The real estate blog.

This burning question comes from reader Susan -

I was wondering if you could explain the best way to buy a foreclosed property. How to I find them? Is it usually best to purchase it from a bank? Or a pre-foreclosure? Do the homes go to auction? Maybe you could do a post on this topic. Do you suggest buying foreclosed properties?

Thanks for the question Susan. Given the state of the real estate and mortgage markets in the U.S. and the increased rate of foreclosures, this is quite the timely question.

Let’s recap real briefly what the stages of foreclosure are and then examine where the opportunities for investment lie in each stage. While every state has different laws and time periods associated with foreclosures, there are in general three main steps:


1. Notice of Default - When a homeowner fails to make a mortgage payment. Typically this takes place after 90 days of non-payment.

2. Notice of Sale - Whether it’s a foreclosure sale or a trustee’s sale does have some nuances. Essentially it’s the lender telling the homeowner their house is going to be sold. This takes place between 90 to 180 days after the Notice of Default, except in Texas.

3. Real Estate Owned - The home will either be sold at auction, or the lender will take it back and try to sell it themselves.

I’m going to add a fourth stage and that is the time period before the first payment is missed, when the homeowner first realizes they’re in trouble.

To answer the original question about the best way to buy, I think there are opportunities to buy in each stage, but you have to understand the process well and have a competitive advantage to be successful. To try and deal with foreclosures as an attempt to buy a cheaper primary residence, probably isn’t the best way to proceed because of the learning curve, but if you want to learn as an investment tool, that’s a different ball game.

In my opinion, one of the best ways to pick up a house on the cheap is to get it early. Signs of distress can present themselves well before the Notice of Default unleashes a slew of offers from would be investors. The competitive advantage here is to know someone like a bankruptcy of divorce attorney who can refer you to people in those situations. One can also be referred by friends or family of the homeowners. Obviously that’s the disadvantage as well. This is the most lucrative, but also the hardest way to buy a pre-foreclosure home.

A notice of default is a public record and as such can be searched by other investors who will write, call and even show up on the homeowner’s doorstep trying to “help” them. Deals can be made at this stage, particularly if the homeowner has equity. Another tactic is to get a short sale from the bank with the seller being able to walk away and the lender providing the profit of the deal. This is also a potentially lucrative step to invest in, but has tons of competition from other investors. The way to get the NOD lists is to go to the courthouse or contact a title company that can provide daily lists. In Utah, one can subscribe to NewReach and also get updated lists. The disadvantage to buying homes in this stage is the competition from other investors and the potential the lender could delay or nix a short sale.

Once a home is ready to be sold at auction it’s had dozens, if not hundreds of investors, agents and potential buyers look at it and pass on it. The homeowners could have damaged it, or had other parties put liens on it that could otherwise cloud the title. In addition, if the homeowners haven’t yet moved out and you win the auction, evicting them becomes your responsibility. You may have not had the chance or ability to inspect the inside of the property and you’ll need to close within 48 hours. Finally, you’ll be bidding against a group of professional investors that know the system inside out. Still want to buy a home at auction? A new foreclosure auction company, Vestus, estimates 25% of all homes scheduled for auction actually get sold there. Further, they calculate only 50% of those homes have profit potential. Essentially only 12% of homes sold at auction have profit potential. This is the riskiest time to buy a home in the foreclosure process.

If a home doesn’t sell at auction, for whatever reasons, the lender will add it to their portfolio of real estate owned or REO homes. They may make minimal repairs if needed and market the home for sale. Since lenders are in the business of lending, they tend to do poorly at selling. Additionally if a real estate agent is hired, their commissions are lowered and these homes spend a lot of time on the market. I used to bid on a lot of HUD homes back in the day. When the Utah market started booming, HUD homes virtually disappeared. The HUD process is a bit different than a regular REO because they do an auction. I never won a bid on a HUD home.

Sometimes a lender that quashed a short sale offer and a low bid at auction will end up selling for the same price, after incurring additional expenses, once the property becomes REO. This is where I think a lot of investment opportunities will lie in the next few years. A buyer has the opportunity to inspect an REO just like they would a regular home for sale. However, an REO could have major problems like a home I looked at that suffered water damage to the wood floors throughout the house, or the one that didn’t get past the wiring phase of construction or the failed flip that was still in mid-remodel.

As you can see, there is no one way to buy foreclosed properties. You’ll need to figure out your financing far in advance. Some distressed properties can’t be purchased using traditional financing because of the home’s condition.

The bottom line is every stage of the foreclosure process presents opportunities for investors that are prepared and have a competitive advantage of that stage. One investor I know only does pre-foreclosures. Others do quite well at auction. I personally look for REOs or other pre-foreclosure distressed properties. One can often find these properties on the MLS through driving neighborhoods or simply contacting lenders for REO lists. Make sure you are comfortable with whichever stage of the process you’re looking at and figure out what your competitive advantage will be.