Real estate foreclosures are often seen as a good buying opportunity by people looking for their first home, and also investors looking to build a large real estate portfolio.  The good news for first time homebuyers is that as long as they are willing to put up with a maybe "not quite perfect" property, there is the possibility of developing what is referred to as "sweat equity".  Sweat equity is simply equity, or increased value, created by the willingness of a new owner to do the clean-up and repairs many distressed properties require.

The key to success is in evaluating the repairs necessary, and being realistic about your capability to do those repairs.  Almost everyone is going to be able to trim shrubs back, mow and water the lawns and greenery on a regular basis.  One of the common factors you will find with almost all distressed real estate is the landscaping needs some serious maintenence, but it's fairly easy to get things back into shape, and it's not horribly expensive to do.

The second common factor with distressed property is paint.  You can drive through almost any neighborhood and find homes where paint is peeling, severely faded, or is just one of those "What were they thinking?" paint jobs.  Although bad paint on a house doesn't necessarily signify a homeowner in distress, it's something to look at, and learn from.  Many housing tracts were built with between 4 and 6 house plans.  If you see a "sad" looking home in a neighborhood, find another home (same model) in that area where the landscaping is maintained and there is quality paint on the house.  The difference in value and desirability is exactly what you are looking for when building sweat equity.

Foreclosure or Pre-foreclosure?   Commonly, homes owned by a lender will be called foreclosures, homes where the owners have fallen behind in payments are called pre-foreclosures.  You can find some information on finding and negotiating pre-foreclosure offers by clicking the link.  Once a lender has taken a property back, they will often schedule and complete the necessary repairs to bring a property back to "market condition".  Banks know a property in good condition sells for more than a property in bad condition, so they do the repairs to recover as much as they possibly can on their loan.  Placing an offer immediately after a lender has taken a property back is one of the best times to purchase a foreclosure.  The difficulty is in tracking down the proper department in the lender's office.  The department you'll want is the REO, or Real Estate Owned department, be prepared with as much information as you can get to identify the property and have plenty of time available to wait on hold.

Oh, yes, I want to buy a foreclosure at 50% of Market Value, change the locks and put a real estate sign in the front yard and make a ton of money in 30 days. Oh yeah, I don't want to put a penny of my money into the deal either!

Well, everyone wants to do that, but I've never seen it happen!

The reality of foreclosure investing is far different than what many people have seen either through infomercials or books that have been written. We don't sell books, so I'll tell you what I'm aware of in the foreclosure investment field. First, everyone I know who is an active investor works an awful lot more than people working 9-5 jobs. Second, serious players either have a significant amount of money of their own or have an investor backing them up. Third, houses that are going to sale almost always need a lot of work to bring them to Market Value. Fourth, finding a solid property to purchase isn't a matter of picking what you want, it's a matter of finding something that works economically, keeping track of it, finding out all you can about it, then beating out all the other investors who are interested in it. Sound discouraging? People treating this business seriously invest a lot of time and energy into finding and following properties.

So, is it possible to make money in the foreclosure business?

Sure, the key is to know your strengths and weaknesses.

The first example is the major problem most beginning investors will have. What is the Market Value of a property you are interested in? Experienced investors will usually all have a property valued close to the same amount (3% variance). They will use local Multiple Listing Service comparable sales, Title Company comps and experience to come to that value. If you are not fully aware of what a property will sell for on the open market, you cannot do anything with a property. All decisions regarding a property are based on the price it will receive, Know The Value!!

The second issue of importance is the law. If you know of a property where money can be made, you do not want to run into legal issues because you structured a deal that is illegal in your state. Yes, states have laws regarding what you can and cannot do with owners who are defaulting on their home loans. Do your research, find out whether your state uses Mortgages or Trust Deeds and the legal timeframes and implications of each.

The third issue is money. It certainly helps if you've got a good amount to back your purchases, but if you don't, it is not impossible to do deals. You do need enough to be able to find properties, keep track of properties and cover on-going office type expenses. I was once told, "Money should never stop you from doing a deal". It's true. If you have a deal, someone to invest in it is easy to find. If investors don't want to invest, it's not a deal.

The fourth issue is knowledge. Federal tax liens, partial interests, leased land, property information wrong, unpaid property taxes and wrong common descriptions are all things that have hurt investors. If you are not aware as to how to check for these things, you shouldn't be investing in foreclosures. The things that will make a deal head south are the things that are not obvious.

Time to evaluate strengths and weaknesses.

You've decided you have the knowledge and the resources to follow the foreclosure marketplace, so the next step is, what are you going to follow? Procedures are very different for following pre-foreclosure compared to properties already foreclosed by financial institutions.

Pre-Foreclosure

Information is everything! If you don't know what properties are scheduled for sale, you are wasting your time. You need to know what properties, how much the loan amounts are and what timeframe you are dealing with. Local newspapers will publish the properties scheduled for sale, this will provide some information and all you have to pay for is the newspaper subscription. You can also go to the county recorder and research documents yourself, but the best way to follow these properties is to subscribe to a service that obtains records and sells the information. The best services give complete, accurate information and others provide the basic minimum, but it saves time spent looking them up for yourself. Once you know which properties are in default, you can approach owners directly to sell, arrange financing to save the property or whatever seems appropriate for all the parties involved. Door-knocking, mailing information or telephone contact, it's all based on knowing which properties fit your criteria. You can find some providers of information at Pre-Foreclosure Listings or you can go to the sale sites in your area and ask the investors who show up for the sale what local providers are available. If they don't want to tell you, ask someone else until you get the information you need.

Foreclosures

Banks are driven by numbers. Their non-performing assets do not generate income, they require reserves to be set aside in addition to the loan amount and large numbers of non-performing assets do not look good on the bottom line. So, if the financial institution doesn't really want to be carrying these properties, why don't they sell it cheap? First, if a bank has a large portfolio of bad loans and they do not want to carry them on their books, they sell the loans as a portfolio at a discounted price to companies in that business. Second, if they have taken a property back and now own it, why wouldn't they want to get as much as they can for it? It's called cutting your losses. If you want to buy from a bank, find properties you might be interested in by either following the auction sales or using a service that gives you fresh REO information.  Fresh information will allow you to put an offer into the bank before they will have any additional costs in the property and will be more likely to cut a deal. Your best opportunities are going to be properties that need a lot of work, have something wrong with them, or that are in a slower moving market. Banks seem to take forever to respond, place an offer with limited acceptance period, wait out that period, then go on to other things. Placing an offer at 60% of market value is something that probably won't fly. Be realistic about the property, your requirements and the bank's position and an offer just might be accepted.
Another possibility is to look for the dogs. Properties that have been on the market for a long time either are overpriced, are ugly or have some other problem. If you feel these problems can be overcome, a bank just might be willing to sell at a reduced price.

You've decided you have the knowledge and the resources to follow the foreclosure marketplace, so the next step is, what are you going to follow? Procedures are very different for following pre-foreclosure compared to properties already foreclosed by financial institutions.

Tools For Investing

There are five basic tools required for successful real estate and foreclosure investing.
 
1. A notebook (I like the subject notebooks, wirebound on the side)
2. A pen kept in your car(maybe two, cars seem to eat pens)
3. A calculator (Nothing too fancy, just to do simple figures without making mistakes)
4. A Thomas Guide or local area map. (This is the best way for finding locations and directions)
5. A mind willing to change behaviors and to learn new things.
The first three are fairly self-explanatory, you aren't going to be able to remember everything you see and everywhere you've been, so you'll need to make notes to refer to later, the calculator will help when you are running numbers on a property.

Let's start with an exercise in behavior.  Take your Thomas Guide and follow the routes you take to go to work, go to the bank and go to the grocery store.  How many neighborhoods do you drive by that you never actually drive through?  How many streets with how many houses are there that you haven't seen in the last six months?  The last year?   For the next week, leave for work 15 minutes early, pick one of those neighborhoods and drive through as many of the streets as possible at a fairly slow pace.     LOOK at the houses, what condition are they in, how are they maintained, what kind of cars are in the driveways, do a lot of people park on the street?   Any houses that are listed for sale and have flyers in front, you should stop, take a flyer and take note of the condition and appeal of the home.  Then, after work, do the same thing in the same neighborhood on your way home.  Need to buy groceries?   Drive through a local neighborhood on the way.  Same thing on the way back.

If you always take different routes and see different neighborhoods, you will begin to see properties that don't fit in with the neighborhood.  It might be the lawn isn't mowed or perhaps it's not maintained the same as the others, maybe there are too many cars parked in front or sometimes the house just looks empty.  The point of the exercise is to train your eye and your mind to always look for property that doesn't quite fit with the surrounding homes.  You take a flyer from the listed homes to start to build an idea of what homes might sell for in that area.  Each day, switch to a different neighborhood, you'll see differences between neighborhoods and individual properties will start to stand out more when they don't fit the neighborhood.  As you become more practiced, look at the style of building in each neighborhood.  Does the style and quality of construction conform with the other neighborhoods you've seen?  Even if all neighborhoods are maintained virtually the same, quality of construction can vary widely between adjacent neighborhoods.  The ability to drive into a neighborhood you don't know and fairly quickly determine housing quality in relationship to surrounding neighborhoods along with establishing an individual property's quality to it's neighborhood is essential for successful investing.  This will be discussed more in following chapters, but for now, start using tool # 5, your Mind.

What else can a Thomas Guide show you?  Things look very different when you look at a detailed map versus driving in the same area.  Look at streets and areas you know well.   Identify the neighborhoods and how they change throughout the area.  Major streets divide neighborhoods, neighborhoods usually get more desirable as they get closer to amenities (parks, open space, golf courses), they usually get less desirable as they get closer to impacts (freeways, commercial areas, high density residential).   Look at your area on the map, then drive your area looking at the housing.  Does it hold true?  Sometimes it's just a little less maintenance, perhaps there are more rental properties than in other areas, but you will find that prices will also be lower for impacted properties.  Properties nearer amenities will usually be highly maintained and sell for neighborhood top dollar.

If you've gotten this far, the two biggest problems of "I don't have the time and I don't have the money" have been addressed. 1. You can begin to learn about property and it's values by taking just a little extra time each day when you are going to be driving anyway. 2. You shouldn't have spent more than $35.00, most of that for the Thomas guide.  Continue with driving different neighborhoods, expand into new neighborhoods and remember, you can't see what's there if you're driving 45 mph.

Yahoo! HOME VALUES
A common question is "how much is the property worth?". You can find recent comparable sales at this site.

DOMANIA
Another source for comparable sales

ZILLOW
Some peple love their comps, others think they are wildly innacurate

SMART HOME BUY
Provides property reports which include recent comparable sales.
$14.95 for 10 reports, $9.95 for 5 reports, $4.95 for an individual report

MORTGAGE CALCULATOR
A calculator to figure out the payments at different interest rates and terms.

NETRONLINE
A portal to official state web sites, county assessors and recorders.   Online record sources listed where they are available.

LANE GUIDE
A complete guide to U.S. lenders. REO depts. and phone numbers are included where available.

Yahoo! MAPS
If you aren't sure where the property is, this will help.

The best first step is to evaluate the neighborhood.  If the neighborhood has shingle roofs, vinyl floors and basic amenities in the homes, you don't need a tile roof, ceramic tile and gold plated fixtures.  The objective when doing a quick cost-effective rehab is conformity with the neighborhood.  Carpet, paint and some landscape are almost always a requirement to freshen the appearance of the property, after that, your rehab should focus on getting the most improvement for your investment dollar.

Structural Rehab

New investors shouldn't be purchasing properties needing structural rehabilitation or rebuild. If there are sagging floors, cracked foundations, fire damage, unpermitted structural changes, water or dryrot damage, stay away from the property. While these kinds of property can be purchased very often way below market value, the rehab cost to bring them back can make your investment a non-profit effort. The difficulty in evaluating cost of repairs means this type of property should be left to more experienced investors and contractors.

Beginning Cosmetic Rehab

You've evaluated the area and know what the house SHOULD look like, now how do you get it there?  If you start on the outside first pruning back overgrown trees, cutting shrubbery back and getting any lawn back to a normal height, that's the first step.  Watering on a regular basis after your trim back will allow plants and trees to start to grow in an attractive fashion.  You start with vegetation first, because you can control the speed of interior projects, but you can't make plants grow any faster.  A freshly painted exterior on a home greatly improves it's curb appeal.  Since you have the existing plants cut back, now is a good time to proceed with exterior paint.  Again, keep in mind you are looking for conformity with the area, colors should be in the same range as other area homes.

Inside Cosmetic Rehab

There are three basic inside area types - kitchen, bath and living.  Kitchen is the most expensive to rehab, bath is the second most expensive rehab and living areas are fairly inexpensive to rehab. 
Starting with basic living areas, pull the carpet from each room, roll it and store it in the center of the living room.  You can leave the padding.  It's much easier to paint without carpet, the living room is usually the largest room and closest to the front door.  The new carpet installers will haul it off when they install the new carpet.  Window coverings, electrical outlet covers, switch plates, light fixtures, door knobs and hinges can all be pulled.  Please keep in mind the power should be turned off at the breaker box anytime you are working around electrical fixtures and outlets.  Mark all the doors on the top edge (no one ever sees the top)   identifying which room they belong to and put them all in one room.  You should be able to see every imperfection in the walls at this point, now is the time to patch, clean and prep for painting.  Mask off doorframes, cabinets and window frames.   When you've completed the prep, start the painting.  Sprayers are the fastest method of applying paint, since the house is gutted, overspray isn't a major problem except around your masked areas.  Ventilation is important though, so you'll want open windows wherever you're working.  Living room first, then bedrooms, hall area last.  Re-inspect each room 1-2 hours after painting to make sure everything is covered and even, retouch any problem areas. 
Time to get an accurate count of outlets, switches, hinges, knobs and light fixtures.   Go through the whole house counting everything you removed or will remove.   Every lightswitch and cover plate should be replaced along with all outlets and plates.  Every living area light fixture(don't forget bulbs) should be replaced, determine whether kitchen and bath light fixtures need replacement or are serviceable.   Every door will need new hinges and a knob.  Do you have to change everything?   Maximizing returns is about impression.  Used hardware will be discolored, scratched, have paint on it and not match throughout the house.  A new knob(with striker plate) and hinges, a new light fixture, new switch, outlets and paint should cost less than $60.00 per room.  For a standard 3 bedroom home that's $300.00 for the living type areas.  Everything will match, be brand new and make the home much more desirable.
Doorframes, window sills, cabinets and doors are usually going to be a semi-gloss enamel paint.  Since you are now done with interior wall paint, lay doors(in the door room) on the floor, 3 or 4 at a time.  Prop one end up about six to twelve inches and you can spray one side and the two edges people see.  Keep overspray off the walls.   When they are dry, flip them over and do the other side.  Brush or use a small roller for doorjambs and cabinets.  Install light fixtures and outlets while paint dries, as doors dry, take them back to the room where they belong.  After doors and jambs are completely dry, they can be re-hung and hardware installed.  There's no need to rush, you can complete painting and installation as you rehab the bathrooms.
Bathrooms need individual attention.  In many cases, fixtures have been upgraded through the years, so a full gut and rehab isn't necessary.  Use your judgement.  It's easier to paint and replace flooring if the toilet and any sink cabinet are removed.  Re-install with new plumbing and seals and you will have a fresh bathroom with no water leaks or built up corrosion.  New handle sets and/or spouts will sometimes be enough so you don't have to replace everything.  Cabinet handles and hinges should all be replaced.  Flooring and paint should be the same if there are multiple baths, often there will be different fixture styles in each, that's fine as long as everything matches in each. 
At this point, you need to clean all the windows in the house, inside and outside.   Pick up anything remaining in the rooms and take it to the kitchen or remove it from the property.   
Kitchens are important.  Clean and paint is the first step if you are keeping the existing cabinets.  If existing cabinetry can be salvaged by intense cleaning and/or refurbishing, that will be your biggest cost savings.  Cabinet handles and hinges should be replaced unless the existing ones are in extremely good condition.  Counter-tops (if ugly or damaged) can usually be changed fairly easily, professional installation is worth it for a finished appearance.  Flooring should be installed after any necessary cabinet work, whether it's cleaning, refurbishment or replacement.  The sink should be free of stains and corrosion, the plumbing underneath should be the same, if it's not, change it out.  Clean and put down shelf paper in all the drawer and cabinet interiors.  Make sure the lighting is adequate, if not, change fixtures or have additional fixtures professionally installed.  If the oven or stove need replacing, there are stores that sell used appliances, these can be a good deal. 
Carpet gets installed during kitchen rehab.  As soon as the kitchen floor is down, get the installers in.  You can schedule installation when bathroom and kitchen floors are done, you should be done with paint and all of the "messy" projects.  Everything remaining shouldn't get the carpet stained or tracked up.  Any remaining tools or supplies should be in the kitchen, the rest of the house should be clean and empty.
Marketing the property can be started during kitchen rehab.  When you have carpet in the property, a "for sale" sign can go in the front yard.   The windows are clean, the property is immaculate and since you will be on-site anyway finishing the kitchen and a few other things, leave the front door open and place an "open house" sign in front while you are there.  Any remaining rehab to the kitchen should not adversely affect a buyer's decision.  They will be able to judge the quality of work by the rest of the house.

Finishing Cosmetic Rehab

It's time to finish the front of the house.   Flowers should be planted where appropriate, either rehab or replace the mailbox, porchlight, house numbers and doorbell.  Keep in mind any plants planted close to the house might die if the house needs tenting for termites.  Leave some room at the base of the house if possible.  Take a critical look from the street, is there anything that stands out as being unattractive?  Is your property now the best or one of the best looking on the street?  If it's one of the best, there's nothing unattractive and you've priced right for the area, it will sell quickly.
You're still not done, so you can't rest yet.  Smoke detectors need to be installed and you need to check all the systems (electrical, plumbing) to make sure they work properly.  Window coverings need to be installed where appropriate.  Just a note, you will sometimes have an offer in before you get the window coverings installed, if you have made no promises to install and it's not written in the contract, you have no obligation to provide them.  It's happened more than once!

How long does the process take?

Depends on how much time you want to spend and how much you want to contract out.  Doing one at a time, cosmetic rehabs shouldn't take more than 30-45 days total.  If you are doing multiple rehabs or require roofs, driveways, major debris removal, these can all cause delays due to scheduling problems.  You can reduce the time by contracting interior and exterior painting, use day labor for exterior cleanup and use supervised day labor for some interior work.  Most rehabbers start to contract out the labor intensive jobs as they progress.  It's often most cost effective to find a new project rather than spend the time actually working on the projects.

How much will it cost?

Recommendations

Conversely, if you ask owners in distress to give you $10,000 because you'd like to have it, how many will consent? Very few, if any.

The solution lies in the middle ground, where you can solve the owners needs and problems, and in return you can realize equity the owner cannot.  A perfect example is an owner who hasn't had the funds available to maintain their property to area average standards.  If they choose to list their property for sale with a Realtor, they will have to deal with showings, the time (often months) to market the property, and ultimately receive a lower "as-is" type price due to property condition.  If the foreclosure auction date is looming, they'll probably need to discount the price even further to get an accepted contract in place and hopefully have the sale postponed.  Your goal is to solve their problem, and maximize the value of the property.

An equity buyout from the owner is one way to solve the owner's immediate problem and allow you to realize additional equity.  The concept is fairly simple and is also sometimes referred to as a "subject to" purchase, which means the existing financing stays in place, with your purchase "subject to" that financing.   One essential thing to keep in mind when evaluating any offer is that you need to base your offer on the owner's NET equity, not gross equity.  Using an example of an owner who has a property worth $100,000 that needs about $5,000 in repairs to obtain that $100,000 value, and they have a loan with $75,000 due (including 2 past due payments).   How much equity is there?  Optimistically, there's really only about $10,400 in equity.  Here's why.

$100,000 Market Value of property in fully repaired condition.
-   $6,000 Sales Commission to sell the property using a Realtor charging 6%
-   $1,500 Closing Costs upon resale- Title insurance, Escrow or Closing Fee
-   $5,000 Repairs necessary to bring the property to market condition
-   $2,100 Payments (3) on existing loan while owner moves, repairs are done and property is marketed.
-  $75,000 Existing loan balance
  $10,400 Actual Equity

Knowing the requirements and costs to sell a property in your area is essential for preparing a realistic Net Proceeds sale sheet for an owner.  It allows you to educate the homeowner to the costs of sale, and allows you to focus discussion on the purchase of the actual equity, rather than loan balances and possible home values.  When considering the Net Proceeds, pay close attention to repair costs because underestimated repairs can alter your profit considerably and consider the possibility your carry costs may be higher than the three months used in the example.  It can be done within a three month time-frame although four months is somewhat more realistic for many purchase and resales.  Allowing five months is fairly safe.

So what's a fair offer?  Consider using 50% of net equity as a fair offer to the homeowner.  Although $5,200 might not seem like a whole lot to the homeowner, it's certainly better than not getting anything if the foreclosure proceeds, and it isn't realistic for you to pay more because you'll have to bring the loan current, pay for repairs, and pay for costs until the property re-sells.  If you can't come to an agreement that works for everyone, and is truly "win-win", move on to your next prospect.  You can't help everyone.

Each state in the U.S. handles it's real estate foreclosures differently, it's important to understand those differences and know your specific state's procedures.  The terms used and timeframes vary greatly from state to state, but the following information provides a general overview of the different processes and considerations.  If you haven't done so yet, you can review our guide to each state's procedures at foreclosure procedures.

Judicial Foreclosures

Judicial foreclosures are processed through the courts, beginning with the lender filing a complaint and recording a notice of Lis Pendens.  The complaint will state what the debt is, and why the default should allow the lender to foreclose and take the property given as security.  The homeowner will be served notice of the complaint, either by mailing, direct service, or publication of the notice, and will have the opportunity to be heard before the court.  If the court finds the debt valid, and in default, it will issue  a judgment for the total amount owed, including the costs of the foreclosure process.  After the judgment has been entered, a writ will be issued by the court authorizing a sheriff's sale.  The sheriff's sale is an auction, open to anyone, and is held in a public place, which can range from in front of the courthouse steps, to in front of the property being auctioned.   Sheriff's sales will require either cash to be paid at the time of sale, or a substantial deposit, with the balance paid from later that same day up to 30 days after the sale.  Check your local procedures carefully.  At the end of the auction, the highest bidder will be the owner of the property, subject to the court's confirmation of the sale.  After the court has confirmed the sale, a sheriff's deed will be prepared and delivered to the highest bidder, when that deed is recorded, the highest bidder is the owner of the property.

Non-Judicial Foreclosures