Before you buy cheap REOs

Are you just starting out? Have limited funds and interested in getting your feet wet with some cheap foreclosures? I was right there with you in late 2009 and early 2010. My plan was to buy cheap residential properties for the biggest discount available, fix them up, and hold onto them for cash flow. Sound familiar?

I am brand new to Bigger Pockets. My first time onto the site was 2 days ago and I just signed up for an account. I thought it would be appropriate to start out my journey on this site with this post and give you the top three things I wish I understood before I bought cheap REOs for rentals.

It's hard to diagnose problems during inspection.

When doing inspections on a "typical" sale you it is fairly straight forward. The water and electric are on, tenants are (or recently have been) living in the property and you identify the current issues facing the property, assign dollar values to the repair and work that into the spreadsheet to see if the deal is going to work.

On a foreclosure, all bets are off. I have bought foreclosures that are on the MLS, at auctions, directly from the bank and the inspections have been different every time. Sometimes the utility meters are not even attached to the house so turning on utilities even after the property is under contract is impossible.

Another issue is that even things that appear to be working might have some serious issues. I have had pin hole leaks in the wall that I had no idea about when the water was turned on during inspection. It wasn't until 2 months later when a renter had already moved in when water was seeping out from under a wall that I had to make that $1200 repair. I have also had sewer issues that went undiagnosed until after a family of 4 had moved in and the sewer was taxed for the first time since I owned the property. The cost of that repair? $22,000 on a single family home that I had paid $30K for.

The solution to this is to become intimately familiar with the property before you ever put down an offer. I call up the bank that owns the property and have them let me in. I then spend 3-4 hours with a flashlight, tape measure and old clothes, crawling around in attics and under crawl spaces. At the beginning I used a home inspector for this, now I do it myself. The reason is that most home inspector's bread and butter is the "normal" home market. When there is a huge list of things that need to be done I have found that most home inspectors don't know how to prioritize and identify the issues that I want to know about. The fact that an aerator is missing from the kitchen sink and the smoke detector is missing a 9 volt are irrelevant when the home is sloping 9 degrees toward the back corner, and the subfloor is rotting in the kitchen.

Learn some basic contracting skills (at least enough to learn to diagnose problems) or develop a relationship with some people that can assist you with this. Making informed decisions about the current state of the property is what it is going to take to come out in the black.

You won't always be doing business with "good" people.

My father is an accountant and in business for himself. From time to time he talks about having to fire a client. There are several reasons he does this. Sometimes the client is trying to push my father into doing something that isn't entirely above board. Other times it is just because they are taking up too much time or they aren't paying on time. Maybe they just are disorganized.

The same thing is true in real estate as a landlord. We can "fire" our clients, sometimes it is just expensive. There is the cost of the eviction, the lost rent during the eviction process, then the cost of fixing up the property and renting it out again.

The majority of the property I currently own is in what we might call "rough" neighborhoods. I believe that three of the streets I own property on might have the three highest police calls for service in the city. It is hard to find good tenants and impossible to find great ones. Every application I receive has something on it I don't like. Some indicator of problems to come. Now sometimes I get tenants that pay on time but trash the house. Other times I get clean tenants that infrequently pay. It's always a crap shoot.

The problem is the situation that it puts you in and the choices you have to make. Do you evict someone who is current on rent because they have already ruined your carpet? A tenant wants you to come by and pick up the rent, and you know if you tell them to mail it to you they will tell you they mailed it and you might never get it. Should you go by the house so you can get the cash even though that's 30 minuets you shouldn't have to spend working if they would just do what they said they were going to do? Yes, you can (and I often do) evict these people but then after spending all of that money what type of tenants is the area your property is in going to attract?

My father, and higher income rentals might have the luxury of choosing to do business with the clients they choose. With these low income properties sometimes that is tough.

Build in a healthy margin.

Take a hard look at your margins and build in plenty of wiggle room. I have had several large ticket (unforeseen (though not unforeseeable)) expenses. One of our saving graces has been how large our margins have been. If you are trying to force a deal to work and have not built in healthy margins, reconsider the deal or drop it. I have dropped deals and had them reappear 6 months later at a much more attractive price.

So having these things in mind would I go back and invest in low income REOs again? You betcha! Investing in these types of properties were what I could afford to do at the time. They have given me a crash course in real estate and I have learned tons and developed lots of good relationships.

If you have any questions that I can help you out with please drop me an e-mail, thanks!

Mark