How I Did It: Buying a Foreclosure as an Investment Property
Diahann Lassus wasn't interested in becoming a landlord. As a certified financial planner by trade, she has watched the housing market fall and fall and fall some more. She heard stories of short sales and foreclosure deals but never put herself into the mix.
That is until earlier this year, when Lassus spotted a foreclosure sale sign on the lawn of a three-bedroom ranch home in the Bonita Springs, Fla., development where she already owns a house. She saw an opportunity.
Lassus, who also is a certified public accountant, is more financially savvy than the typical home buyer. But before she bid on a distressed property, she knew she needed to learn more about the current market.
"I've really never had the desire to get involved in buying investment properties before," says Lassus, who splits her time between Florida and New Jersey. "I did a very extensive analysis prior to making my first offer."
If you're thinking of buying a home, Lassus' recent experience offers a helpful case study of how to navigate the foreclosure market.
Here's what you need to know.
Investigate Your Own Finances
About 4.5 percent of all homes were in foreclosure nationwide at the end of March, according to the Mortgage Bankers Association. Florida, Nevada and New Jersey topped the list with the highest foreclosure rates. Of course, that news isn't good for the economy, but if you're in a solid financial position, buying a home or a second home as an investment property could be good for your portfolio -- if you buy smart.
Simply put, it's a numbers game. Before you start looking at properties, make sure you can afford a home and contact a lender to get pre-qualified for a mortgage.
"Banks are looking for a fast close in the foreclosure market," Lassus says. "If you are ready to go with a mortgage, you are in a much better position to negotiate."
Be prepared to shop around for a loan. Some lenders are very cautious about financing a home in a foreclosure-laden area, and others won't finance investment properties in certain locales. If you're able to pay cash, you're in a stronger position during negotiations, Lassus says.
Your cash is important for more than the purchase price, especially if you're buying an investment property. You'll need extra money for repairs, maintenance and to cover monthly bills if you're unable to find a renter.
"Anyone buying property today needs to make sure they have the cash reserve to carry the property for a long time," Lassus says.
If you normally maintain three to six months' of living expenses in an emergency fund, you'll need even more available if you're carrying an additional property. (As you build your emergency reserves, consider these smart places to park your cash.)
Know the Market
Driving past a "bank-owned" for-sale sign in an attractive neighborhood isn't enough of a reason to make an offer.
You need to understand what's going on the local housing market. Talk to real estate agents and look at websites such as Zillow.com to get a feel for price trends in the area. Markets such as Southwest Florida, where Lassus bought her second home, and Las Vegas have not necessarily hit bottom in terms of prices, so home values could fall further. If that happens, it might be years before you see a return on your investment.
The home Lassus purchased is in the same complex where she has owned another property for 15 years, so she knew the area well. An avid golfer, Lassus liked the house's proximity to the development's golf course, its spacious enclosed lanai and the fact that the neighborhood association also offers access to a gym, restaurant and tennis courts -- all attributes that might appeal to a tenant.
The foreclosed home sat empty for more than two years, she says, and it was listed for 12 percent less than what it was valued in 1996. That was a good starting point.
She was able to negotiate an even lower price.
When the deal was done, Lassus says she paid 30 percent less than the 1996 market value and 70 percent below the market value in 2006. Comparable homes in the area have recently sold for 40 percent more than her purchase price, she says.
A low purchase price is important, but it's not the only factor. If you plan to rent out the home, you also need to research the current rental market.
"As long as you can rent the property and carry all the costs, you can make money over the longer term," Lassus says. "If you have to carry the cost and are not able to rent it, it could be a really painful process."
If the potential rental income won't cover your costs and give you a solid return on your investment, don't buy it.
Expect the Unexpected Costs
There are potential land mines in buying any property, but foreclosure homes -- especially those that have been vacant for an extended period -- can be ripe with troubles.
When a bank wants to unload a home, it offers the property "as is." Before you make an offer, hire a professional to do a thorough home inspection so you can limit any surprises after the purchase. Try the American Society of Home Inspectors or the National Association of Home Inspectors to find a qualified pro in your area.
Review the inspection report and get estimates for the cost of fixing everything so you can factor that into your costs.
"The hidden problems can be the most expensive, so you have to be prepared," Lassus says. "Recognize that houses that have been sitting for a while will need major updates including air conditioning, plumbing, hot water heaters and many other items that may increase the overall cost."
In her case, Lassus installed new air conditioning, lighting and floors, and also painted her investment property to make it more attractive to prospective renters. All the improvements added up to about $40,000, more than she initially expected.
Another factor to consider: If the property is part of a homeowner's association, make sure the association is in good financial condition. Even if you buy a home at a bargain price, you could end up in a development that can't afford to maintain the golf course or the common pool. This happens more frequently these days, especially in areas where there are a lot of foreclosures and homeowners are not staying current on their association dues.
Also investigate the cost of homeowner's insurance for your new neighborhood. Lassus says policies can be very expensive in areas where some insurance companies have stopped writing new policies. If you plan to rent, make sure that renters are covered as part of your policy and consider purchasing additional liability coverage. She recommends you line up insurance coverage before you close on a new house or condo.
Settle on the Bottom Line
If the house or condo passes all your tests, decide what you are willing to pay before you make the first offer. Then stick to your bottom line.
"Don't get emotionally caught up in the negotiations," Lassus says. "If the seller isn't willing to let the property go for what you are willing to pay, move on to the next property."
Now that the deal is done, she says she's looking forward to reaping the rewards of her research and sweat equity.
Lassus says she's finishing up all the details including a thorough post-construction cleaning this week, and the home will go on the rental market by the end of July.
"I expect it will rent quickly because of the nice space and good demand in the area," she says. "It has been an interesting adventure which I am confident will be profitable over the long-term. However, I am definitely looking forward to seeing that rent check start coming in."