Real Estate Investing For Physicians: Part 3 - Foreclosure

Thinking of putting your foot into the real estate investing market with Foreclosures?

Foreclosure! It's a word that strikes fear and loathing (at not just in Las Vegas) to the homeowner, and is music to the ear for the investor.

For the majority of foreclosure properties, the homeowner has already lost title to the home, well before any investor gets involved - essentially the damage is already done. Later in the process, the bank now owns the property and is trying to take it off the bank's liability sheet. That's when the knowledgeable and aggressive investor jumps in.

Most of this jumping takes place at foreclosure and bankruptcy auctions. Speaking of a place that is NOT suited for the uninitiated and uninformed! But I'm getting ahead of myself.

The first step in acquiring foreclosure properties is to research all the available houses in your target market and price range. This research takes the form of public records search, title search, neighborhood analysis, "down and dirty" property inspection, rehab and cosmetic improvement costs estimates and comparable property value pricing. Armed with this information, the experience investor comes to an auction knowing which properties he is interested in bidding on, what will be his opening bid and most importantly, what will be his maximum bid. The investor must also have a significant portion of the accepted bid price in cash at the time of purchase and the ability to get the rest immediately.

Some auctions require full price at auction. The auction serves as a somewhat orderly market to move these deeply discounted properties. But even if you have all the afore-mentioned information in your briefcase, unless you are VERY experienced, you will be outbid, or purposely bid up, or pressured in one form or another to not stick with your pre-conceived game plan.

A typical scenario for disaster is being a new-comer at an auction where all the other attendees know each other. These veterans don't want the newcomer to succeed as that will just increase the competition. It's very hard to succeed in a face-paced selling enviroment where everyone else in the room doesn't want you to ever come back. Assuming you escape from this scene with a newly-purchased foreclosure property in your pocket and a few remaining dollars in your bank account, now the real work of property management begins. But before you figure that out, you have to have a clear plan and focus for what you're going to do with the property. Hopefully, you have that plan and exit strategy firmed up before you even get to the auction. The big decision is "buy and hold" or "buy and sell".

In the first case, you are planning on holding the property for medium to long term, i.e. 3 to 7 plus years. The goal is future appreciation and possibly some cash flow. The action plan would then be: clean up and fix up what the property needs, enlist a property manager and get a tenant, and keep it and maintain it as a rental property. This whole process not only would take another blog post to describe in detail, but more likely another hour of instruction.

The second case is a bet on the fact that you purchased at a price so far below current market value, that you can clean up the property and sell it quickly to an owner-occupant buyer by selling it still below current market value. This of course requires that you did your pre-auction homework correctly and didn't overpay during the auction. There's an oft-told saying in real estate investing - you don't make your profit when you sell, you make it when you buy.

This is a thumbnail sketch of the steps needed to take advantage of these bargain properties, some at 20% of peak values. If you can do this all, and do it repeatedly, you can do very, very well. But this whole process requires lots of time, in addition to access to cash, experience and knowledge of local markets.

I have been involved in just a few of these transactions and they were indeed quite profitable. But I no longer have the time, and still lack the adequate expertise to play the foreclosure game consistently well. I believe a more user-friendly approach to the foreclosure opportunity is to invest cash and not your time, efforts and gastric lining. You can do this by buying into R.E.I.T.s (Real Estate Investment Trusts) that specialize in foreclosures, which essentially is buying shares in a publicly-traded entity, not unlike buying a mutual fund. Another way is to become a limited partner in a private syndication. Next time, we can talk more about these two investment vehicles, as well as thoughts on the buy and hold-or-sell decision.