Opportunities in Foreclosure Properties

The following charts show the trend in Notices of Default and Notices of Trustee's Sales published in the Daily Commerce newspaper. Founded in 1917, the Daily Commerce is a very informative business journal with articles relevant to both local and regional business as well as a complete section of foreclosure listings, REO listings and bulk sales postings. Listings and postings are specific to Los Angeles County, Orange County, San Bernardino County and Ventura County. Weekly editorials by Warren Racine and Cleo Katz on the subject of foreclosures are a "must read" for anyone wanting to stay current on this specialized area of real estate. (For subscription info, call 213.229.6300.)

The following charts are compiled by summing the total number of Notices of Default and Notices of Trustee's Sales in each of the two halves of the month. Each month has two data points - one for the first half of the month, the other for the second half. The data and charts are compiled by our staff and, to our knowledge, are unavailable through any other web site on the internet.

General Notes:

Many people have the idea that foreclosure properties are typically purchased at auctions for pennies on the dollar. Spending as little as a few thousand dollars on cosmetic repairs, properties can be turned around and resold for hundreds of thousands of dollars in profit. Is this true?

Our research shows this rarely happens. More typically, foreclosure properties are sold at prices of a 5% - 10% discount to market value after accounting for repairs, acquisition expenses, interest costs and miscellaneous issues such as outstanding IRS tax liens. Interest costs are a key expense because foreclosure properties purchased at Trustee's Sales are all cash or Cashier's Checks transactions.

The typical net profit margin is influenced greatly by the prevailing rate of price appreciation in the resale market. When the residential market was "hot" between 2002 and 2006, auction bidders would pay near-market prices for properties. With prices rising 2% to 3% a month, it didn't matter if they needed to wait six or months before they would be able to resell the property. In quieter markets, as is the case these days, auction bidders are not willing to pay nearly as high a premium.

Still, a 10% profit on a $500,000 condominium or $700,000 home translates into a profit of $50,000 to $70,000 - a healthy return if you buy and sell one or two properties a year. Are most properties purchased quickly "turned"? Our research finds only one in 20 properties sold at a Trustee's Sales having been resold within six months of the auction. Apparently, most Trustee's Sales property buyers are buying with the intention of buying the home either as a long-term investment or as their personal residence.

Over the past year, an increasing number of properties have sold below 75% of market value. We estimate the ratio to be approximately one property out of 30 - 50 Notices of Trustee's Sales that will sell at auction at a discount of 25% or more below market. Why don't more properties sell for greater discounts to market value? In our opinion, the main reason is the small group of people known as "the regulars". You can spot them fairly easily at Trustee's Sales auctions. They're the folks constantly talking on one or more cell phones - before, during and after each property auction. Most work in partnership groups. Some are front men or front women for investors funded in the tens, if not hundreds, of millions of dollars. Collectively, these people are like the market makers on the floors of the major stock exchanges. They effectively set the level on the percentage discount to market for properties selling at auctions.

Most properties scheduled for auction on any given day don't sell at all. Either the auction date is postponed to a future date or there are simply no bidders. Unsold properties are sent, as the Trustee auctioneers say, "back to the beny" - the beneficiary (i.e. the lender). The percentage of unsold properties returning to the lenders is rising due to the fact that an increasing percentage of foreclosed properties have insufficient residual equity for a buyer to make a profit in the course of buying and reselling the property.

Do people buying deeply discounted properties merit the returns? We would say "yes". The risks involved are enormous, especially when you consider the risks of buying auctioned properties "as is" with absolutely no recourse for material flaws, the risk of the "position" of the foreclosing lender being junior to another note and the possibility of many months of possession delays due to uncooperative tenants occupying auctioned properties.

Here's an example of what can happen when you mistakenly buy a junior note. An auctioneer told me of a man who successfully bid $75,000 on a property at a Los Angeles County auction. After the gentleman gave the auctioneer his Cashier's check, the auctioneer proceeded to call out for the next Trustee's Sale - which was for the same property on behalf of the lender in the next highest (first) position. The man who paid the $75,000 didn't realize he had bought a second position trust deed, not the first position trust deed. The second auction ended in a matter of several minutes with the first trust deed being auctioned off to another individual. At that moment, the gentleman's $75,000 investment was instantly wiped out! He went from being jubilant (thinking he had bought a half million dollar home for only $75,000) to being one very unhappy person. Certainly, there are procedures that one takes to verify the position of the trust deed as well as the condition of the property of interest. It's critical that no step is over-looked.

As a general caveat, you will likely lose money buying foreclosure properties if you don't follow a number of important steps in verifying the legal status and physical condition of all candidate properties. Some of the more important steps include:

• Verification Requirements

Contacting the County Recorders Office, your local Title company, third party data vendors and local REALTOR, you will need to verify:

• The identity of the current property owner for which there is a pending Trustee's Sale.
• The position of the foreclosing lender and the dollar value of any and all senior liens/loans.
• All recordings at the County Recorders Office that could affect the value of the property or result in financial liabilities the new property owner will be assuming. Examples include pending law suits, family support judgments, bail bonds, etc.
• The existence of any outstanding IRS tax liens. The past ten years of recording data must be researched in order to make sure you are aware of all possible outstanding IRS liens. Due to the impact of daily compounding interest on the penalties, IRS liens typically have a total cumulative value of approximately twice the amount of the taxes owed. If the taxes owed are large enough, the daily compounding interest can be in the hundreds of dollars.
• The approximate value of the property, based on recent comparable sales.
• The physical condition of the property and estimating the expense of needed repairs.



• Financial Calculations

Based on the above research, you will need to run a number of calculations to verify that the subject property fits the parameters of both your financial resources and personal needs. The more important issues include:

• The maximum price you are willing to pay for the property after adjusting for the net value (deducting the value of senior liens, property repairs, IRS tax liens, real estate agents commissions, escrow fees, interest or mortgage costs incurred during the time you plan to own the property, possible loss of property value due to changes in market conditions, etc.).
• The maximum price you are willing to pay for any property as a percentage of the estimated net value. Only under special circumstances should you pay more than 80% of the estimated net value.
• The amount of money available to invest compared to the required minimum bid and the calculated maximum amount of money you would pay. Often, the minimum bid exceeds either the available funds or the amount of money you would pay for the subject property. In this case, the property must be eliminated from your "candidate properties" list.

• Additional Issues

There are a number of additional issues that need to be checked such as:

• Checking for subordinated agreements between lenders that could possibly reverse the lenders' positions.
• Finding out if people are residing at any subject properties and, if so, whether they are owners or tenants.
• Keeping track of auction dates and postponements. Auctions that are rescheduled do not need to be re-advertised in the newspapers and therefore are sometimes overlooked by prospective buyers.

The above summary is by no means complete. It is intended to give you an overview of the research you will need to do (and we do) if you want to find financial opportunities in foreclosure properties. There is a tremendous amount of field research required. It can pay off if you have enough time and resources.

If you have any specific questions regarding buying foreclosure properties, simply call us at (888) 868-REALTY (7325) or send us your request for more information.