What is Foreclosure and Why Is That Important As A Real Estate Investor?

Real estate investors are savvy shoppers, always seeking out the best deals. That means eyeing low-cost properties with the potential to fix up and sell at a profit or get in renters at a profitable monthly rate.

But especially in a piping hot real estate market, finding low-cost properties is a serious struggle.

My husband and I have been searching for our next rental property for years, making very few offers and no purchases.

It seems like the market where we live continues to get more competitive every day. And I think investors across the country are feeling the same. So I started thinking about the possibility of investing in foreclosures. 

To this point, we’ve primarily focused on turnkey properties or those that require minimal renovation. But as I think about that strategy further, we’re pretty handy people; we could likely take on a more extensive renovation for the right price.

Yes, of course, I’ve heard the horror stories; people purchasing worn-down properties for dirt cheap prices only to find that the bones of the house required a complete teardown.

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So the question I want to answer as a somewhat beginner investor is, are foreclosures a good real estate investment? And if so, what might I need to know before jumping in.

In this article, we’ll cover:

• What foreclosure is
• The pros and cons of investing in foreclosures
• What to know before buying a foreclosure

What is Foreclosure?

Foreclosure is the process of a lender removing a property from an owner due to an unpaid mortgage. And it’s an apt term for that process. Foreclosure is a word that comes from the Latin fors, which means “out,” and clore, which means “to shut.”

So quite literally, a foreclosure means being shut out from a property.

But once you buy a property and have a mortgage, don’t you own it? Well, yes and no.

The bank (or whoever issued your mortgage) has extended you a loan that allows you to live in the property and work towards ownership through monthly payments. But that loan is backed by the property as collateral.

That means until it’s 100% paid off, the lender can revoke the property and send it into the foreclosure process.

In general, lenders don’t want to take someone into foreclosure. They’d much rather avoid the legal battle and work with the borrower to get caught up on payments.

But when push comes to shove, the lender needs to take back their property to stop the ongoing loss from missed payments. At that point, they can try to find another buyer who can quickly take the property off their hands.

The reason foreclosures often cost far less than “regular” properties is that lenders often sell them for what they’re still owed in mortgage payments.

But it’s important to note that foreclosures can come in a few different flavors: short sale, pre-foreclosure, and foreclosure.

Short sale: A short sale comes into play when an owner owes more than the property is currently worth. The owner asks the bank to allow them to sell the property for under the loan amount. Short sales are trickier than people think.

Lenders can choose to refuse a sale if the price is too low or they think the borrower can get current on payments. For these reasons, a short sale can drag on for years and ultimately the lender has the final say on if a sale goes through.

Pre-foreclosure: A property goes into pre-foreclosure after 90 days of missed payments. The owner still technically owns the property, which means pre-foreclosure homes still have a chance to be saved.

Frequently, purchasing a property in pre-foreclosure means you’re going directly to the homeowners to cut a deal. But it’s critical to check laws in your state first, as you may not legally be allowed to approach the owners.

Foreclosure: When a property goes into foreclosure, that means game over for the owner. The lender has officially taken back the property and is now seeking someone (often a real estate investor) to purchase it at the cost of the remaining mortgage.

Foreclosed properties are often purchased as-is and sight unseen at auctions where hopeful investors bid (frequently in cash) to win ownership. The fact that properties are often unseen means it’s a bit of a box of chocolates for investors; you never know what exactly you’re gonna get.

The Benefits of Foreclosure Investing

When a homeowner is unable to make their mortgage payments, a lender often puts the home on the market in search of a new owner that is better able to keep up with the costs. But their loss is your gain since foreclosures often go for much less than a fair market rate. In fact, you can find insane deals among the foreclosed properties in your area, or even across your state, if you bother to look. It also means an opportunity to fix up that lackluster foreclosure, selling it for a tidy profit a few months down the line.

It's known as flipping, and most flippers focus on foreclosures as investment properties due to the much lower costs that, one renovated, will inevitably rejoin the market and potentially bring a windfall to your bank account once you sell. Better yet, you may even decide to live in it, getting a great new home at a reduced rate — and you can always turn around and sell it down the line.

Here are some additional reasons why you may want to consider becoming a foreclosure investor.

Find Great Deals

While some people may worry about whether a foreclosure investment will ever pan out, most foreclosure investors know that a foreclosure can be like winning the lottery. If you end up with a great house for the price of a cheap one, you may only need to do a little bit of work to recoup that investment and make a small fortune. The reason such great deals can be had is because of the lenders that are more interested in selling the property and recouping a majority of their investment rather than waiting for that perfect buyer to come along.

But the lender's haste is your gain, and all those nagging issues that were never fixed will chase buyers away that actually want a move-in ready home, leaving a fixer-upper that may not need much work at all to get up to speed. Compared to other homes in the same neighborhood, a foreclosed home may go for 20 to 50 percent less — and once you fix it up and sell it, that could be a huge payday.

Build More Equity

If, however, you decide to live in that foreclosure and make improvements here and there when you can, you'll be building equity much faster than surrounding homes. Part of it is because of the cheap price today, which may not be so cheap years or decades down the line, and once you get those repairs made you'll have a much more valuable home on your hands. On the open market, investing in foreclosed homes and then eventually selling can often double your investment or more. And if you're doing a lot of the labor and fixes yourself, you'll save even more money on associated costs, making any appreciation largely profit.

Buy More Quickly

It's not always about the savings when you're a foreclosure investor. But real estate is a numbers game, and the more you buy and sell, the more wealth you'll accumulate. Because lenders are looking to sell quickly, you'll also be able to swoop in and buy that great property with outsized potential in no time at all. After all, if the price is right, there's no reason the lender won't want to sell, and they'll be highly interested in completing that sale as quickly as possible. As opposed to sellers that may back out at the last minute and reject your fair offer, foreclosed lenders are highly motivated to make the purchase process go as quickly as is legally possible.

Pros and Cons of Foreclosures as Investments

As an investor, when I hear the word foreclosure, the first word that comes to mind is “deal.” But that’s followed very closely by the word “problems.”

Foreclosed properties may conjure up images of boarded up windows and unmowed lawns, but that’s not always the case. Some properties that slip into foreclosure have been neglected or abandoned, while others may have just been in an area that experienced a drastic decline in value.

Whatever the reason, foreclosures can be a bit of a grab bag. Which leads to an exciting opportunity for real estate investors. But before you start planning extensive renovations in your mind, you’ll want to assess the pros and cons.

Pros

• Lower purchase price: Some properties in foreclosure can sell for 20-50% below market value. That means these investments have far more potential upside than flipping something purchased for 5-10% under market.
• Save money on settlement: The lender typically wants to offload a foreclosed property reasonably quickly. That means you might be able to save in key areas like closing costs, financing options, interest rates, and down payments.
• Quick access: Many foreclosed properties have no occupants, so you can gain access immediately upon closing. For savvy investors, that means renovations can begin asap. If, however, tenants remain in the property, the new owner (read: you) will be responsible for eviction post-sale. So, if the former homeowners are still sticking around after the sale, it’s now your job to send them packing.

Cons

• Competition: Lenders generally want to move on foreclosures quickly, but sometimes that process is slowed down because they’re inundated with offers. Real estate investors think alike, and they’re often vying for the same properties. For this reason, investors looking to purchase a foreclosure need to be prepared to make offers and have cash on hand to do so. Limited cash on hand is something that newer investors like myself may not be prepared with. Because I realized I was unprepared in this area, I’ve set my sights on a new savings goal for the year that will enable me to be a bit more flexible if we choose to go the foreclosure route in the future.
• Subpar home conditions: Some foreclosures may be for dilapidated homes in underserved areas. While you may be aware of cosmetic issues with the property, you can sometimes find unexpected surprises when you start a renovation. Investors must have a cash buffer for the “unknown” unknowns that come with foreclosed properties.
• Steep learning curve: Even if you’ve been buying rental properties for years, foreclosures are a whole new beast. As such, you’ll need to fully understand the legal process and how it differs from a typical sale. It also pays to research where to look to find the best properties and how to make the purchase before it hits the market for other investors to scoop up.
• Possible liens: Foreclosed properties could have liens or unpaid taxes, which you’ll be responsible for as the new owner. Be sure to search the public records for the property online first to be aware of and budget for these costs.

What to Know if You’re Considering Buying a Foreclosure

Buying a foreclosure isn’t always the best move for a brand new real estate investor. The best path for beginner investors is to consider a turnkey property or one that’s a bit more straightforward before diving into foreclosures.

Then, when you’re ready to get started, you’ll want to remember:

Research, Research, Research

You’ll need to know a lot about the local market to know if a foreclosed property is worth your time, money, and effort. And that means asking a lot of questions and doing some digging. Below are just a few of the questions you’ll want to answer when you’re contemplating a specific property.

You can research much of this information for free online or consult with a local official or realtor as needed.

• What do the public records show for this property? Are there existing liens or mortgages I may be responsible for?
• When was the last inspection? What were the findings?
• Is there going to be demand for the property as a sale or rental in the coming months or years?
• What drives the local economy? Are the jobs in those industries stable?
• Are there plans to revamp infrastructure in the area? Do you see construction for roads, schools, etc.?
• Is the home occupied? If no, how long has it sat unoccupied?
• Is the property the only foreclosure in the local area or one of many?

Have a Strategy

As with any real estate investment, you need to begin with the end in mind. When my husband and I assess a property, our strategy is a long-term buy and hold.

We want to find rentals in stable or up-and-coming areas, get great tenants in, and use them for cash flow over the years.

Other investors may see a property and think it would be better serviced as a flip. They’d plan to renovate the property and sell it (hopefully) at a profit when the renovations are complete.

Whether you plan to renovate to sell or renovate to rent could mean two very different things. You may opt for nicer finishes and more upgrades when selling and choose easily replaced options for a rental.

Use your strategy to drive your decisions and to set your budget. And more than anything, stick with it.

Get the latest foreclosure listings for your area at Foreclosure.com

There’s Help If You Need It

You’re not the first person looking to invest in foreclosures, and you certainly won’t be the last. Use the knowledge of the others who have gone before you.

There are so many books and podcasts full of information and best practices for investors.

I’ve found so much valuable information listening to podcasts. And the best part is, so many of them feature real stories from people like you and me.

They’re not millionaire real estate moguls, just average people trying to acquire a few properties to give them steady cash flow and more financial freedom.

There are also real estate agents who work specifically on helping buyers purchase foreclosed properties. If you’re not comfortable navigating the market alone, you can bring in the expertise of one of these professionals.

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The Bottom Line

Real estate investing is an incredible way to build wealth and diversify your portfolio. But investing in foreclosures is not a “get rich quick” scheme. Investors thinking about foreclosed properties should be sure to:

• Research the area to understand the larger economic forces that could impact the property’s value in the coming years.
• Budget sufficient funds to cover repairs, renovations, liens, and unpaid taxes (if applicable).
• Have an acquisition and exit strategy in mind, like flipping or buy-and-hold.

After learning more, I certainly feel open to the possibility of purchasing a foreclosure and am ready to dig deeper.

The whole process feels much more approachable if you carefully research and plan for the unexpected. And if you’re able to do so correctly, foreclosures can be an excellent way for real estate investors to buy at a discount and turn a nice profit.

Keep Reading:

• 10 Real Estate Investing Tips For Beginners
• 7 Reasons Why You Need to Start Investing Today
• Our Complete Review Of the Fundrise Real Estate Investing Platform