The subprime meltdown and financial crisis of 2008 had caused thousands of houses to undergo foreclosure. With the massive increase, many real estate investors sought out foreclosed homes as an investment opportunity (to flip or use as rental properties) as these properties tend to have below market value property prices.
However, there are certainly risks of buying foreclosed homes that many encounter despite the low purchase price. Therefore, successfully buying and selling or renting out a foreclosed home requires research, real estate market analysis, money, knowledge, experience, and time as foreclosed homes tend to be high-risk investments.
But what exactly are the risks of buying a foreclosed home and how could you mitigate them? This article explains 4 major risks of buying a foreclosed home and outlines how any real estate investor can overcome them.
But first, a little history…
The Emergence of Foreclosures
The number of foreclosures increased significantly in the United States following the housing bubble. During the boom, house prices increased as demand for housing increased. As more property buyers entered the real estate market, demand was driven up and so were house prices. The housing boom accompanied by low-interest rates at the time prompted mortgage lenders to give out home loans generously, even to people with poor credit.
After some point in this housing boom, demand stagnated at the same time that the housing supply increased. This resulted in a sharp drop in prices causing the bubble to burst. The sharp increase of high-risk mortgages that went into default beginning in 2007 had lead to the most severe recession for some time. When the bubble burst, many borrowers were unable to make payments on their subprime mortgages and their mortgages went into default.
In September 2010, approximately 120,000 homes entered foreclosure in a month, marking the peak of the crisis. Real estate investors today find these cheaper houses for sale for really good deals as many of them have not been up kept since 2010. So, should you be looking for foreclosed homes for sale? Is it hard to buy a foreclosed home? Foreclosed homes can be some of the most profitable investments, whatever real estate investment strategy you use with them. While the process of buying a foreclosed home can be a little complicated as it still involves investment property analysis and market analysis in addition to other steps, a beginner can still undertake it. But it’s important to know the risks first. So, what are the risks of buying a foreclosed home?
Related: How to Buy Foreclosed Homes: The Expert’s Guide for Real Estate Investors
The 4 Major Risks of Buying a Foreclosed Home
#1: Lacking the Knowledge of the Foreclosure’s Condition
One of the risks of buying a foreclosed home is the risk of not being able to know the condition of the interior of a property. This is because, when buying a foreclosed home at a house auction, potential buyers are not allowed inside the house before bidding begins.
Related: Buying a Foreclosed Home at House Auctions: What Real Estate Investors Should Know
In order to avoid this pitfall, you should first collect information available through public records. You should also run a home inspection of the exterior of the investment property as it could be indicative of the interior conditions. However, while a good exterior can be comforting, looks can be deceiving. There could be pipe leakages or foundation issues that are not visible to the naked eye.
If you’re not buying a foreclosed investment property at a house auction, then be sure to consult with a professional contractor and tour the property with him/her before you place an offer. The professional contractor will detect and advise you on the foreclosed property’s investment viability. If a foreclosed home’s exterior or interior is in bad shape and needs a considerable cosmetic rehab, you should at least be able to negotiate and reach a good price.
#2: Paying for Liens
When you are buying foreclosed homes to rent out or flip, you are also buying any liens code violations or title issues that you would not have been able to know about prior to purchasing. This is one of the grave risks of buying a foreclosed home.
To mitigate such a risk, you could pay to get a real estate attorney to run a title search on the investment property and disclose existing title defects and any other liens and burdens. The attorney can then issue a commitment letter to ensure the title after purchase. Alternatively, seek out reputable lenders who are the first lien holders as they tend to be a fairly safe investment.
Related: Pros and Cons of Buying Foreclosed Homes
#3: Underestimating the Cost of Potential Repairs
Many real estate investors who have bought a foreclosed home suffered from the miscalculation of potential repairs and ended up with a bad return on investment. Some have even incurred more expenses than profit in the medium run, resulting in a serious negative cash flow property.
In order to accurately assess the number of expenses you will be paying for repairs, we recommend that you speak with experts and real estate agents working within the neighborhood of the investment property. Prior to setting the budget for repairs, visit the foreclosed property and assess the conditions of the roof and the property’s foundation and factor in any expenses. Additionally, to avoid the risk of miscalculating the to-be-incurred expenses, assess the big-ticket items. These include the HVAC, electrical, and plumbing systems. Note that some of these items can be assessed visually to some degree like the roof condition and AC compressors.
After calculating the expenses of potential repairs, we recommend adding 10% to cover any additional contingencies. This is because real estate renovations tend to have unexpected costs. If you’re going with the fix-and-flip real estate investment strategy, your renovated foreclosed home should sell for 70% of the purchase price along with the repair costs.
#4: Neglecting Flipping Regulations
When buying a foreclosed home to flip, many real estate investors fail to study regulations that govern them and end up incurring more costs. Avoid these kinds of risks of buying a foreclosed home by reaching out to the local city council and inquiring about regulations that govern the purchase and resale of foreclosed properties.
While buying a foreclosed home is an affordable option for many, you should carefully assess the risks of buying a foreclosed home. The risks of buying a foreclosed home can bring an end to your investment while leaving you indebted. To avoid these risks, prepare yourself by learning the ins and outs of the process and specifically the legal issues. Gather as much information as possible about, not only about the investment property but the neighborhood as well. Mashvisor’s real estate investment tools can help you study the performance of the neighborhoods and thus contribute to your decision making. After that, you can select the foreclosed home of your choice and perform a thorough investment property analysis using the Airbnb calculator.
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By exhausting your research and analysis, you will be able to minimize the inherent risk of buying this type of investment.
