Sunday, February 4, 2007

Flipping a Foreclosure

Buying low and selling high is the key phrase with real estate purchased for the purpose of flipping. The most important part of that phrase is "buying low". With a foreclosure there are three times a purchase can be made.
(1) Pre - foreclosure, when, or before the homeowner has been notified by the bank that because they are behind with payments the mortgage company is requiring a financial solution to be worked out that is acceptable to them, or to pay the loan off.
(2) At the auction, or commonly called "at the courthouse steps".
(3) Or an REO property which means real estate owned. REO is what the bank calls the property, when they have gotten the property back, because it was not purchased at the auction.
The common problem with a foreclosure is that because lenders have had available 100% financing, or ARM’s which is short for adjustable rate mortgage, or allowed lower income qualification, and higher debt allowances, there is very little equity in 95% of the foreclosures. With a tight budget a for a homeowner, any little, or big change in their family budget can spell disaster for their mortgage payments. Therefore if foreclosure comes, there is very little equity in the property. Sometimes there is so little, that if the owner wants to hire a real estate agent to sell their property, they would have to pay the agent "out of pocket". This is further complicated by the fact that the owner probably does not have the cash, because they are in foreclosure.
During the pre foreclosure stage, sometimes a homeowner is in denial, or thinks they will be able to sell for a big profit, or thinks they will win the lottery. When this is the case they often will not allow an investor to purchase the home. At the auction the opening bid is usually what the bank is owed, plus late payments, and late fees, plus attorney fees. A home with very little equity, could well be over the market price when all that is added, even though repairs are needed. The last stage is the bank listing the home through a real estate agent, and trying to sell it in the competitive market. Many times it will be listed at full retail price of other homes in the neighborhood that may be in tip top shape. Just because a home is a foreclosure home, or bank owned home does not mean it is a bargain. There are other things to be beware of, such as liens, and 2nd mortgages. At the auction most liens are wiped out, but not Federal tax, or if it was the second mortgage that went into foreclosure, the 1st position mortgage is still due. There are other strategies of working with the homeowner in distress, and with the bank that an experienced real estate investor can use. These are too lengthy to explain under this title.
To flip a house and make a profit you need the price you buy the property for to be 65 to 70% of ARV (after repaired value). In that percentage you need to include the cost of closing fees on financing, and the cost of repairs, not just the cost of the property. Most often things that will be estimated in error are the repairs. The estimation is often too low, either by the repair labor or material costing more than expected, or by missing some important repairs or replacements like needing a new roof, or a termite infestation. A temptation I often face is to upgrade, or add some things to the rehab that I think will really sell the property, but I failed to include in the original estimation. Most of the time, a regular lender will not lend the sale price plus the repair money to a real estate investor. There are lenders called "hard money" lenders. These lenders are where most investors go to get short term money including repair money at a rate of 13-18%. But the loan is for the 65 to 70% of ARV that I mentioned above.
Now you have purchased the property. You already have your list of repairs, and costs. Are you going to do the work yourself, or hire it done? I like to do the work myself, and sometimes do, if the list is not too extensive. However, time is money. Can you really save money by doing it yourself, when it may take you three times longer than hiring it done? Sometimes I hire most of it done, but reserve a few projects that I like to do, and are really expensive to have done. One example is ceramic or stone tile. I like doing it, and can save at the minimum $5.00 a square foot. If you hire contractors, handymen, etc., be sure you have several estimates to choose from, and make sure they can show up for the time you have allotted to start and finish the job. Again time is money. If you have to wait two weeks for them to come, it is costing you money. While working on the house you still have to pay mortgage payments, and builder’s hazard insurance.
What should you do to the house? First of all, plan on the necessary repairs needed to make the house sound, and livable. Things such as roof, and plumbing, electric, HVAC are first on the list. Fresh paint is a must. Choose a neutral color. All the rooms painted the same color make the house appear larger. For cosmetic upgrades, concentrate on the kitchen, and baths. Use hardwood, or ceramic tile, and new carpeting to give a solid, and plush look. Especially hardwood, and ceramic tile will add value to the home for the appraisal. New appliances in the kitchen give a polished look. New faucets throughout, and new switch, and outlet plates are two fairly low cost items that help give the new look.
You are now almost done with the rehab. Start your marketing now. In doing the rehab, take care of any exterior fixes, and upgrades, including landscaping first. This is so you can take a nice picture of the outside for advertising purposes. You can add other pictures of the inside as the rooms are completed. Assuming you have chosen a neighborhood that most of the houses are appealing, and well kept, this first impression will go far. When prospective purchasers call, have them drive by the home and see the outside and the neighborhood first. Also tell them the date of your first open house, or make an appointment with them to see the home at your finish date. It is a good strategy to schedule more than one appointment at about 15 to 30 minutes apart.. This creates an urgency to decide.
If you sell the house before 90 days FHA loans are hard to get because of the ruling in mid 2003. It was called anti flipping law. The prospective purchaser can go to a non-conforming loan. A list of repairs, and copy of receipts to give to the prospective lender is an important document to use. Mortgage lenders that specialize in investor loans, often can help the end purchaser in getting a loan. Also, a short term lease option with a prospective owner that qualifies for financing is an option. It could be for three to six months, and take it past the time required by some lenders.
The house is sold. Have you made $50,000, $30,000, or just a couple thousand, because of misjudgments. It is commonly said with real estate investing , "Do not quit your day job." Although it can become your full time job, you will have to go through a learning curve when actually doing projects. You will learn through mistakes. Beginners, and seasoned investors can make mistakes, and in the real estate investing business they can be costly.
Kathleen Couch who also goes by the pen name of Purple Leaf has written a variety of articles. She has gained expertise in many areas by having rich and fulfilling life experiences. You may read more of her articles at this site:
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