In the old days it was more common to find a foreclosure in process on a property where the owner actually had equity. In today’s climate, it’s more likely that the owner is underwater on the loan, or loans. Consequently, some investors avoid preforeclosure investing because they don’t want to navigate the bureaucracy of the lender’s loss mitigation department, or deal with all the paperwork that goes along with a short sale. And some would rather not work directly with owners in foreclosure.
In addition, it’s possible that after you spend the time and money to vet the property and the owner, the homeowner could avoid a sale completely by working out a deal with the lender to avoid foreclosure, such as a loan modification or a deed-in-lieu arrangement.
On the other hand, the preforeclosure investor has some advantages over the auction investor. Homeowners who are not in denial but instead are open to finding an alternative to foreclosure will allow access to the property for inspections. This reduces risk and allows for more accurate valuation and pricing, both for the purchase and the subsequent sale in a flipping strategy.
Creative financing is sometimes an option, such as subject-to financing, in which the investor assumes the existing loan, or a lease-back deal, where the investor buys the house and leases it back to the current owner. See Negotiate the Deal later in this guide for more information on financing options.
Also, you can do title research and buy title insurance to reduce the risk of unpleasant surprises after the sale. Because you’re buying directly from the owner, redemption rights are not an issue. And then there are those better discounts.
It’s especially important to research liens and title for preforeclosure investing. At an auction, all subordinate liens are wiped out, but before the auction, all liens are in force. You have to satisfy all the lien holders while negotiating a deal that is also profitable for you.
To invest in preforeclosure properties, you have to know about them. The starting point is the courthouse, or rather, with the documents that get filed at the courthouse.
New Notices of Default
Basic foreclosure information is free. There are a number of ways to get this information, but some more efficient than others.
Foreclosure information services. The most efficient way to track public notices on foreclosures is through an online information service. The best services, like PropertyRadar, provide deep search capabilities to let you focus on specific lenders, number of loans, large lots and the potential for lot splits, making your job easier than researching it one property at a time at the county recorders office.
It’s a Feature: Deep Search
PropertyRadar tracks not only all the information available at the courthouse, but synchronizes that information with county recorder records, tax assessor records, geo codes, automated valuation model data and HUD fair market rent data, giving you over 60 criteria to base your searches on. ForelosureRadar does extensive cleanup and tracks each property, from Notice of Default (NOD) to Notice of Trustee Sale (NTS) to Trustee Sale (Auction) and after, to provide the freshest and most usable data available.
County recorder’s office. Foreclosure notices, both NOD and NTS, are publicly recorded documents available at the county courthouse. Access to the to the index, which records the document number, recording date and names of the parties, is free. The actual documents which contain more information are available for a small fee.
You can see an example of an online document index and sample documents in the Title Research webinar.
Newspaper legal notices. By law foreclosure notices are published in the newspaper. You can get the basic information in the newspaper the day after the notice is filed prior to the sale date. Timelines vary by state.
Title companies. In some states, lists of properties in foreclosure are available from a title company. In 2008, SB 133 took effect in California. It prevents title companies from offering certain services, including providing lists of foreclosures, to real estate agents.
Foreclosure Following Bankruptcy
Many, if not most, preforeclosure investors focus on the beginning of the foreclosure process, the Notice of Default. It’s where the volume is in terms of properties becoming available. Other investors follow bankruptcies and watch for a motion for release from stay.
Some homeowners resort to bankruptcy in an attempt to stop a foreclosure, not realizing that it is nothing more than a delay tactic, not a solution. Creditors are issued a restraining order to prevent them from contacting the owner about payment, or in the case of a foreclosure, to postpone the foreclosure process while the bankruptcy works through the process.
When the bankruptcy has run its course, the creditors file a motion for release from stay, which allows them to resume collection (and foreclosure) efforts. The motion signals to the owner, and the savvy investor, that the lender is coming after a payment or the property. These opportunities are off the radar of most investors because the NOD happened a long time ago and the trustee doesn’t have to file a new NOD, so investors that track NODs won’t see it.
When you see a trustee sale that is postponed due to bankruptcy, make a note of it and use the pay-per-search feature at websites such as Pacer.gov, which provides access to all bankruptcy documents, to check the status of the case. When you see a motion for release from stay, it’s time to contact the owner.
Dealing with a homeowner coming out the other side of bankruptcy can be easier because they have exhausted all their options and are no longer in denial. In addition, other investors moved on to fresh properties months ago and you may be the last man standing, the only option the homeowner has to avoid foreclosure.
It is important to develop the skill of separating the sheep from the goats quickly. Given the volume of foreclosures in the market at present, there is no time to look at them all. The key is to develop a screening process to efficiently eliminate deals that are a waste of time and quickly end up with a manageable set of qualified, quality prospects.
There are essential steps in a screening process that are covered in the chapter on Analyzing Opportunities, but you will develop your own process as you learn by trial and error what works for you.
Where’s the equity?
In the current market cycle, most homeowners are under water and there is no equity in the property. But in any market cycle there will always be properties that go into foreclosure due to one of the Five D’s of Foreclosure. And there’s always the option of buying short.
Tales from the Trenches: How old is that loan?
A $200,000 house went to auction in Kern County and nobody bid on it. The amount due was only $15,000 and everybody assumed it was a second. In fact, a subscriber contacted PropertyRadar and complained that it was showing the loan as a first when it had to be a second due to the amount.
We checked the Transaction History and saw that the loan was originated 25 years earlier. It really was a first and it was almost paid off. It was the deal of the century, but it went back to the bank because nobody checked to see if it really had that much equity.
In a deal where the owner has no equity in the property, one option is to negotiate with the lenders to do a short sale, which means the lenders agree to accept less than is owed and retire the loans without recourse. The first mortgage holder is the primary negotiating partner, but you must also get buy-in from all other lien holders. Often the first is willing to cede a small portion of the proceeds, such as $3K to $5K, to the second to get the deal through.
Things can get more complicated when private mortgage insurance is involved. The insurer may be unwilling to cover the loss and challenge the price as being below market value. Or it may be near insolvent itself and are denying everything in an effort to stay afloat. If the loan has been charged off and sent to a collection agency, they may be less willing to deal.
Short sales work best when subprime loans are involved. If the owner got an option ARM loan from Lehman Brothers for $300K that was sold off during the collapse for 15 cents on the dollar, the new holder of the note only has $45K in the deal. A preforeclosure investor looks at the property and the liens and decides that she can make a profit if she can get the price down to $225. The new note holder, who hasn’t been getting payments for months or years, will likely take that deal.
Tales from the Trenches: Double escrow
Many of the no-money-down real estate investing gurus advocate a wholesale quick flip with a double escrow. In a double escrow, the property is sold and closes escrow twice on the same day at two different prices and with two different buyers, the first buyer being the investor, the second being the investor’s buyer.
You should be aware that even if you can find a title company willing to do a double escrow, which is difficult, such a transaction will likely draw the attention of the FBI, who sees such transactions as potentially fraudulent, ones they like to investigate. When they talk about double escrow sales, they use the word perpetrator instead of investor.
The fraud in question here is misrepresenting the value of the property to the bank, taking a profit by causing the lender to take a bigger loss on the loan than they would have in a “legitimate” transaction.
See Listing Short Sales in the Listing and Selling Foreclosures Guide for more information on short sales.
Dealing with the Owner
Once you have the golden list of good prospects, it’s time to engage your personal communication skills.
One challenge unique to the preforeclosure investor is dealing with the owner of the distressed property, and the first step is to contact the owner. This may be as simple as knocking on the door, or as complicated as tracking down an absent owner who has no desire to be found. This is a critical stage of the process and involves direct personal contact with someone who may be emotional or in denial. To be successful, you must have good interpersonal communication skills, or a person on your team who does.
Contacting the owner
Phone. The phone is not the best way to contact the owner of a distressed property. People in debt typically develop the habit screening their calls through voice mail or the answering machine. If they do answer or return your call, you’re not going to be at your most persuasive over the phone. A face-to-face discussion is preferred.
Knock on the door. The simplest and most direct way to contact the owners is to knock on their door. If they actually answer, you’ll need to use the techniques from the Building Trust section below.
Meet the neighbors. If the owners are not in, or are not responsive, the neighbors can be a good source of information on how to find the owners. See the Building Trust section below.
Direct mail. There are two approaches with direct mail: personal versus volume.
Personal. In the personal approach, you don’t blanket the market with junk mail. You send out hand-written, hand-stamped, highly personal letters that establish an emotional bond with the owner and motivate them to sell to you as opposed to another investor who is courting them.
Volume.Like cold calling, it’s a number’s game. You have to generate the volume to get the return. Return rates on direct mail in the prefoclosure market are very low, maybe 1 response per 1,000 pieces sent. Somewhere around 1 out of 10 responses will result in a closed deal. Why do it? At 50 cents per piece for 10,000 pieces, that’s an investment of $5K, but you could uncover a deal that generates $100K in profit.
Tales from the Trenches: Returned Mail
Some of the most successful tactics for finding owners may be counterintuitive. Some investors don’t put “Or Current Resident” on their mailings because they are looking specifically for the returned mail. They then use various methods to locate and contact the owner. Absent owners have emotionally divorced themselves from the house and are more likely to be motivated sellers.
For example, it could be a case of job relocation where the old house never sold and they’ve been carrying two mortgages for months and can’t keep up. In addition, there is little competition for the business of the absent owner. Most investors are knocking on the doors of the people who are still in the house.
Skip tracing. It may be necessary to track down an absent owner. That involves skip tracing, which is the practice of using public and private records to locate an individual. You can do this own your on via commercially available services or websites, or contract someone to locate absent owners.
Building trust. Not surprisingly, few people are interested in talking to a complete stranger about their financial problems. You have to approach the owners carefully.
Find common ground. Use clues you have gathered beforehand or that you observe at the property to establish a mutual interest. If you see a dirt bike in the driveway and know about dirt bikes, mention it after the introductions and chat a little before cutting to the chase.
Educate. The owners may be hiding from the problem and not even know the current status of the foreclosure or what that means. You can provide a service by educating them, but be careful to avoid sounding condescending, which is a deal killer.
Show empathy. Starting off with “I understand you can’t make your payments and are about to lose your house if you don’t do something about it” is unlikely to result in closing a deal. Show them that you know what they’re dealing with and sympathize with how things got to this point.
Listen more than talk. Once you’ve established rapport, ask questions and listen. The owner won’t be interested in hearing what you want until he’s comfortable with you as a person and your understanding the situation.
Use testimonials. Tell a story about someone else you helped and provide contact information. It shows that this isn’t your first rodeo and that you’re willing to let them check references.
Be honest. Give them the full picture, both the good and bad, without glossing over potential obstacles. If they’re going to feel deceived by someone in the process, don’t let it be you.
Be fair. Be legal. Not only do you want to be fair, you want to stay out of jail. You’re in this for the long haul as a wealth-building strategy, not as a get-rich-quick scheme. Make your standard higher than the letter of the law. By acting in not only a legal manner, but also an ethical and compassionate manner, you’ll build trust and create a positive reference for future deals. See Foreclosure Laws in Foreclosure 101 for more information on the civil codes.