property purchase to the next, so you’ll be able to estimate them with better accuracy as you gain experience.

Construction Costs

Since you never really know the true condition of properties offered at auction, you should bid with the expectation that work will be required to get the home back to salable condition. In Bidding to Buy, we cover exactly how we calculate line-item renovation costs, so check that out for an in-depth outline of what we typically pay contractors per job.

In a pinch, you can calculate these costs with the assumption that material and labor costs will be roughly equal. Simply double the price of material costs for a figure to factor into your max bid.

Formulating Your Max Bid

After calculating the costs outlined above, don’t forget to factor desired profit into your max bid. In most markets today, a figure between 10-20% is reasonable.

Now, with estimates for resale price, costs, and profit complete, you can formulate your max bid. Here’s how the equation from the beginning of the article should look after expanding on it to account for expected costs and desired profit:

Resale Price – (Realtor Commissions + Closing Costs + Past-Due Taxes + Liens + Occupancy Costs + Miscellaneous Expenses + Construction Costs + Desired Profit) = Max Bid

Your max bid, the final figure in the equation above, should serve as your stop point on auction day. As long as you’ve done your homework and don’t exceed your max bid, you should stand to make a profit from your foreclosure flip.

Have questions on estimating costs or calculating resale price? Let me know in the comment section below. Also, be sure to check out our upcoming book, Bidding to Buy, where we detail our step-by-step system for investing in real estate foreclosures.

Bidding to Buy: A Step-by-Step Guide to Investing in Real Estate Foreclosures by David Osborn and Aaron Amuchastegui will be released in the BiggerPockets Bookstore in August 2020. Keep an eye on your email for pre-order and launch announcements!

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Questions? Comments? 

Join the discussion below.

    Symone Fisher New to Real Estate from Miami, FL
    Replied 4 days ago
    Very helpful, thank you David!
    Katie Rogers from Santa Barbara, California
    Replied 4 days ago
    The commission is likely to be about 6%.
    Katie Rogers from Santa Barbara, California
    Replied 4 days ago
    I have been to several auctions. The vast majority of time, the house is pulled from the auction on or before auction date. The one that remain generally have no bidder, so the house goes back to the lender. It is very important to do your own title search. Search according to parcel number or address of house, and also search according to owner(s)' name. A search of owner's name once revealed a $100,000 lien with the house as collateral, but did not turn up in a search of the house. At auction, there were three bidders, me and guys from two different hedge funds. They blew past my maximum bid in no time, then their egos overbid the house by about $150,000. I thought, "Wait till the winner finds out about the lien." I kept an eye on the house and about a year later it was sold at a small profit, too small to have bothered with, but cheap lesson learned, I guess.
    Christopher Stacy Rental Property Investor from Wiesbaden Germany
    Replied 4 days ago
    Great article David thanks. I am intrigued with buying foreclosures and I can't wait to read your book. My first investment property was a foreclosure and I still have it today after 11 years. This is a very lucrative niche if you do your homework and don't let your ego get in the way!
    Richard Dale-Mesaros Investor from Campton, New Hampshire
    Replied 3 days ago
    Often when auctions get postponed, the sale that actually goes forward doesn't get advertised as widely as first time around, so if you feel it's a good one, it's worth tracking it and being there for the bidding when it re-emerges. Talking with the neighbors in advance of the auction might reveal some issues with the house that aren't apparent on auction day, which might influence how high you can go with your bidding......... same goes for the town assessor, they may have important information you can glean before bidding!. *Make sure you close quickly and record the deed ASAP; why? Because between the point of your high bid being accepted and the new deed being recorded, the owner can still file bankruptcy and get the sale thrown out. Good luck everyone! :)
    EMMANNUEL CHRISTOPHER from MERRILLVILLE, IN
    Replied 2 days ago
    Could you please list, or describe all the processes involved in a self Title Search??? Where, Who, What do you search??? I do not want to miss anything critical. I know how to search County Records, and Courthouse DOCS. Thanks a bunch.
    Katie Rogers from Santa Barbara, California
    Replied 1 day ago
    I also like to look at permits pulled. They show you what major work has been done on the house and also give you the name of the contractor who did the work. If the permit is recent, it may indicate a potential lien that has not yet been recorded. Remember , the title search is a snapshot in time. There could be a new lien tomorrow.
    Jamie Mason
    Replied 1 day ago
    I agree with @katie rogers -- I'm not sure where you're finding 3-4% Realtor commissions. In Maryland, they're generally 5-6%. And as in all things, you often get what you pay for.