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Offset Your Investment Portfolio with Foreclosures

June 6, 2008
URL: http://www.entrepreneur.com/article/194548

In the second of my three-part series on alternatives to house-flipping, I'm focusing on how to balance your potentially upside-down portfolio with foreclosure properties--or any property you can get for far less than its market value.

There are many ways to buy houses on the cheap. What's cheap? Thirty to 50 percent below market value, in my view.

Why will banks give up properties for little? First, they don't want them on their balance sheets. Also, what many don't realize is that a foreclosure, even on a house worth less than $100,000, costs the bank about $50,000 in legal and agent fees, fixing up the home and so forth.

What's the ultimate goal? To balance your portfolio with properties that are worth more than you owe and to hold onto them until the value returns, at which point you can either leverage the equity or sell the home. That's why you want to buy properties in the best condition with the least hassle.

Getting Started
There are three primary ways to buy foreclosures. The first is to buy the home in the pre-foreclosure stage. This is the ideal position because you can help save a homeowner from foreclosure, and the bank, homeowner and you--the buyer--work together to decide on a price. Of course you'll offer far lower than the home is worth. But banks frequently accept low offers because they don't want the asset on their books or the $50,000 in costs to foreclose on a home.

Another option is to buy at the REO (real estate-owned) stage, which essentially means a bank-owned property or a home that was taken from the owner and the bank now owns. You can get some deals, but remember the bank will want to get some of its $50,000 back. This isn't where the best deals are found; however, if you're looking into buying a residence to live in rather than invest in, it can be beneficial to buy at this stage because the bank often puts decent money into the home to fix it up. A home I recently visited, still selling for $200,000 under market value, had new carpet, new granite and hard-wood floors just installed by the bank.

The third option, of course, is to buy at auction, but you won't get the best deal here, either. Auction houses take a percentage; many companies aren't reputable, and you may not have a chance to inspect the house before you buy. Add to that the need for at least the down payment in cash and quick financing, and you may find yourself regretting your auction decision. If you do go this route, don't get into the "auction mentality" of getting excited and bidding for the "fun of it." It sounds incredible that people will do that, but it happens.

The bottom line is that if you're upside down, one way to balance your portfolio, just as you'd do with stocks, is to buy cheap and create equity. This balances your overall portfolio a bit better. Foreclosures are a great way to do that.

Tips And Tactics
As with any investment, there are gotchas to avoid and processes to go through. Here are some tips on how to buy foreclosures:

  1. Inspect the property! Demand an inspection no matter how you buy it.
  2. Be prepared for the bank to request an as-is buy. If that's the case, do a second inspection so you know what you're getting into.
  3. Try pre-foreclosures as an alternative to REO and auction sales.
  4. Use tools that will help you determine the value of the home, such as domania.com and housevalues.com. HomeGain.com also has some good valuation tools. Also, look for things like the crime rate in the area, how good the schools are, the cost of living, median income compared to national average, and the job growth rate in the area before buying. All these may impact your ability to sell later, as well as how fast your home appreciates.

Danielle Babb is an experienced real estate investor and specialist on the use of technology and real estate. She is also the co-author, with mortgage broker and realtor Bill Nazur, of Finding Foreclosures: An Insider's Guide to Cashing In on This Hidden Market, available at Entrepreneur Press. For more information on Danielle Babb visit, www.drdaniellebabb.com.

Next month, Danielle Babb discusses buying or investing in commercial real estate.