Financially Distressed Properties; Pre Foreclosures, Short Sales, REO Property Investing
Investing in Foreclosures:
People use the word foreclosure very loosely in this business. The real definition of a foreclosure is a property that has been taken back by a lender because of non-payment. The property is owned by the bank, and is typically listed for sale with a local realtor at fair market value. The bank or lender is most certainly a motivated seller, but you have to keep in mind their bottom line (and remember that the bank is operating as a business, without too much emotional baggage.) Bank Owned properties, or REO's, are discussed in more detail later.
A short sale refers to the sale of a property before foreclosure. The home owner is in trouble, recognizes that they are in trouble, and are trying to negotiate a sale that will get them out of the property without too much of a black mark on their credit. In a short sale situation, the lender has agreed to a sale, usually at a loss, and has approval authority over any offers. The specifics of a short sale will be discussed later.
Default properties (Pre-foreclosure)
A property in default is a prime candidate for a short sale. Sadly, many home owners refuse to acknowledge or accept that they will lose their home, and take no action. A home owner is considered to be in default once they become 30 past due on a payment, and the mortgage lender typically starts legal action (by serving a notice of default) when the payment is 60-90 days past due. Default properties are good to watch (and I keep a data base of every home in default in Thurston County), for obvious reasons. A strategy found in many real estate investment books is to approach properties owners in default and attempt to negotiate a sale (a technique I call a "cold short sale"). When working this technique, be aware of what you are competing with. The homeowner is being hounded by bill collectors, receiving calls, mail and email promising solutions, and is also being called by every realtor in town asking to list the property. Needless to say, these people are gun-shy, and are in denial about their situation...or they would have listed and tried to sell the home themselves.
Real Estate owned by banks and lenders (REO's)
Following Short sale, Real estate owned (REO) property is the best source of financially distressed properties. As I said before, the bank is operating following a business plan, or model, that clearly spells out how they will deal with foreclosed properties. They of course want to get as much as possible for the property (they will almost inevitably loose money, but they try to limit the loss), and they will hire a local real estate agent knowledgeable of the market and able to protect their interests.
The bank will try to get as much as they can for properties they own, only makes sense. But they also consider holding costs, taxes, insurance, and other expenses when deciding how to price a home, and in the offer that they ultimately accept. A good way to look at it (and you should look at your own investments the same way) is that every month that you hold a property, the price should go up by the amount of holding costs. Conversely, a price decrease now may make sense rather than taking a month to month loss waiting for a higher price....it's all in the numbers.