Third Revision
I invest in foreclosures in the Monterey Bay region. I have been doing this for 2 years and have had 7 profitable deals.
This is a short tutorial of the process. By the end of this post you'll have a rough idea of how foreclosure investing works and how to go about it.
How do Foreclosures Work?
-If you take out a mortgage on a home and falls behind on the payments, the bank can start the foreclosure process on the home. This is when the owner can try to short sell the home: sell it for less than he owes the bank. At the end of the process, before taking back the house,
the house must be auctioned off at the courthouse steps. This is the foreclosure auction. If the bank sets the price too high and no one buys, then the bank takes it back, and it becomes a REO, a real estate owned. The sequence is short sale, foreclosure auction, REO.
Why Foreclosures?
-Because you can make 50-60% returns per year, at 2 deals per year and 25% returns on each deal.
At the auction, homes routinely go for 75% of market price or below. This is because of all the obstacles between the buyer and the house:
The entire amount is due in cash. This eliminates 99% of buyers right away. You cannot get a mortgage because it's a foreclosure.
The auction is held on weekdays during working hours.
The property is sold as is, where is. The loan being sold may be a worthless second loan. There may be back taxes.
-The climate is right. There is a wave of foreclosures from the housing crisis. Efforts by the government to prevent foreclosures have failed.
see http://www.nytimes.com/2010/01/02/business/economy/02modify.html
Prerequisites:
-Cash. Foreclosure auctions require a cashier's check for the full price of the property. This is the single biggest obstacle you face. As long as you can find the cash, everything else is doable. How much you need depends on the location and whether you partner with others. Go to your local foreclosure auction, and see how much the cheapest properties sell for.
-Time. You need to attend the trustee sales, which are held weekday mornings at the courthouse. You need to research properties, visit properties, read books, manage agents, contractors, potential buyers, and a hundred other things. To a certain extend, this work can be delegated.
-Local Knowledge. This is incredibly important. When bidding on a property, you must know exactly how much it can sell or rent for on the market. Do not rely on zillow estimates. Do not rely on comparables you found on the internet. Again, this can be delegated. Find a good agent.
How to get started:
-Step 1: Visit your local foreclosure auction. It's at your local county courthouse. In California it's held weekdays between 10-12. In some states it is held once or twice a month. Google "XYZ county foreclosure auction", or visit the website of your county. At the auction, ASK THE BIDDERS WHERE THEY GOT THEIR FORECLOSURE INFO.
-Step 2: Finding Foreclosures.
You need to know which houses are selling before hand, for how much, and if possible their loan position(see #3). How you go about this depends on your area.
Getting info from public notices is doable is only 1 or 2 sales is held per month, for example in Texas. There are often information sellers who gather this data for a fee. See Rich's post for how he operates in Texas:
http://www.biggerpockets.com/forums/41/topics/32392-buying-at-foreclosure-is-easy-
In California trustee sales are held daily, and the properties sold on any one include not only those posted, but also those delayed from a previous sale. On any one day, there will be properties postponed from 10 different previous sales. Keeping tack of them becomes a nightmare, and foreclosureradar.com or a similar online information provider becomes pretty much necessary to have foreknowledge of every day's sales.
www.lpsasap.com is free and has information on 17 states, including CA. It covers only about half of all foreclosures and has a week of back data.
If you are in CA, AZ, NV, OR, or WA, you are in luck. www.foreclosureradar.com is a one stop shop with all the relevant data and saves 4 months of back data. $50/month, 3 day free trial.
-Step 3: Verify Loan Position.
MAKE SURE YOU ARE BIDDING ON A FIRST LOAN! The auction is not for the property itself, but the loan. Loans are ordered by the date they are recorded. This is also the order they get paid in when a property is auctioned off. If the money runs out, too bad! The first loan is usually the primary mortgage, for 75% to 80% of the property's value at the time it was recorded.
In today's climate, because property values have fallen so much, the auction price will almost always be lower than the first loan, rendering second loans and below worthless.
How to find out if you are bidding on a primary loan?
The safest way is to teach yourself to do title searches at your local county recorder office. In California, the search goes like this: from the address, find the APN or parcel number. From the parcel number, find the owner's name. From the owner's name, find the Notice of Trustee Sale. That gives us the doc # of the loan they are foreclosing on. Make sure this is the primary loan, without any other outstanding loans before it. As can be imagined, this process is time consuming.
Information sellers like foreclosureradar.com provide info about loan positions, but are not always accurate.
The amount of the loan being sold is a big clue. We expect the primary loan to be 80% of the price of the property at the time it was made. In California trustee sales, a $400K loan on a house that was $500K 2 years ago is usually safe to buy, while a $100K loan on the same house is never a good idea. BE EXTREMELY SUSPICIOUS OF LOAN AMOUNTS THAT APPEAR TOO LOW.
Another option is to form a relationship with an agent, who often have relationships with title companies and can find this information with a simple phone call.
-Step 4: Estimate the Market Price.
Go to www.zillow.com. Look at their estimate, but keep in mind it is often inacurrate. Far more useful, see how much comparable properties sold for (yellow icons) and are selling for(red icons). Go to www.realtor.com and see what comparables are listed for sale. Go to wwww.maps.google.com, type in the address, and use Streetview to see street level pictures of the house and neighborhood.
Keep an eye on the neighborhood of your interest. Look for for sale signs and note the type and size of the house, and how much it is selling for. Pay especial attention to properties that sell. This is how you build up local knowledge.
Talk to your agent for his or her opinion of the market price of the property. If you don't have an agent, get one.
Bring all of this together and estimate what the market price of the property is.
-Step 5: Setting Your Bid.
Go to your local auction and see what others bid on, and how much each type of property go for in your area. There should be a general "auction price" for each type at your auction, and it should be 50% to 75% of the real market price, less back taxes and repairs. Anything lower and you need to ask yourself if you're bidding on a second loan.
For an added layer of safety, identify savvy investors who are there day after day, and only bid on what they bid on.
The novice investor should be bidding on new, easy to flip(or rent) properties with a reasonable margin of profit, and not risky properties that may offer a large reward. Obvious deals such as these attract many bidders. Do your own research, set your own upper limit, and do not be afraid to outbid regulars, since they will leave a margin of profit for themselves. This was how I worked up the courage to start bidding on my very first property: someone whom I knew was competent raised his hand first.
