The Great Foreclosure Game (2015)
The appeal of a low asking price on “foreclosures” is strong enough that I receive a good number of calls each week about individual properties, as well as inquiries about what might become available. I would say that when I am finished with the conversation, most of the potential buyers on the other end find that they would rather search for a home that is not REO.
If you are not familiar with the term REO, it is how people refer to property owned by banks, financial institutions, governmental agency, or governmental loan insurer.
There is usually a reason that an asset is valued at a bargain basement price. Often these discounts relate to open permits, physical deterioration, unpermitted “improvements”, code violations, and a long list of other problems a buyer would inherit along with title to the property.
In many cases, these problems can be solved relatively easily, however occasionally a buyer can get themself into a quagmire that requires them to invest much more capital to remedy these issues than they had accounted for. I recently worked with a potential buyer on a canal front home. After a good bit of due diligence, he decided to avoid this particular property because there were fines accruing at the rate of thousands per week. The fines that had already been assessed totaled over $75,000. According to the selling agent, at the time we inquired, the bank was not planning on paying the fines at the time of sale, these fines would have to be taken on by a buyer. This made the purchase of the home more than it would have sold for if it were a non REO property.
The moral of the story is that 95% of the time the price of a REO reflects the value of the asset. Banks are not giving properties away, they are trying to recover as much as they can expediently. The bank has enlisted the assistance of both a real estate agent and an asset manager working to determine the highest price the asset will bring.
It’s Going To Require Some Work…
Many foreclosures require work. In the field of Real Estate, we refer to much of this as deferred maintenance, which is a posh way of saying, “someone should have put a spot of paint on it about a decade ago”. There is something far worse that doesn’t have professional nomenclature, or at least didn’t until now. The “flipaster”, as I will name it, occurs when someone, in a poorly executed attempt to flip a property, has created a disaster of epic proportions. Many of the foreclosures I have seen in this area could be referred to as flipasters.
Imagine a house that has half the kitchen tiled, half the cabinets completed, and various other projects partially completed throughout the house. The previous owner, in a fit of rage at the banks impertinence, took the remaining materials with him as he left. The tile that is needed to finish the project isn’t available at Home Depot anymore, because he bought it in a clearance sale. So, as a potential buyer, you are faced with a good bit of demolition before you can finish this “almost done” flipaster.
Further, there is a more pressing concern. The air conditioner drain was plumbed into the kitchen sink drain, and both have been capped, causing the sink to overflow and destroy more than half of the new wood floors in the second floor living room. The upstairs is filled with standing water and left to sit for weeks. It sounds like a big project, but it could be manageable, right? Hold that thought, we will get back to it below.
Oh, By the Way, Here’s a 15 Page Addendum.
With the most recent difficulties in the financial and housing markets, banks and lenders have become increasingly wary of liability. So they have introduced an addendum to contract that covers almost any and every possibility. The issue is, it is designed to protect them, NOT you. One gem from a REO addendum I have seen recently translated to the following:
“The buyer shall accept the property as-is, and once accepted, shall purchase the property on the date the seller decides. Seller has the right to extend closing, at the seller’s sole discretion. Should buyer not close on the date chosen by the seller, a per diem charge of $100 will be assessed at the time of closing.”
So, for the sake of argument, the waterlogged house from earlier is the subject property. It is sitting without a running air conditioner, and the lender has been working for a couple months to get a clear title. The contract states that they have the right to extend the closing indefinitely, the buyer is stuck watching the house he is contractually obligated to purchase continue to degrade, develop mold, etc. while the bank attempts to get the paperwork together.
This is only one example of the myriad of risks associated with such a one-sided contract in a REO transaction. The possibilities for a disastrous outcome are too many to list. I will say that most of the time things seem to work out for the best, however, the burden in a transaction such as this rests squarely on the shoulders of the buyer.
Tips for Success Buying Foreclosures
Use a Realtor® who has a strong background working with REO properties, preferably one who also has construction, mold remediation, and rehabilitation experience. This isn’t an area for people who dabble in real estate, or for someone who is more worried about the volume of business they are going to turn in a given year. It takes care and experience in order to attempt a transaction that avoids disaster.
Use a reputable home inspector who will take the time to give the home a thorough vetting, and provide you with information relating to major and minor issues pertaining to the property.
Pay cash. Financing a foreclosure is nothing short of a miracle, and the majority I have had experience with are not able to be financed.
If you have found what you feel is a good value, make a reasonable offer. Banks and Lenders have already been bailed out. They aren’t as worried about selling their foreclosed properties as you would like them to be. The motivation of many asset managers is to do enough to just not get fired, and because their employing corporations were bailed out by the US Taxpayers, they really aren’t that worried about losing their jobs. If things were different, and the banks and financial institutions had been forced to work themselves out of the mess they created, we would have seen some real bargains, and banks would have had some real motivation to sell these distressed properties.
Eliminate emotion from a transaction involving REO, I promise you, the lions share of asset managers don’t care about anything other than the bottom line. I have referred to keeping your emotions contained in previous articles, but it is essential to keep a clear head when purchasing a bank owned property. Always be willing to walk away if it is the prudent action. No one goes broke from a missed opportunity, and the list of people who have gone broke taking the wrong opportunity grows daily.
Use a Realtor® who has worked with municipalities before and understands the permitting process.
Ask questions. Use professionals. Do due diligence. Find someone who treats your concerns as if they were their own.
John Gallant, Broker of Engel & Völkers Islamorada
*Originally published in Keys Life Magazine