Best Bets: Fishing For Foreclosures

Regina Peters smells profit.

The 58 year-old resident of Yonkers, N.Y. has been following the rise in mortgage foreclosures for more than a year and plans to purchase her first distressed property in early 2008.

“I have a lot of equity built up in my primary residence, so I’m going to use that to purchase a foreclosure, which I’ll move into and renovate,” she said.  “I’ll then rent out the house I currently own.”

If all goes as planned, the new income stream will help supplement Peters’ living expenses during retirement, while rent will pay off the mortgage on her second home, which will continue to appreciate in value.

Reed Saxon / AP A home is advertised for sale at a foreclosure auction in Pasadena, California.

“I’m already looking, but I’m going to wait for prices to fall a little further, probably another three or four more months, before I buy,” she said.

Peters is not alone.

Sizing Up The Market

Foreclosed properties have long appealed to investors who are looking to build equity -- and aren’t afraid to roll up their sleeves.

In most cases, buyers can purchase such homes for 20 percent to 60 percent off their potential market value.

“This is a market where somebody who does their homework can save significant money on a home purchase and create a nice investment opportunity on a longer-term basis,” said Rick Sharga, spokesman for RealtyTrac.com, an online foreclosure marketplace.

Investors entering the market today, however, will have to employ a different strategy than those who came before.

“If you’re looking for something to buy and hold, investing in a foreclosure is a very reasonable thing to do right now,” said David Wyss, chief economist for Standard & Poor’s. “If you’re thinking about a quick flip, forget it.”

Sharga agrees.

“What’s fundamentally shifted about this market is that it used to be suited for investors who were looking to buy, renovate and sell,” he said. “Now, we’re looking at people who can afford to buy and hold, either with the notion of turning a property into a rental unit or sitting on the property until the market rights itself again."

Indeed, certain segments of the residential real estate market have taken a hit over the last three years as would-be buyers sit on the sidelines waiting for prices to bottom out, particularly in cities like Miami, Boston and Los Angeles that benefited most from the housing bubble.

Nationally, existing home sales are projected to fall 10.8 percent this year to 5.8 million, down from 6.5 million in 2006, according to the National Association of Realtors.

At the same time, the number of foreclosure filings – default notices, auction notices and bank repossessions – were up 99 percent in September over year-ago levels, reaching a total of 223,538 nationwide, RealtyTrac.com reports.

Many emanated from the subprime market, where borrowers with weak credit histories found themselves unable to keep up with rising monthly payments on their adjustable rate loans. (More: Mortgage Industry Meltdown)

For investors, a rocky residential market and a growing inventory of distressed homes could mean a bigger potential payoff down the road, said Sharga.

“If you combine a down market with the kind of discount you’d be looking at with the typical foreclosure, that doubles your opportunity for success when the market comes back,” he said.

David J. Phillip A foreclosed home for sale.

Pitfalls

Yet, the process of purchasing foreclosed properties is also fraught with risk.

Without preemptive research, investors could end up buying homes with tax liens or other liens outstanding, which they would then assume.

“I’ve even heard about people going to auction and buying a second mortgage rather than the first and thinking they got a great deal on a house,” said Sharga.

Before making a buy, investors need to crunch their numbers carefully-- that means hiring a contractor, where possible, to complete a home inspection for big-ticket problems, like structural damage or costly mold.

Investors also need to secure as precise a figure as possible for how much renovations will likely set them back, a major drag on profit.

Finally, buyers should consult a real estate agent to learn about comparable home sales in the same neighborhood, which will help determine how much the house might eventually fetch in resale.

They should also take note of how long listed homes – both rental and resale – have been sitting on the market.

“Many foreclosure investors won’t purchase a property unless it is at least a 30 percent discount,” said Sharga. “That’s because you’ll typically need to do a rehabilitation to bring the property to back up the neighborhood standard, you’ll probably have to finance it for a short period of time and it’ll cost you some money to market the property.”

CONTINUED : Buyer's Guide

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