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August 2, 2021
Most folks assume that just because a property is bought at a foreclosure auction, that it is an automatic “deal.” We read in public records that a property with a repaired value of $250K was sold for $125K at auction and think, “I need to get in on that action.”
But since we don’t know what we don’t know, a novice investor could lose big giving auction buying a try without first conducting necessary due diligence.
That is what I will address in this Foreclosure Auction Purchase Case Study…that list of necessary due diligence before and after winning the bid.
An investor starts by obtaining a list of foreclosure auction properties and corresponding auction sale dates. This information is public record, and the local courthouse can direct investors where to locate that list.
Upon reviewing the list, the investor narrows down locations and price points he/she would consider investing. Then the investor must consider answering the following questions.
Do I plan on driving by each property or just blindly bidding on a property I have never seen? What if the property is occupied? Will I knock on the door and ask for a tour? How will I know that what I am really buying?
There are a lot of questions to consider answering and I have only just begun.
Let us assume for the sake of this Case Study that the investor locates a property worth the risk, finds recent photos of it online, and decides to pursue bidding. The investor drives by the property, and it is clearly vacant (they will not have to worry about a time-consuming or costly eviction).
Regardless of the amount of the foreclosing lien, the investor must obtain comparable sales and determine an as-is and after-repair value of the property. With a real estate agent’s assistance, the investor uses a bidding formula that takes the retail value into consideration and then subtracts from it: (a) renovation costs; (b) carrying costs: (c) closing costs; (d) commissions; and (e) profit. Doing this will determine the maximum bid amount the investor can make at auction.
If the investor determines that it is unlikely a competing investor will pay this amount or more, then the investor can proceed. There is plenty of competition at auction. Savvy investors love buying at auction because it is a satisfying, “Here’s a property today” strategy.
Savvy investors will pay more for this benefit. For this reason, it may be hard to outbid competitors at the courthouse so new investors may want to “study” the prices that properties sell for at auction before considering if they will be competitive.
Next, the research for a clear title begins. In most jurisdictions, the legal foreclosure process and all filings must be reviewed to ensure all parties with a possible interest in the property have been properly named and notified.
This research should be done by competent and qualified attorneys or title clerks. It is also important to ensure that the foreclosing lien is in first position. This is the lien that is foreclosing, and the lien investors are bidding against. Investors must take all priority liens, as well as other protected liens (such as real estate taxes) into consideration since as the successful bidder, they will be responsible for paying them.
Following positive foreclosure case research, the next step is to investigate the title of the property, and then all liens that may be filed against the property. Note that some outstanding utility balances may be due even though they may not be recorded as such, therefore skipping a valid lien search could be a costly mistake.
At this point, provided there are no issues to resolve, the investor is ready to bid.
Assuming our investor in this case study wins the bid, they must then take into consideration any “redemption period” afforded the foreclosed seller or inferior lienholders.
Redemption periods are periods whereby redemption rights are given to the foreclosed parties (for a specific timeframe) that allows them the right to obtain ownership of the property by exercising available specific rights.
Redemption rights in certain jurisdictions are so unfavorable to investors that no one bids at the auction but instead pursues working with sellers facing foreclosure during and after the scheduled foreclosure auction.
At this “winning bidder” point, our investor may have a deadline of just 24 hours to pay the final balance of the bid amount PLUS all court costs and related fees. In most cases, these funds must be delivered by wire transfer or certified bank check.
During this short timeframe, all outstanding due diligence must be performed. This may involve accessing the interior of the property to confirm occupancy and condition.
Upon entering the property (when allowed), there may be no working electricity or water, hindering a better inspection. Regardless, a renovation budget and list of repairs must be determined to ensure the “numbers” allow the investor to earn a profit.
Smart investors will include a misc. figure into their budget because it is nearly impossible to fully ascertain what must be addressed in a walk-through inspection. An investor can guestimate for the worst and hope for the best.
This is also the time to verify all outstanding title and lien search unknowns, including validating all outstanding service provider arrearages due prior to any new owner receiving service. This only matters in cases where service providers have the legal right to lien the property for said services. Such is often the case with city water, city gas, and similar services.
In other words, the investor is about to own this property along with all its faults, known and unknown. Whatever unknown remains upon the successful bid must be researched and made known.
Additionally, it is in the investor’s best interest to bind the proper homeowner’s insurance policy simultaneously with paying the final balance of the bid.
Once the investor is satisfied that a profit is waiting on the other end of this project, the investor pays for the property. It is often the case where not all outstanding issues can be resolved before final payment is due. The investor must decide if the risk of each unknown is worth taking. Although the unknown eventually becomes known, the investor will own the property by then.
The biggest mistake new and even seasoned auction bidders make include foregoing proper advance research. This research is not free, but because the odds of winning are not in their favor, they often forgo spending on proper due diligence.
Many foreclosure cases are canceled or postponed at the last minute and since most research takes days to complete, bidders must start at least one week (or more) in advance of auction dates to obtain important data.
Because of this, many investors just “take their chances” and hope the cost to cure any missed title or foreclosure defect will be minimal. That is not an advisable way to do business, but I see it all the time.
I see bidders drop 5% deposits after winning a bid and then discovering defects they cannot or do not want to resolve. Instead of paying the final balance due by the deadline, they forfeit the deposit and chuck up the experience as the cost of doing business.
When volume is involved, perhaps these losses can be absorbed; however, for the one-time “give it a shot” investor, any mistake or loss may take them out of the game completely.
If you are interested in investing in foreclosure auction properties, I suggest you get the right team of experts working on your behalf. It is far better to invest in education than to lose an investment while getting educated.
Disclaimer: I am not a CPA or financial adviser.
Sharon Restrepo, Author
Broker & Investor
*This site contains educational content provided by third parties. NuView Trust does not endorse, recommend or approve any of the companies or individuals or investment vehicles or strategies that may be discussed. NuView Trust encourages clients to seek legal or tax advice as necessary and to perform their own due diligence before engaging in any investment vehicle or strategy.