Panning for Gold

The huge glut of fraud derived foreclosures coupled with the lack of mortgage finance has created huge opportunity. But what may be huge may not be obvious! There are fantastic deals out there...  but they are not as easy to grab as you may assume.

How good are the deals? I recently sold a home to an investor for $65,000. This 3 bedroom, 1 bath home is on a large lot and came with a 2 car detached garage. We fully renovated the home before renting it and it is in fantastic condition. The home is located on a street that looks great and in a neighborhood less than 5 minutes from downtown Atlanta. The tenant is paying $800 per month in rent. This home sold in December of 2006 for $152,000. Zillow.com current places the estimated value at $149,500. The buyer’s return on capital invested is over 12%. I believe that when the economy begins to recover (or when the stimulus packages get around to bailing out the housing market) this home will go up in value until it is once again valued in line with incomes for the area. This should mean the home is worth a conservative $90K - $100K. This was an excellent investment.

 These opportunities are not difficult to identify and there is no shortage of investors chasing after these cheap houses. When I began buying these homes and putting together a business plan I feared that the most difficult aspect would be having quality renovations done while keeping the expenses under control. It appeared that with such a massive glut of foreclosed homes on the market, purchasing these homes from the banks would be a snap. The reality has proven to be the exact opposite.

 I have an excellent renovation crew foreman and workers who are skilled and reliable. They are able to quickly jump into a project, work through demolition and reconstruction rapidly and deliver a high quality end product without breaking the bank. While staying on top of this process does take up a good bit of time and keeping costs under control can be a struggle, overall the renovation aspect of this business has proven to be rewarding and relatively easy to manage.

 Buying quality homes at prices that make my business model work has proven to be very difficult. My business is fundamentally very simple. I buy a house, we renovate that house, we rent the house out and then we sell the house at a profit to an investor. The key to such a strategy is buying the right home at the right price. If I pay too much for the home up front then even if the renovation comes in on budget and we place a good tenant at the projected rental price I may have too much invested into the home to make selling it at an attractive price viable. If my initial evaluation of the home relative to estimating renovation costs is flawed, then the renovation may run over on costs and I again have too much invested into the home to sell it at an excellent price.

The sheer number of homes on the market, the wild variances in asking prices and the incredible variety of home conditions make finding the “good” houses something of a crap game. So far, for each home I have purchased, I have viewed or researched at least 50 houses and made offers on at least 5. Many of the homes are simply teardowns. I have watched homes sell at auction for less than $10,000. That may sound like a fantastic deal, but in reality the buyer is purchasing a lot with a $5,000 garbage removal expense associated.

 One would think that the banks owning these homes would be falling all over themselves to sell the homes when a qualified cash buyer steps up. Nothing could be further from the truth. The employees at the banks tasked with liquidating these home assets are often incompetent, apathetic or sometimes both. Throw in that they are also extremely overworked and the situation becomes a fiasco.

 I have made offers on homes and had to repeatedly resubmit the offer over the period of a week before getting any response back at all. I have repeatedly submitted full price offers only to learn days later that the home had gone under contract to another buyer AFTER my offer had been submitted. Selling agents often do not return phone calls at all. Many properties lack a lock box or have no provision for gaining entrance to the home at all. Properties that have long since been sold are often left active in the MLS system and on real estate foreclosure sites for months. Properties are listed as short sales despite the lender holding the lien having never authorized a short sale. I have repeatedly had homes under contract delayed being able to close because the lender and their attorney cannot provide a clear title report despite the fact that the lender has owned the home post foreclosure for over a year. The banks do little to nothing to maintain the properties and I have had homes that were under contract and pending closing further vandalized before we could get closed despite my repeated requests that the seller ensure the property is secured. It truly is amazing how utterly incompetent many of the banks real estate liquidation departments have become.

It is not only the banks in this crazy market that are tripping all over themselves. Many buyers jumping into the market have no clue what they are doing and in consequence they make ridiculous mistakes. I have inspected many homes where it was clear the asking price was absurd given the amount of renovation work the home was going to require yet the homes soon show as under contract. Perhaps the seller accepted a dramatically lower offer, but too often I fear the buyer is paying far too much.

I have seen this play out at many real estate auctions. I attended one auction on a home located near Grant Park. This was a very nice home built in 2004, over 2800 square feet and finished with all the goodies including granite counter-tops, stainless steel appliances and mahogany floors. The home had been listed with a real estate agent with a listing price of $145,000 for many months and it had failed to sell. The bank that owned the home then listed it with a foreclosed property auction company that charged the buyer a flat auction fee of $5,000. At the auction, there were two couples each bidding aggressively on the home and the final sales price was $158,000! With the auction fees, the buyer was required to pay $163,000 for the home and they could have purchased it from the realtor only 3 weeks before with a full price offer of $145,000! This kind of stupidity is typical of buyers who simply have not done their research.

Of course the scenario for many buyers is very different than what I am trying to accomplish. Many buyers are looking for homes they will live in as a primary residence. They can clearly afford to pay more for the home because they are not looking to resell the home at a fair market price and turn a good profit. Other buyers are working under assumptions for a short term housing recovery that I view as unrealistic but which justifies in their minds a higher price to be paid today. In either case, I end up losing on a home I would love to own because someone else is simply willing to pay far more.

The number of investors seeking homes today has been surprising to me. Clearly, the fact that home values on these small houses inside Atlanta have overshot to the downside has brought out lots of investors seeking bargains. This is evident at the auctions where time after time I watch homes bid to sale prices far over what I view as acceptable. It is also apparent when I contact a selling agent on a home I want to purchase and learn that there are already multiple offers in hand. There is no shortage of buyers for these homes. The key is all about price. When the homes are overvalued for their condition and location, they sit. But when the bank finally gets to the point of pricing the home properly, then there is a rush of buyers and only the fast come out with a contract. I have both won and lost contracts on homes I really wanted by a matter of hours.

The best analogy I have come up with relative to the current market for buying these homes from the banks is that it is just like panning for gold. Except the pan you are using is 3 feet across and there are 5 other guys holding and sloshing it with you. As the dirt and water are cast aside and a small flake of gold becomes visible, everyone grabs for it at the same time and its winner take all.

There are many buyers trying to purchase these homes who end up doing nothing more than wasting everyone’s time. Home shoppers will often get pre-qualified by a desperate mortgage broker looking for any business he can dredge up. Then these shoppers make offers and put a contract on a home only to discover after a couple of months of attempts that either they cannot obtain financing or the home cannot be financed due to condition. The banks will not lend on a home that needs substantial renovations.

The bottom line in buying these foreclosed homes from the banks is that you have to be prepared to move very quickly and pay in cash.

No Cash = No Play. If the banks were smart they would offer special renovation financing to buyers with a 20% or more down payment so they can move the homes quickly to a larger pool of potential buyers but as we have seen the banks are anything but smart!

Allow me to clarify briefly one point:  These homes cannot be financed when they are purchased as foreclosures from the bank because they have too much deferred maintenance and renovation work required. Banks and Mortgage companies will not lend on a home that requires anything more than very basic maintenance as this violates their lending guidelines and the guidelines of Fannie Mae, Freddie Mac and FHA. This does not mean that there is no financing available at all! Once the homes have been fully renovated and are ready to go there are all of the normal financing programs available. If the banks were smart….  They would renovate the homes themselves, secure them properly against future vandalism or theft and then sell them, but as has been consistent throughout this housing market crisis, the banks are not that smart.