REAL ESTATE INVESTMENT: Where’s the Inventory???
If you are in the real estate game—or just looking for a home to live in—you have probably noticed there is not a lot to choose from at the moment. Some people speculate the banks are holding onto many foreclosed properties in order to increase property values. That is probably true.
So, what are your options? There are a few different ways to find properties, each of which has pros and cons. We will start with the traditional methods and work our way progressively towards paths less traveled.
I. Traditional Sources: MLS
Let’s start the way most people do, by hiring a realtor. All realtors have access to listings on the MLS, so they all pretty much know what up for sale at any given time. The MLS is a beautiful program, providing a centralized database of properties organized by geographical location, price, features, etc. The system is designed for convenience and it is very reliable. Those are the pros.
The con is that everyone is looking at the same properties, so when the market is hot—as it is now—there is a great deal of competition. That drives up the prices.
If you are looking for a place to live for many years then, despite the higher price, the traditional route may still be the best option for you. For people looking for a place to live, it is probably more important to find the right place than to get the very best possible deal. If you are in it for the long haul, then you can afford to wait for the equity to build over time. You do not need to take risks in order to increase your profit margin. You just need to be happy with the home.
II. REO Properties
Many realtors also have access to what are called “REO properties.” These are home that have been foreclosed by the bank. In Florida, where our firm is headquartered, the foreclosure process ends with a judicial auction. The auction is public, so anyone can bid. However, many times the bank that is foreclosing will be the winning bidder. When that happens, title to the property reverts to the bank. As you can imagine, that has happened quite a lot over the past six years, so there is indeed a good deal of inventory in this category.
As for pros, it may be possible to get a better price on an REO property than you will get in the “open market.”
Banks are not in the property management business, so one would think they would be anxious to move their REO properties. Well . . . yes and no.
It is true the bank loses money each month a property is in REO. After all, the bank is probably not receiving rent, and there are carrying costs (i.e. HOA fees, maintenance, taxes, insurance). So, the bank should be looking to make a deal, right?
Maybe. But, then again, the bank did not have to pay real money to acquire the property. Lenders are bidders at the foreclosure auction just like the general public. However, the general public has to be ready to put down cash to walk away with a title. Not so for the foreclosing bank. The bank has a credit in the amount of the final judgment. Since most of these properties are upside-down, the amount of the final judgment is almost certainly far greater than the value of the property. (not to mention lenders pad those judgments liberally)
The result is the bank can usually win the bid without having to come out of pocket with any money at all. Yes, the lender is out the money it originally loaned the former owner, but those losses have already been covered by the government and mortgage insurance companies. So, at this point, the bid is pretty much play money for lenders.
The point is banks do not have the incentive to move these properties you might think they do. The carrying costs are probably relatively low, and the banks stand to make far more by holding back inventory and keeping property values on the rise.
So, to recap the pros, REO properties are a source of inventory and you may indeed be able to get a better price than you would by buying off the MLS.
There are some cons as well. Foreclosure by a lender in first position (i.e. the first mortgagee) will extinguish all junior liens, which should be most everything. And, the lender is entitled to cure past due HOA fees by paying a relatively small amount (i.e. one-percent of the loan or one year of fees). Nonetheless, you could find yourself dealing with stubborn lienholders who, rightly or wrongly, do not feel like being extinguished. HOAs are rather notorious for that, and they certainly can be a thorn in the side.
Also, foreclosed properties that have been vacant for a while may have had a rather rough time of it. Vandalism and theft are common—sometimes perpetrated by the former owners themselves—maintenance has probably not been a high priority, lack of A/C can cause mold, pests may have moved in, etc.
Good candidates for REO properties include handyman types—or companies with crews—and those with some expertise estimating the costs of getting the property in rentable or resaleable condition.
III. Foreclosure Auctions
The courthouse auctions – which are actually done online now – have been a fantastic way to pick up properties at a great price. Of course, the word got out . . . in a big way. Nowadays, the bidding is extremely competitive. In fact, some companies actually overbid for properties because they have so much investor money to spend. The whole auction scene is rather a shark tank these days, full of both well-funded, savvy investors and naive homebuyers hoping to find a place to live at a discount price.
If you got into auctions a couple of years ago, as some of my clients did, then you love auctions. You know all the key players, you are an expert at due diligence, you know when to go all in and when to let the property go. If you did not get in while the getting was good, then you are waaaay behind the curve.
First, there are usually far too many properties up for auction any any given day to perform the due diligence one would like. And, some of the properties—maybe many of the properties—will be yanked off the docket at the last minute due to canceled sales or a bankruptcy filing. So, you are not going to go driving around beforehand to inspect properties you my want to bid on—at least, you won’t do it more than once or twice. That is too inefficient and, largely, a waste of time. You will have to buy the properties sight-unseen. And, yes, there will be some unpleasant surprises sometimes.
You need to be quite knowledgeable about the different kinds of foreclosure auctions. I cannot tell you the number of calls I have received from individuals who thought they had picked up a home for $20,000 only to find out what they purchased was an HOA foreclosure. HOA foreclosures do not extinguish mortgages. So, more than likely, rather than the amazing deal they thought they had pulled off, the buyers probably just threw away $20,000.
There are tax lien foreclosures, HOA foreclosures, first mortgage foreclosures, second mortgage foreclosures, partition actions, etc. There are a lot of moving parts, and everything happens quickly. Every scenario requires a different analysis, and there simply is no time for hand-wringing or reflection. By the time you feel comfortable with your bid, the property is long gone.
It is not nearly as easy as it once was, but auctions can still be a good way to acquire property. Let’s face it, though. Auctions are no place for the faint of heart or the uninitiated. These days, it only makes sense to team up with a company that is in the business of bidding at auctions. There is economy of scale when performing due diligence for twenty potential buyers, as opposed to just one. And, the person who attends auctions every day knows all the angles and can make quick decisions.
In my opinion, the auction game is strictly for investors. You cannot fall in love with any one property. You have to be all about the numbers. If done correctly, you should not lose money. However, not every property will be the home run you want it to be. It is a numbers game that has to be measured over time.
IV. Short Sales
Short sales are almost the perfect solution. You do not have to rush into the purchase the way you do with auctions. You will have plenty of time to perform due diligence and feel comfortable with the purchase. And, you will probably be able to get the property for 10-30% below market value. That is instant equity. Ideal, right?
There is one potential drawback. Short sales can be long and tedious. I could – and probably should – write an entire article on the different evolutions our office has seen with short sales. There have been periods when short sales were being approved right and left at great prices, other periods when it seemed nearly impossible to get a short sale approved, and everything in between.
At this particular moment, we seemed to have found a middle ground. Short sales are not exactly easy to get done, but we do not usually get the maddening run-around routine that has been too common in the past.
If you are in a hurry to buy a home, then a short sale may not be for you. If you are prone to falling head over heels in love with a place to the point you will be shattered if the sale does not go through then, again, a short sale may not be for you.
But, if you can wait half a year in order to pick up a property you feel good about at a below-market price, then you should talk to someone who deals with short sales. A lot of realtors do not like short sales because they involve so much work, the commissions are lower, and there is always the possibility of the deal not going through.
If you are looking for short sales, you may be better off contacting a firm like mine that has lots of clients looking to get out from under an inflated mortgage by short selling their property.