Foreclosures and Short-Sales: Don’t Believe the Hype!

Every now and then a prospective client approaches me and tells me they want to buy a short-sale or foreclosure.  This has happened enough times that I am dedicating an entire blog post to it.  I understand why these clients think they want to buy a short-sale or foreclosure – buy a property under market value and score a deal! Sounds great, right?  Well, I have news for you.  That isn’t necessarily the case.  Purchasing a foreclosure or short-sale is not some flawless, guaranteed scheme for making money or capturing value.  I think there are two culprits creating this common misperception: misleading marketing and unexpected costs.  I am not saying that you should not buy a short-sale or foreclosure.  I have written hundreds of offers on foreclosures for prospective buyers, and I even bought one myself; however, a prospective buyer should be armed with the right information before attempting to buy one.  Instead of setting a goal to buy a foreclosure or short-sale, I think consumers should aim instead to buy a great house.  If it happens to be a foreclosure or short-sale, so be it.  If focused only on the foreclosure and short-sale markets, you might just be missing out on a great deal.  Why limit yourself to just these markets when there are plenty of deals to be had in all markets!

I. Misleading Marketing

In a previous blog post, I talked about how real estate search engines work and how agents use them to convert browsing consumers into real estate leads and potential clients.  With foreclosure and short-sale marketing, something similar is occurring.  We have all seen the ads where a brokerage or company wants you to sign up to gain access to their special list of foreclosure or short-sale listings.  They are perpetuating the public perception that foreclosures and short-sales are automatically great deals.  The misleading part is that their “special” list isn’t so special at all.

First of all, the overwhelming majority of foreclosures and short-sales are sold the same way as regular sales – on the MLS.  A bank forecloses on a property then assigns it to a listing agent who will put the property on the MLS for everyone to see.  These “specialized” foreclosure b are simply creating a list of information that was already available to you.  So really, they just want prospective buyers to think they have inside informationin hopes of landing them as a client.  That is misleading marketing.

Secondly, if someone wants to know what properties might be going to foreclosure ahead of time, this is public information as well.  Check the Washington Post!  Banks are required by law to display public notice of a pending foreclosure.   These public notices are placed in newspapers, thereby enabling consumers to become every bit the expert that these “specialized” foreclosure companies are. That special list of pre-foreclosure properties they are baiting you withis not inside info.  It is misleading marketing.  No matter what they try and tell you, they don’t have a special list to get you a special deal.

II. Unexpected Costs

When buying a foreclosure or short-sale, there can be hidden costs in the way of property condition and real estate financing.  Foreclosures and short-sales are frequently referred to as distressed properties.  This term applies to the nature of the sale, but should also apply to the physical condition of the property.  When buying a distressed property, a buyer doesn’t always know what they are purchasing.  When a property becomes distressed, people stop paying attention to it and bad things can and usually do happen.  An owner going through a distressed sale isn’t likely to keep up with maintenance on a house they will not own in the future.  A disgruntled owner might even take out their frustration on the property, and sometimes in ways that may not be apparent.  If a previous owner took the fridge with them, you can see that.  But what if they ran toxic chemicals through the water lines?  Yes, you can always get a home inspection, but inspectors cannot and oftentimes will not find everything.  Frequently, utilities are turned off making it impossible to know if there are cracks in pipes, faulty electrical wires, etc.  Furthermore, if the property was not occupied, the seller cannot possibly disclose any known defects.  Buyers of distressed properties too often underestimate the cost of the unknown.  Again, I am not saying don’t buy a distressed property.  Just make sure you do your homework, account for the unknown, and enter into the transaction with reasonable expectations.  Distressed sale prices tend to be lower for a reason, so budget accordingly.

Secondly, many consumers don’t think about real estate financing when they buy foreclosures or short-sales.  There is cash and then there is loaned money, and they are not created equal.  Nine times out of ten I encourage clients to finance the cost and keep their cash in the bank, especially with interest rates being uber-low right now.  Home equity is great, but it isn’t liquid, especially not in the current market.  Sure, a buyer could take out a home equity line of credit, but then it just becomes loaned money.

Distressed properties have a lower price tag, but they often require a buyer to use more cash because repairs cannot typically be financed.  For example, a turn-key $350,000 home with a 20% down payment requires a buyer to use $70,000 in cash.  A distressed property for $300,000 would require $60,000 in cash.  But if repairs and carrying costs total $30,000, the buyer has spent $90,000 in cash.  Yes, the buyer spent $20,000 less on sticker price, but they also have $20,000 less in their bank account.  With an interest rate of 4%, the buyer’s mortgage payment for an extra $20,000 on a 30-year loan would only rise $80 per month.  Again, each situation is unique, but I’d take the turn-key and keep the cash.  I repeatedly remind my clients that if they have a problem and cash will solve it, then they do not have a problem.  It might be better to keep your cash in the bank.  Once again, I’m not saying you shouldn’t buy a foreclosure or short-sale.  I did!  Just make sure it makes comfortable financial sense to do so.

If you have any questions or comments, please feel free to contact me.  I am busy, but never too busy to learn something new.  Plus, I am always on the lookout for new business.  But be warned, I don’t have a “special” list of distressed properties.  What I do have is good advice about what to consider if you want to buy one…Buy Smart.  Live Well.