The growing inventory of distressed homes on the market may be sending shock waves through the economy, but it’s also giving investors a wider window of opportunity.
Despite federal initiatives to stem the rising tide of foreclosures, some 358,471 foreclosure filings were reported in August, according to RealtyTrac. Such filings include default notices, auction sale notices and bank repossessions.
Over the last three years, more than 4 million U.S. homes have been sent into foreclosure.
“Whether you’re an investor looking to purchase a rental property, or a homeowner who’s ready to retire and move someplace more affordable, the price of foreclosed properties right now is right,” says Debra March, executive director of the Lied Institute for Real Estate Studies at the University of Nevada Las Vegas, the nation’s leading state for foreclosures.
More than 1.9 million properties have received some sort of foreclosure filing—default, auction or bank repossession—this year through the end of August. The inventory of so-called REO—bank owned—properties, is now much higher than historical norms but neverthess below its peak at more than 900,000 in November 200
Foreclosures have long appealed to investors who are looking to build equity—and aren’t afraid to roll up their sleeves.
Often, 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 of RealtyTrac.com.
Investors entering the market today, however, will have to employ a different strategy than those who came before.
If you’re looking to renovate and flip, forget it. But if you’re in a position to buy and hold, with the intent of either renting your property or sitting on it until the real estate recession subsides, the market is ripe for the picking.
“Investors need to be cautious and have a long-term strategy,” says March. “I don’t think we’ve seen the end of this economic downturn, so you have to be in a position financially to be able to afford the new mortgage even if you lose your job.”
That means buying in a location where prices are low and demand for rental properties remains strong.
According to RealtyTrac.com, Nevada, Florida and California lead the nation in foreclosure rates, while Sunbelt cities, including Las Vegas, Cape Coral-Ft. Myers, Fla., and Stockton Calif., are posting the largest number of foreclosures.
For investors, notes Sharga, a rocky residential market and a growing inventory of foreclosed homes could mean a bigger potential payoff down the road.
“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.
The process of purchasing foreclosed properties, however, is also fraught with risk.
Without preemptive research, an investor could end up buying a home with an outstanding tax or other lien, for which you become responsible.
“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 do their homework carefully—that means hiring a contractor 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 at 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 back up to 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.”
It may be not sit well to profit from someone else’s misfortune, but keep in mind that when you purchase a distressed property you’re not just doing your investment portfolio a favor.
By reducing the inventory of available homes, you’re also helping to stabilize the residential real estate market which, in turn, will buoy the troubled U.S. economy.
(Editor's note: This story has been updated since it was originally published in March 2009.)