UNDERSTANDING HOW TO NAVIGATE THE FORECLOSURE PROCESS AVOIDS COSTLY MISTAKES

By Rick Schlosser

Foreclosure rates are approaching an all-time high and as a result, the market appears to be dominated by foreclosed or bank-owned property. Conventional wisdom seems to be that buyers can purchase a foreclosed property from a bank for a substantial discount, in some cases as much as 40 percent of the original asking price. Then logically, it seems to follow that the smart buyers who made this great deal with the bank will be the proud owners of a $500,000 house that they purchased for only $300,000. They can live in this house and when it is time to sell, they will make a huge profit or in the case of investors, they can do some modest cosmetic repairs and “flip” the house for $500,000.

Sound too good to be true? Sure does, and by analyzing the conventional wisdom espoused by sellers of foreclosed property, one can easily conclude that buying a foreclosure is not the best path for everyone.

Background
The rise in home prices — both new and resale from 2002 through early 2007 — was unprecedented and largely artificial. Those increases were a direct result of buyers accessing easy and overly-generous credit to purchase homes of a size and price that were two or three steps up from what they should have been buying.

Homebuilders who recognized this phenomenon early in the growth cycle created showy “Dream Houses” or “McMansions” now for a market of buyers who should have waited 10 years to acquire such a house. The homebuilders were creating their current sales by “borrowing” from their future sales. They were actually stealing future sales, since there was to be no paying back. In fact, the depth of that problem has not been fully explored, but the sad fact is that all of the homeowners who lost their houses through foreclosure will not be in the market to buy for between three and seven years, depending upon the individual circumstances.

The five-year growth cycle did run prices of new homes up in most areas and as is usually the case, resales increased in price as well. The easy credit and low interest rates provided homebuilders, buyers, sellers and lenders with a false sense of security and a completely illogical belief that 2002-2007 was a normal market. Naturally when earnings and profits increase every year, complacency sets in. More about that later.

The cycle we are in now is a classic market correction where artificially inflated values decrease back to a level that would have been supported by a normal market increase during the pervious growth cycle. Another way of stating this is that prices rose 12 percent per year for five years and should have only risen by about seven percent. We are paying back that extra five percent per year — 25 percent total, and it is happening all at once instead of being spread over several years.

The discount
Using the example stated above of a $500,000 house being sold for $300,000, it would appear that a 40 percent discount has been given by the seller. Not so. While the subject property may have been priced at $500,000 at one point, that does not tell the whole story. It is always a good idea to note that there is a reason that this property is in foreclosure. Most of the reasons center around the uncomfortable fact that the previous owners were not able to sell it for $500,000 for one reason or another. It is true that there may have been a tragic human-interest story behind the foreclosure — such as the loss of a job or an escalating payment on a sub-prime loan, but that is not the central issue upon which a buyer needs to focus. If the previous owner of the house made any effort to sell at $500,000 and failed, that proves the house was not worth $500,000 at that time and probably not now.

The most important thing is how much is this property worth now? If the market correction figure of 25 percent is used, then that $500,000 house is now worth 25 percent less or $375,000. So, if that house can be purchased from the bank for $300,000, is that a good deal? It depends on many other things.

The process
The bank that owns the foreclosed property is only interested in minimizing its loss and selling the property. As you proceed through the process of buying a foreclosure, you will wonder why banks act the way they do or even if the preceding sentence is true. Local banks who are not part of a huge national or regional organization are by far the most reasonable and motivated sellers of foreclosed properties. A local bank recognizes its place in the community and understands the value of a good positive image. Some local banks will make an effort to make repairs to the house before it is sold and may even offer permanent financing for the buyers. That’s the good news. The bad news is that there are very few local banks left, and the odds are that you will be dealing with a large national lender or their asset managers or loss prevention consultants, usually a third-party who adds one extra step in the buying and communication process.

Buying a foreclosure from a bank is just like buying a vacant house in the same neighborhood, albeit with no answers to your questions about the house and neighborhood. There will also be no assurances (or even clues) about the future condition or value of the house, no historical repair data about the house or even information about who used to live there. Even if you do find the previous owners, they likely will not be forthcoming or even friendly. The process is just like driving down a mountain road in a heavy fog and it takes place in extreme slow-motion, and 60 to 90 days just to get a signed contract is not unusual.

What the buyer does not receive
There is no actual person who is the seller able to answer questions about the house. After all, it is highly unlikely that the individuals working for the lender to sell this house have ever seen the property or are even in the same part of the country as the house. Therefore, there will not be any of the following offered by the lender:
* A Seller’s Disclosure on the property showing if the seller had any knowledge of previous repairs, defects or termite damage
* A warranty that provides for the repair of all major structural defects and some minor defects
* Pass-through warranties on major systems such as heating and air conditioning, plumbing, electrical and appliances
* A general warranty deed that enables the buyer to obtain a legitimate title insurance policy to protect against future defects that may be discovered relative to the chain of title

What the buyer might receive
Most foreclosed property is advertised to be in “as is” condition and this means that you are buying the house as it is on the day you see it. You usually have the right to inspect the house and see what you are buying or what may be missing or need replacing. Some buyers will hire a professional home inspector to help evaluate the condition of the house and determine the buyer’s anticipated repair costs.

Other buyers may choose to purchase foreclosures without an inspection or to do their own inspection and be secure in the knowledge that they can personally handle any repair or renovation themselves. This is workable for the one in five homeowners who can actually use the tools available for major projects. The other four in five will need to hire a professional to handle the repairs and be satisfied with the professional’s competence, licensing, insurance and hourly rate.

Water and termite damage are two things that can be severe and well-hidden at the same time. In some cases, it can be years before the extent of the damage is known. Most banks do not continue termite treatment or clean out the rain gutters or do much of anything else during the period they own the house and sometimes that can lead to other problems. Polybutlelane (or blue) pipe installed during the 1980’s and early 1990’s will eventually fail, and it is important to know if that is part of what you are buying when you buy an older foreclosure.

Recently, thieves have begun to harvest copper from vacant homes because the relatively high resale value of copper. This means that you may discover the copper pipes have been removed or the copper in the security system wiring or in the HVAC unit has been removed. Will the bank replace those items? What happens if those items are stolen after your inspection but before you move in? Does the bank have an insurance policy that covers theft? It takes about 30 minutes for a two-man crew with tools to remove every bit of copper in a vacant house.

The neighborhood
One huge variable in buying a foreclosed property is the neighborhood in which it is located. Some foreclosures are an aberration in an otherwise stable neighborhood of well-kept homes with 100 percent owner-occupants and no real issues relative to future value or appreciation. If that is the case, one can feel comfortable buying in that neighborhood.

On the other hand, some neighborhoods are poised right on the brink of almost certain devaluation. Some devaluation scenarios are offered below. The warning signals should be obvious to the attentive observer, but sadly some buyers will overlook the obvious because they are focused upon the huge “discount” they are getting on the purchase.
* There are many vacant lots in the subdivision. The lots are owned by the bank or will be soon. If the bank is willing to sell a foreclosed house in this subdivision for a 40 percent discount, then that same banker (or another) will be willing to sell the lots at a 40 percent discount as well. When building lots are discounted 40 percent, most builders who are able to obtain construction loans will be encouraged by their banker, Realtor® and market conditions to build at the lowest possible price. One can easily imagine a large-volume production builder buying all the lots from the bank (discount is now well over 50 percent because the builder bought all the lots) and undercutting the prices by $50,000 or even $100,000. That means that foreclosure you bought in there for $350,000 is now worth $275,000.
* The foreclosure you are about to buy is one of 14 in the subdivision. In fact the only houses on the market are foreclosures. Homeowners who want to sell their houses can’t compete with the foreclosures because their loan balances are too high, so they simply abandon their house and let the bank have it. This is a case where each sale occurs at a slightly lower price than the one before it and there are so many of that type sale that the new lower prices become the standard for the subdivision. Eventually the prices reach the point where it makes sense for some homeowners to rent their property instead of selling it.
* The foreclosure you buy is in a swim/tennis subdivision with a homeowner’s association and annual dues of $450 per year and an annual property tax bill of $4,000. The previous homeowner and later the bank have not paid these dues for two years. Oddly enough, the law in some states actually allow the bank to not be responsible for past due tax or association fee payments and in some cases the bank thinks this applies to the period during which they own the house as well. After moving in, you discover a tax lien has been placed on your house and the homeowner’s association has filed a lien against you for two years’ dues. You may avoid paying either of these liens and your attorney might get them removed after six months of legal wrangling. The bank you bought from does not help you with your legal fees.
* A variation of the homeowner’s association scenario is the Helpful Neighbor who has cut, fertilized and watered the grass, removed the trash, trimmed the shrubs and other routine maintenance — all to preserve the appearance of the foreclosed house so it does not become an “eyesore” for the neighborhood. After you move into your foreclosure, the neighbor gives you a bill or lays a guilt trip on you that you feel less than welcome in the neighborhood. Sometimes the ”Helpful Neighbor’s” place can be taken by the homeowner’s association or even the city or county government and they may have the power to recover their cost for doing that work from the buyer or filing a lien on the property. One county near Atlanta is in the process of passing just such an ordinance so they are able to maintain lawns of foreclosed property.

Pre-foreclosures or Short Sales can be a safer alternative
Some astute property owners facing foreclosures are able to negotiate with their lender to create a below-market sales price for their property. Most of the time these sellers are professional sellers such as homebuilders or investors who have a good relationship with their lender and multiple properties in that lender’s loan portfolio. These pre-negotiated below-market sales prices are usually a combination of the seller giving up equity and the lender giving up interest and principal — in effect writing down the loan balance to a level that appears to be realistic in view of current market conditions. In other words, both lender and seller are professionals, realistic in their acceptance of the 25 percent immediate drop in values that occurred in 2007-2008, motivated to preserve their relationship with each other and dedicated to avoiding the foreclosure process.

These sales are called short sales because both the seller and the lender are left “short” of their expectations of profit or payback. The difficult part is that not all lenders or sellers will acknowledge they are participating in a short sale. That makes it very important for a prospective buyer of any property to either be an expert on relative pricing in the area in which they are considering or be willing to hire such an expert in the form of a Realtor®, known in the trade as a Buyer Brokerage Representative or a Licensed Appraiser, who will charge a fee for each property evaluated.

What could be better than a short sale
Some local lenders have taken the short sale concept a step further than that required by banking regulations and practices and even applied innovation to the marketing of their foreclosed properties. They are to be commended for this. These lenders will actually hire a local homebuilder to evaluate the house and make any repairs or renovation before the house is put on the market, use that same builder to maintain the house during the marketing period and to provide the buyer with a builder-type warranty for a year or more after the sale. These houses are still priced using the same methods that are used on regular foreclosures, basically a realistic and unemotional evaluation of real market conditions, so they are real bargains. Frequently, these houses are marketed as if they are owned by the builder and some may be. Either way, this is a huge step up from buying a foreclosure with all the unknowns and uncertainties.

What else should a savvy buyer consider
Builder closeouts are something advertised quite heavily in recent months. In some cases it means the builder wants to reduce his inventory in certain areas or price ranges so he can continue his building elsewhere. Other times it means the builder is going out of business. It is obviously important to know which is the case before making a decision, but some of the builder closeout prices are every bit as low as foreclosed property.

Some local and national homebuilders have been paying attention to the market over the past several years and have already made the adjustments necessary to compete in today’s market. Their pricing is competitive with the foreclosures and short sales because they have made purchasing decisions that have taken advantage of lower lot prices and lower prices for both material and labor, both of which have fallen since early 2007. These builders are usually found in well-located subdivisions in good school districts where they are the exclusive builder in the subdivision. Typically these builders will offer buyers the assurance of a neighborhood that will be completed as planned and very strong warranty and builder service programs.

Conclusion
To summarize, there are many aspects to consider in the purchase of a foreclosed property. The ultimate success of your transaction can, and probably will depend on how these factors are handled.

(A graduate of Northeastern University, Rick Schlosser began working in real estate during college with The Codman Company in Boston, specializing in townhome sales, rentals, renovations and condominium conversion of properties in the Back Bay and Beacon Hill sections of Boston. Rick was joined by Jay Grossman at Codman in 1973 and together they expanded the residential division to the suburban Boston area and eventually all of New England. Recruited by Equitable Life Assurance in 1977, he moved to Atlanta to work as sales and marketing manager for Rivermont, an Equitable Life Assurance owned country club community in North Fulton County. Rick became project manager in 1979 and in 1981 when Rivermont was nearing completion, he moved to another Equitable project, Peachtree City, in 1982, taking responsibility for sales and marketing for Peachtree City Marketing Group and Peachtree City Development Corp. under the umbrella of Equitable ownership. In 1993, Rick joined Eagle’s Landing in Henry County as vice president of sales and marketing, taking responsibility for commercial, industrial and residential sales. He later started Metrosouth Realty Advisors Inc., later known as Metrosouth Realty Inc., keeping Eagle’s Landing as a client. Rick became director of builder services in 2001 for the Coldwell Banker Bullard Realty organization, the largest Coldwell Banker franchise in Georgia. Joining the Coldwell Banker Bullard Realty organization in 2001, he first served as director of builder services for what is the largest Coldwell Banker franchise in Georgia. When Bullard purchased American Land Mart, a company in Conyers with a major share of the luxury home market in the Rockdale County area, in early 2004, Rick became managing broker of what is now Coldwell Banker American Land Mart. His company’s website address is www.americanlandmart.com, and his email address is schlosser@comcast.net.)

Add comment July 2nd, 2008

CARING FOR WOOD FLOORS: AN ALTERNATIVE APPROACH

By Michael Purser
Rosebud Co.

With the economic instability we are currently experiencing, homeowners are showing an interest in alternative approaches to refurbishing and caring for their wood floors. Recoating is proving itself as a high value an economically practical option. This is an ideal way of upgrading the look and value of your home without the chaos or traditional refinishing. It is environmentally responsible, dustless and has a very rapid turn around time. Compatible with fully occupied house and families with active lifestyles recoating has proven itself to be very successful in “staging” homes for resell. It is also ideal for engineered or prefinished floors with tough original factory applied coatings that are in bad need of repair. Recoating is the perfect complement to Rosebud Co.’s services that preserve and protect floors without sacrificing excessive amounts of wood.