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9 STEPS TO GETTING STARTED INVESTING IN PRE-FORECLOSURES

        By Robert Irwin

        Author of THE ARMCHAIR REAL ESTATE INVESTOR, to be published in early 2008

Foreclosure itself is a process whereby a lender takes ownership of a property on which it has previously given a mortgage.  Typically a buyer wants to purchase a home, but doesn't have all cash.  So, that buyer finds a lender (such as a bank, insurance company, and so on), typically using a mortgage broker, and obtains a mortgage as part of the purchase price of a home.  

        It's when the borrower runs into trouble (job loss, divorce, mortgage resetting to a higher payment, and so on) and cannot make the monthly payments and cannot refinance to lower payments or cannot sell, that foreclosure occurs.  After missing a number of payments, the lender will send the borrower a "notice of default" indicating it is initiating the pre-foreclosure process.  

If the borrower does not make up the back payments, interest, and penalties, in a trust deed state (such as California) the trustee publicly sells the property to the highest bidder "on the courthouse steps".  In those states which use judicial foreclosure (such as Florida), a court hearing is held and a ruling given, after which the property is publicly sold.  Unless outbid, the lender takes title and the property is now referred to as "lender owned."  (It's also called an REO for "Real Estate Owned" [by the lender].)

BUYING A PRE-FORECLOSURE

        It is during the pre-foreclosure stage that most investors look to getting a good deal.  There are 9 steps to buying during this stage:

1.         PLAN YOUR EXIT STRATEGY

While it may seem strange to begin with an exit, think of it terms of a good detective novel.  In order to write a detective novel, the author needs to know above all else, how it ends.  The author needs to know "who done it, how, where, and why."  Once he or she has that information, the author can then work backwards to the sleuthing, the characters, and the crime itself.

        The same holds true when working foreclosures.   You need above all else to know what you're going to do with that property.  Are you going to flip it?  Rent it out short term?  Keep it for the long haul?  What are your goals, what is your exit strategy?

        For example, if your goal is to quickly resell (flip) the property, then you're going to be mainly concerned that properties are still selling well in the area and that you get sufficient equity out of the property to make a quick profit.

        On the other hand, if your goal is to hold for long term appreciation, then you want to look for an area where rentals are strong - they bring in a high rental rate and there are few vacancies.  Because you're in it for the long term, you may be less concerned about obtaining a property with equity.  You may be willing to pay close to market price as long as the terms are favorable (offer a positive cash flow) and the home is likely to make a good rental.

        2. DEFINE YOUR AREA

Websites are national in scope.  To simply look for foreclosures on them can be an exercise in futility.  (There can be a million properties or more in foreclosure at any given time.)

        While the tendency is to simply look for foreclosures on the street where you live, that may not be the best tactic.  A better suggestion may be to look at areas where there are fewer foreclosures.

        Remember, you're going to be in competition with other investors out there both when you're looking to buy, and when you're looking to later rent or sell - see exit strategy above.

KEY CONCEPT 

        A word of caution:  If you're planning on holding your foreclosure and renting it for a time, I strongly advise against making a purchase at any distance from your home.  Indeed, ideally you won't make such a purchase more than 30 minutes drive away - an hour at most.  The reason has to do with the difficulties in managing rental properties.

        When hunting foreclosure locations on a website, typically all you need do is insert your zip code.  A good site will then almost instantly indicate all the pre-foreclosures available in that zip code area.  (Be sure to limit your search, in this case, to pre-foreclosures, else you'll probably get too many properties to deal with.)

        Learn all about the area you're concerned with.  Learn the property values.   You can use the Internet to check out what homes are selling for.  Go to local agents' websites or check out Realtor.com.

        In investing, knowledge is your most formidable weapon.  Learn the areas in which you wish to purchase until you know them like the back of your hand.  Check out the schools, as listed on the foreclosure websites and also at Foreclosure.com.  Property values are most closely linked to the quality of schools.  The better the schools, typically, the quicker and easier it is to sell a home for more money in the district.  Also check out crime statistics - you may want to avoid a foreclosure in a high crime area.

        And make it a point to understand where the foreclosures are located in terms of shopping, freeway and metro access, and centers of employment.  Simply using mapquest.com can often provide you with a terrific overview of a location.

KEY CONCEPT 

        In foreclosures, buying cheap is often the key to success.  Once you've identified a specific area, check the median price of properties available.  When looking for properties, try to find those that are below the median.  These may be your best foreclosure opportunities.

1. IDENTIFY A NUMBER OF PROPERTIES 

When investing it's important to understand that you have to play a numbers game.  For one thing, you're not operating in a vacuum.  There are other investors out there competing with you.  For another, any given property which may look good at first, may turn out to have problems that are fatal to making an investment in it.  (Pay special attention to maintenance and refurbishing issues - an owner/borrower may have let a property go so badly that it would take more to fix it up than you can reap from a sale.)

        Therefore, it's always best to identify at least three foreclosures that are of interest and if possible, as many as five.  Who knows, you may end up buying more than just one!

Once you've got your properties, check them out.  Good foreclosure websites will allow you to quickly link to county appraisal records - used for assessing property taxes.  (These used to be available only through a process of showing up at the assessor's office and spending hours thumbing through dusty record books.)  Keep in mind, however, that many states, such as California, only appraise properties for tax purposes when they are sold and when additions are put on.  In such states, if the appraisal records are old, they may be less useful.

Also make good use of zillow.com and similar sites.  (Foreclosure.com offers "zestimates" of home prices using zillow.com.)  These are sites that allow you to quickly determine the potential market value of the foreclosure you're considering as well as comparables in the area.

1. REFINE YOUR FOCUS 

You can either approach this investment as if you're holding a shotgun, or a rifle.  In the shotgun approach, you look at everything, and can quickly become overwhelmed with what's out there.  In the rifle approach you focus on just those properties that are likely to be profitable - you narrow the field and make it easier to handle.

1. 1. • Lower priced homes - Most investors who are getting started find that the homes at the bottom of the price range offer the best opportunity.  They are easier to finance (require less of your money and not as much income) and they are often easier to sell.  Think of the pyramid model.  At the narrow top are the buyers who can afford higher priced homes.  At the wide bottom of the pyramid are the many buyers who can only afford lower priced homes.  Where are buyers most plentiful?  Look for homes that are below the median price for the area in which you're interested.

      • Homes with sufficient equity - Just because a property is in pre-foreclosure does not mean it's automatically a good deal.  The owner/borrower may not have much equity in the house.  As explained above, he or she may be upside down.  The only way a purchase here might make sense to you is if you can get the bank to agree to a short sale.  And that could be a difficult and lengthy process.  On the other hand, if there's sufficient equity in property, than a conventional purchase can make good sense.

      • Look for a bargain - Most investors are not in the game for the fun of it - they're looking to make money.  And you'll make the most money if you can find a bargain.  Look for the "good deals,"  not the "okay deals" or the "fair deals."

KEY CONCEPT 

        It's really all about timing.  You need to identify the property, contact the owner, make the financial arrangements and do it all while warding off the competition.

        5. DEVELOP A PURCHASE PLAN       

Remember, you're going to have to get that owner/borrower who's in foreclosure to be willing to work with you.  This is at the same time that he is being bombarded with "sales pitches" from other investors.  (The Internet makes this a level playing field - everyone has access to the same information.)  

Most investors begin with a letter that they send to those in pre-foreclosure.  Some of the better ones I've seen create a friendly and helpful tone - you're going to provide assistance, a way out.  The letter should emphasize what you can do for the owner/borrower, not what she can do for you.  Some investors create a letter that sounds as if it goes to everyone on the block, so the person in pre-foreclosure will not feel singled out.  Of course, you'll only send it to those who are in the process.  Keep in mind that a letter will never seal the deal.  People in pre-foreclosure typically get hundreds of such letters.

Next, try calling.  Again, use a helpful tone.  Be honest and straight forward.  You're an investor.  You're looking to make a profit.   But, you may be able to assist the owner/borrower in pre-foreclosure as well.  In a good deal it's a strictly win-win proposition.  If you start talking about how much profit you hope to make and why they owner/borrower needs to be more realistic and take less, you may as well not even bother to make the call.  You have to show how it can be profitable to both of you.

Finally, get physical.  While this book emphasizes how much can be done on the Internet, there comes a time when showing up physically at the home you're interested in makes great sense.   One investor I know recounts an incident where he knocked on the door of a person in pre-foreclosure, was asked in, and began to explain how he could be of assistance.  The person looked at him and said in amazement, "I've had hundreds of letters and phone calls, but you're the first person who actually came by!"  Naturally, he got the deal.

        6. WORK OUT THE FINANCIALS

Remember, it's all about making money. If there's no money to be had, you're just wasting your time - move on to a better foreclosure property.  Online you should be able to get at least the initial debt that the owner owes.  As noted above, you should also be able to come close to determining the market value of the property.  Subtract debt owed from market value and you have owner's equity.   Don't forget to now subtract any costs of repair to bring the property into saleable or rentable shape, any other costs involved, and, of course, your profit.

KEY CONCEPT 

        Be sympathetic.  After all, this person is about to lose their home.  That's not just a financial, but also an emotional crisis for them.  Don't come on so strong that you sound like you're trying to steal their equity, which you're not.  Use common sense.  Remember, owners are mostly scared.  They've been receiving letters from lawyers telling they're going to lose their home.  Offer hope.

        7. PRESENT OPTIONS TO THE OWNER/BORROWER

As an investor, you're familiar with (or ought to be!) with the foreclosure process.  For the owner/borrower, it's probably a strange, new, and frightening process.  Simply explain what's happening, what the timelines are, and what options are available that can give that person a sense of control over the situation, and make them more amenable to doing a deal with you.  Here are some options that you can offer to the owner/borrower:

*        Outright purchase - you'll buy the home and give the borrower so much money (if there's enough equity).  At the least this should help them save their credit from showing a foreclosure on it.

*        Second mortgage - You can offer to give the owner/borrower a second mortgage thus providing them with enough money to bring the existing first mortgage current.  If you're providing the money yourself, be sure you get at least market interest rate.  Be aware that if you arrange financing from a third party, you will probably need a mortgage broker's and/or real estate license.

*        Offer to share equity -  One of the oldest techniques in the book is to bring in a partner when you're having financial difficulty.  Offer to be that partner.  You can bring in enough cash to bring the mortgage current.  In exchange, you and the owner/borrower will jointly share the property.  In an equity sharing arrangement, however, be sure that you have a strong written contract that specifies who is to make payments, how the equity it to be split when the property eventually is sold, and what is to happen in other eventualities.  You need a good attorney to draw this up.

*         Leaseback - Here the owner/borrower gets to stay in her property.  She sells it to you (for whatever equity you agree upon), and then leases it back from you.  She transforms from an owner to a tenant and pays you rent.  From your perspective, it's a great way to get a built in tenant.  Of course, your long term exit strategy in this case should involve holding the home as a rental.

KEY CONCEPT 

        Remember, if you present yourself as someone who can offer the owner/borrower options, ways out of the problem, they are likely to be sympathetic to you.  If you present yourself as someone who's out to make a buck at their expense, they'll likely tear up your letter, hang up the phone, and show you to the door.

        8. DON'T FORGET ABOUT A GOOD PURCHASE AGREEMENT, HOME INSPECTION, DISCLOSURES, TITLE INSURANCE, AND MORE

Most pre-foreclosure deals are not handled by real estate agents.  Rather, they are between the seller and the buyer (you).  That means that there's no intermediary to handle all of the paperwork.  Typically, it falls on you.

        If you're unfamiliar with real estate transactions, then it will behoove you to pay for the services of an agent to handle the paperwork.  Today, many will do so on a fee-for-service basis or for a  commission on resale - see below.  You might also consider having a good attorney do the same.  On the East Coast attorneys typically will handle the paperwork of an entire real estate transaction for under $1,500.  They can also advise you about special rules in your state that may apply when an investor buys a home that's in pre-foreclosure.

You'll need a solid purchase agreement that includes contingencies for a home inspection, disclosures, and of course, title insurance.   Whereas in a typical transaction, the seller may pay for title insurance, a termite clearance, and repairs, here it's likely you'll pay for everything.  Although, you'll probably subtract your costs from the seller's equity.

        9. RESELL OR RENT

Depending on your exit strategy, this is the goal you're aiming for.   When you resell, many investors plan on doing it themselves, selling as FSBO, to avoid paying the real estate commission.  This could be a mistake.

        Consider bringing an agent in early on in the deal.  When you make the purchase, the agent can handle the paperwork and grease the wheels of the transaction.  He or she may be willing to do this if you pay a full commission when you resell.  It could be very well worth your while, since you'd be getting two deals serviced for the price of one.

KEY CONCEPT 

        Consider partnering with an agent.  If that agent knows that you're going to be regularly buying and reselling foreclosures, she may be willing to cut you a significant discount, as well as help out with all the transactions.  In some cases, agents and investors work together to purchase and resell foreclosures splitting the profits down the middle.  It's something to consider.

The agent can be invaluable when it comes to marketing the resale of the property.   She can put it on the MLS, advertise it, publicize it to other agents who may have buyers waiting for such a property, show it - all the things you probably don't have time for.

ADVANTAGES OF BUYING A PRE-FORECLOSURE 

        To sum up, here are some of the advantages of buying a home directly from an owner/borrower who's in pre-foreclosure:

1. 1. • Properties are easy to locate on the Internet 

      • You can find out pertinent information about the original loan balance, the schools, the crime rate, the market pricing and other vital information on the Internet. 

      • You can get title insurance, again on the internet. 

      • You can physically inspect the property yourself as well as hire professional inspectors, again on the Internet. 

DISADVANTAGES OF BUYING A PRE-FORECLOSURE 

1. 1. • You have to make the contacts and negotiate the deal yourself directly with the owner/borrower, who may be both scared and despondent.  

      • You have to arrange for the financing to make the deal as well as arrange for someone to handle the paperwork. 

      • You have to arrange for inspections, repairs, and other work. 

      • You may get a property in disrepair, and it's up to you to clean it up.