WHY REAL ESTATE INVESTORS SHOULD INVEST IN SHORT SALE PROPERTIES AND FORECLOSURES
A short sale or a foreclosure might be a headache for the banks and homeowners, but it can be a great opportunity for diligent investors. Foreclosures and short sales allow investors to get potentially great properties for relatively cheap.
Don’t get me wrong, these properties can definitely become headaches for investors who aren’t prepared especially for investors who treat the deal emotionally. But there are great deals to be found in short sales and foreclosures for investors who stick to their numbers.
Another great reason to invest in short sales is the opportunity to help out someone in a bad financial situation. Imagine if you yourself were in this distressed owner situation; financial hardship, late on your payments, impending foreclosure, and armed with no knowledge about your options.
Who wouldn’t want someone to come and help? You, as the investor, need to educate and help the seller make the best well-informed decision.
Amount of Money You Can Make
Every market is different, so it is hard to give a ballpark profit for short sales and foreclosures. However, it is safe to say that short sales and foreclosures are legitimate deals to shop for in the real estate market. There are opportunities (like an example done below) everywhere. It is up to you, the investor, to identify them. Are you ready for a scavenger hunt?
Benefits of buying a short sale or foreclosure:
- Major Discounts
- The lender or bank will have the property appraised. However, they are usually willing to accept as low as 80% of that appraisal. Especially if you can provide evidence of serious property defects.
- Less Competition
- Another great benefit to shopping for short sales and foreclosures is that there is less competition. Both investors and homeowners don’t usually shop for these deals (because they can take a long time to find and the window to capitalize on them is typically pretty small).
Downsides to buying short sale or foreclosure:
- Slow Progress
- These deals are known to take a while. Short sales especially could take months to finalize. However, in an article written by Tracey Royce, a short sale specialist, she describes that short sales are becoming easier and easier as more people begin to use them.
- Strict Terms
- Resale restrictions are restrictions that the lender imposes on the buyer during most short sales, that don’t allow the buyer to sell the house for 90 (or 120) days. This can deter an investor who is looking to flip the house and sell it as quickly as possible.
How do you find these properties?
***Direct Mail Marketing (DMM)***
Direct mail marketing is the process of directly mailing homeowners of the properties you are interested in (in the case of short sales, most likely distressed properties). This strategy consists of making letters, the shorter and more direct usually the better, and mailing them out to as many people as you can. The key is to mail as many homeowners as possible; the more distressed owners you reach, the more likely you are to find a deal.
This strategy seems simple enough, right? Well not always.
This process can be extremely tedious, expensive, and can take a long time to show success. In order to be successful at direct mail marketing, you as the investor must be consistent.
While the investor might have to spend money on this marketing strategy, studies discussed in Anson Young’s “Finding and Funding Great Deals” support Direct Mail Marketing by describing that success comes from consistency (i.e. the more letters you send the more likely you are to discover a deal).
Now, you might be thinking, we haven’t actually told you how to find these properties? Knowing what Direct Mail Marketing is and how it works is useless if you do not have a way to find these target properties. Seeing as we are discussing short sales and foreclosures mainly, we can assume that our target audience needs to be distressed sellers. This means we are targeting homeowners who are underwater on their mortgage.
Three of the best and most accessible groups of distressed sellers to target are:
- – Owners 1-3 months behind on mortgage payments.
- – Owners who have been notified of a pending foreclosure.
- – Owners who had listed the property on the MLS or internet, but the listings have expired.
So now we know how to establish a Direct Mail Marketing campaign and what sellers to target, but we still have no idea how to obtain these sellers addresses. Seeing as physically mailing letters to these owners is a pretty important step, it’s a good thing there a few ways to do this. Finding addresses can be done in several different ways, especially if you are willing to be creative.
***Driving for Dollars***
A method used by real estate investors that consists of physically driving (or walking, biking, etc.) around the area you are looking to buy real estate. Seeing as we are interested in a short sale, and therefore interested in distressed sellers, you will want to keep an eye out for distressed properties.
A few things to look for are unkempt or messy lawns, old siding or siding falling off of the house, broken windows, bad roofing, neglected looking backyards/pools/sheds, degrading porches, or any signs of possible vacancy. Record these addresses and mail to them. You might be able to catch a distressed owner in a bad situation and you could potentially help them by buying their headache property through a short sale.
Maybe the owner of this property just passed away, and their son/daughter received the property as an estate. If the property is distressed, and if the owner is not currently in a situation to take care of the property, your letter could be the lifeline they are hoping for.
Another, more tedious but more creative, way to generate leads on short sales is by googling “legal notices” for your specific county. There are public records and shouldn’t be too hard to obtain. Then, you can mail addresses that have recently been notified of foreclosure.
Another creative method is to locate distressed properties by searching for owners who are delinquent on their taxes. This information can be found on your county’s Tax Assessor website. Record the addresses of properties owned by someone who is delinquent on their taxes and mail letters to them.
The MLS is the place where listing agents place properties online. You must contact a real estate agent in order to access (only those with real estate licenses have access to the MLS). There is no national MLS, so find a local real estate agent. The MLS is great because almost all properties (REOs, short sales, and retail sales) listed by real estate agents will be available on it. It is a great tool for finding properties.
If you plan on using the MLS to find short sales, look for phrases like “potential short sale” or “Lender approval required” on the properties your agent sends you. There are several websites out there (not all of them free) that can show you a list of properties in pre-foreclosure also.
However, there are two drawbacks to using the MLS from an investors perspective.
1. The MLS is one of the easiest ways to look at lots of properties. The MLS is one of the most commonly used tools for finding properties; meaning more competition for you; both as investors and homeowners.
2. You need a real estate agent in order to access the MLS. To some investors, this is a part of their process, and they have a real estate agent as a member of their team. However, some think of this as a hassle; another link in the chain where a problem could arise. A bad real estate agent might not relay a good deal to you quickly enough; causing you to lose the deal. The problem could be as simple as the agent not agreeing with the investor, and simply not cooperating. Not all real estate agents are created equal, so be very careful and very particular when choosing yours.
Steve Berges advocates advertising and advertisement mediums as highly effective in his book, “The Complete Guide to Investing in Foreclosures”
This can be done in so many different ways, a few of which are; on the internet (organic or paid traffic), on social media, in the newspaper, on a billboard, and on bandit signs and flyers.
Anyway, you can think of that will get your advertisement seen by a large number of people might be worth a shot. This is an opportunity for you the investor to really get creative and use a marketing strategy or advertisement that suits your market.
Many of you may be familiar with the sign below, but did you know that most cities have laws against bandit signs which are small signs advertising properties. Therefore, someone looking to buy short sales in a city might want to advertise online or in the newspaper instead of making/hanging bandit signs that will be torn down within the week.
Even though we feel this goes without being said, we figured it should be at least mentioned. Finding short sales can be as simple as a day-to-day conversation. Talking to people in their daily lives could generate a lead on a distressed property.
In this section of the article, we will take you through the process of finding a potential property and determining whether or not this property would be a good deal. Now, since most short Sales/REOs are distressed homes and you have been learning how to find distressed properties; chances are you won’t be trying to live in or rent out this property.
While wholesaling is a possibility with short sales/REOs and a lot less complicated than rehabbing, it doesn’t return as much profit. For that reason, and because the wholesale process isn’t all that complicated; we will analyze this property as a flip. So let’s walk you through the MoveInPhilly Process to analyze a distressed property.
***First Step: Finding the Property***
We located a home in pre-foreclosure using the MLS (the house has since been foreclosed on but is still listed). 1354 Glassboro Rd, Woodbury, NJ 08096 – is the property address. It was listed for $29,900 (it still is, but now by the bank).
***Second Step: Analyze Property (Determine Deal Quality)***
Then, we began thinking about the flip formula discussed in “The Book On Flipping Houses” by J. Scott.
(MPP)= Sales Price – Fixed Costs – Rehab Costs – Profit
This formula is very important to flippers because it is a way to determine the quality of a deal relatively quickly and accurately. We researched other homes very similar to the listed property for the Woodbury area and obtained comparables.
We conservatively determined the sales price to be $125,000, based off of the comparables. Then we determined our fixed costs to come in around $22,250 using the NJ state tax assessor site.
We then added into the flip formula how much we would want to profit from the deal, which for us was $20,000. Not a great margin, so usually you will want to start with a higher number.
Remember, we are flipping a property and Murphy’s Law is in effect. If something can go wrong, it probably will. We heard of a recent local project where the copper piping was stolen, TWICE!
Last, but certainly not least, we inserted rehab costs. We have a built our own rehab calculator that we use for every property evaluation we do. Seeing as a great deal of work was needed to return this property to great condition, and for the sake of the exercise, we estimated rehab costs super conservatively at $50,000. Our flip formula now looks like
MPP=$125,000 – $22,250 – $50,000 – $10,000 —–> MPP= $42,750
This means that the highest possible price we could pay for this property is $42,750. Seeing as the asking price is only $29,900, this potentially could be a great deal.
***Third Step: Making an Offer***
Now, the next step of this process would be for us to make an offer. In this case, since we found the property on the MLS, we would be dealing with real estate agents and therefore automatically be using state contracts. This will ensure that everything in the contract is legally binding. There are 5 major parts of the contract that both parties must agree on. The offer can be countered, ignored, or accepted.
- – Purchase Price: The amount of money the property is being purchased for.
- – Cash or Financing: This will determine whether the buyer is paying cash or using a financing plan.
- **Pro tip: Purchasing a property with cash is a major incentive for seller’s and can usually get a buyer a better price on the property.**
- – Earnest Money: Money (usually in the form of a check) that is submitted with the offer in order to confirm the seriousness of the buyer. It will usually be added into the down payment on the property.
- – Closing Costs: All the different fees and expenses that come with closing on a property. In today’s market most seller’s are expected to pay most if not all of the closing costs, however it varies between every real estate transaction. Here, you can estimate and learn everything you need to know about closing costs.
- – Contingencies: Clauses placed in contracts that allow a party to back out of the contract under designated circumstances. These essentially work as get-out-of-jail-free cards and can be used by every investor.
Common contingencies include inspection contingencies, insurance contingencies, and financing contingencies. An investor should be sure to put these in a contract in order to cover their own behind in case major issues are uncovered during inspection or in case their financing falls through right before closing for whatever reason.
Often times a good investor will use these as leverage to negotiate with sellers. If a foundation problem is discovered during the inspection, the buyer could ask the seller to fix the issue or drop the price by the amount the issue would cost the investor. It’s important to try and always save the deal. If the seller denies, simply use the contingencies and watch a headache property disappear from your list of problems.
***Fourth Step: Due Diligence***
Once an agreement was made, we bought the property. In our contract we put two contingencies; an inspection contingency and a financing contingency. These are typically the best contingencies for new investors to use in contracts.
A financing contingency allows the buyer to back out of the deal with no repercussion if the said buyer cannot obtain financing by closing.
An inspection contingency allows the buyer a time period (usually 1-2 weeks after the purchase) to again, back out of the deal, with no repercussion to the buyer. At this time, we as investors would need be completing our due diligence.
This is when we make sure all of those estimates on rehab costs and the length of the rehab can actually be accomplished. We would get the home inspected and see if there were any major problems hiding beneath the surface of the property. If anything were not to our liking, we could back out during this time period with no consequence.
As an investor, you must be prepared to negotiate with sellers when buying properties. That being said, when buying short sales and foreclosures, there typically isn’t much to negotiate. The owner is either underwater on their mortgage or going to be soon and is offering the property as is. The seller is conducting short sale because they don’t want to deal with this headache property anymore and quite frankly they don’t have much to negotiate with.
Keys to Buying a Short Sale
A very important thing to know before engaging in a short sale transaction is that a short sale or pre-foreclosure sale is between the buyer and the current borrower on the property; not between the buyer and the bank (which is a post-foreclosure sale). This means that the current borrower will have to review the terms and sign/accept the terms before the contract can be submitted to the short sale lender.
Keys to Buying a Foreclosure
A major thing to know before investing in foreclosures is what type of foreclosure state you are in. There are two different kinds of foreclosures; judicial (in lien theory states) and non-judicial (in title theory states).
The biggest differences between these two options are the way lenders secure their investment (mortgage lien in lien theory states OR a deed of trust in title theory states) and how the foreclosure process happens (in a courthouse in lien theory states OR by the trustee in title theory states).
An investor must know what kind of state they are in so they know whether they are dealing with a bank/mortgage company as they would be in lien theory states or if they are dealing with a trustee as they would be in title theory states.
- Pennsylvania and New Jersey are lien theory states: therefore the mortgage company secures the title of the property and a judicial foreclosure process is required.
You are now ready to conquer the world of short sales and foreclosures. Check back soon for access to our innovative calculators that we mentioned above. The real estate game is based on numbers and if you are armed with the MoveInPhilly rehab calculator you will have the confidence you need to close your first deal!