Markets

Opportunities in the Housing Slowdown

Investing in a foreclosure can be rewarding, but success is hardly a sure thing.

By Pat Mertz Esswein, Associate Editor

From Kiplinger's Personal Finance magazine, December 2006

If you flip channels late at night, you probably see the infomercials that portray investing in foreclosed houses as a sure thing. But talk to people doing it, and they'll tell you that buying a foreclosed home to flip or rent out isn't an easy, quick, cheap or surefire route to wealth. The pitch for foreclosures seems timely, with all the talk about homeowners overburdened with rising ARM payments and little or no equity who will throw their keys back at the bank. But the typical deal comes with more problems than the average do-it-yourselfer can handle.

Investing in a foreclosure can be rewarding if you're willing to do your homework. Compared with a year ago, foreclosures are up more than 60% nationally, according to RealtyTrac, an online marketplace for foreclosed properties. And the chance of obtaining a bargain is likely to rise as the slowing housing market forces foreclosing lenders to offer bigger discounts to lure a smaller pool of buyers.

Investors Andy Heller and Scott Frank say they're "licking their chops" in anticipation of diminished competition for foreclosures as fair-weather investors flee the market and would-be owner-occupants look for easier pickings. "This is the time when you should be diving in," says Heller, who co-wrote, with Frank, Buy Even Lower: The Regular People's Guide to Real Estate Riches (Kaplan, $19).

Range of discounts

At the market's peak, in the first half of 2005, the nationwide median discount off market value for foreclosures was 14.6%, according to First American Real Estate Solutions, in Santa Ana, Cal. As the market slows further, the discount is bound to increase, although opportunities will vary from area to area.

How much of a bargain you need to make a deal work depends on your post-purchase plans. The shorter the time you intend to hold a property, Heller and Frank say, the greater the "minimum investor discount" you require. They recommend trying to buy homes for 20% to 30% off market value if you plan to flip the property; 10% to 20% off if you'll rent it out with the option to buy; and 5% to 10% if you intend to rent it out indefinitely. Keep in mind that the days when you could flip for a quick profit are over -- at least for now.

Savings per square foot

Bruce Reeks has been adding to his retirement savings by buying foreclosures. Reeks, who owns 15 such properties, identifies a bank-owned foreclosure on a multiple listing service, then compares its price per square foot with those of homes recently sold in the same subdivision. The difference signals opportunity, he says.

Last year, Reeks purchased a five-bedroom, two-bath home in Austell, Ga., northwest of Atlanta, for $102,900. After he spent $7,800 on repairs, the property appraised at $142,000. If Reeks had flipped the house, he would have made about $24,000 after commissions and other costs. Instead, he collects rent of $1,190 and pays $850 per month toward the mortgage, reaping a gross profit of $340 a month. Meanwhile, Reeks builds equity as he pays the mortgage with the renter's money, he enjoys tax write-offs, and he expects to benefit from price appreciation. He anticipates cashing out his portfolio in the next five years and retiring to Asheville, N.C.

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