Should You Buy a Foreclosed Property?

Even though the number of foreclosed properties available today is much less than in recent years, many buyers continue to charge forward with this type of investment and courageously embrace the uncertainty and frustration associated with these transactions. The conditions of foreclosures are often rough, which is why they are also called "distressed" properties. If you’re thinking of buying a foreclosed property, you need to be prepared for the special challenges that come with it.

Needless to say, the main advantage of buying a foreclosed property is the price. You will likely receive a good bargain, regardless of whether you buy directly from the owner at the stage of pre-foreclosure, at a foreclosure sale, or directly from the bank, also known as "real estate owned," or REO. Despite the advantages, you should also be prepared for the disadvantages of buying foreclosure properties. A few main disadvantages are listed here:

  • No usual buyer protections: At most stages in the foreclosure process, you give up some of the normal protections available in a typical transaction.

  • For example, you may not be able to inspect the property before your purchase. You will have to buy the property "as is" and have to accept that the property does not come with title insurance.

  • Waiting period imposed by foreclosure laws: All states have enacted laws to protect property owners and to make sure that banks cannot take over the properties of late-paying property owners with very short notice. What these laws mean for you as a buyer is that you will have to observe and accept a number of deadlines, delays, court rules, and uncertainty. This situation is more exaggerated in the states that allow the former property owner to buy back the property after it was sold in foreclosure within a certain period of time, which is usually from ten days to one year. Of course, you will get your purchase money refunded if the owners redeem the property, but the uncertainty associated with the redemption is worth your consideration.

Tellus TIP:

Think very carefully if you want to be held in this uncertainty while buying your property. You should always try to make sure you will be able to occupy and keep the rental.

  • Competition from experienced real estate investors: Since foreclosed properties usually mean a good bargain, you can rest assured that other real estate investors will have their cash ready and be lined up in front of you.

  • Risks of undisclosed repair needs, tax liens, or other issues with the property: Keep in mind that these homeowners of foreclosed properties may have been under financial pressure for some time. They may have stopped repairing, stopped paying taxes, or used the house as collateral for other debts.

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If you are still interested in pursuing foreclosed properties, you should try to find an agent who specializes in them. Although some agents do not deal with foreclosed property as a whole, some agents go so far as to arrange bus tours of local foreclosures. A good source is REO Network. If you already have a regular real estate agent, you should tell both agents what you are doing, and set each agent’s limited role. It is also wise to hire a real estate attorney to help you navigate this complicated area.

Now that you know some of the major pitfalls in connection with buying a foreclosed properties, you should be extra careful in the whole process. If you choose to go forward, here are some recommendations:

  • Investigate the maintenance history of the property: If you’re buying the foreclosed property at pre-foreclosure, depending on the laws in your state, the current owners should give you a disclosure form filled out with answers to any questions you might have, including the property’s maintenance history. This disclosure form could be a good starting point. You should then have the property inspected by a professional inspector before closing. It is also possible that the property has already been turned into a rental before.

If you are unable to reach the prior owner, you can likely ask the neighbors for help. You can ask them questions such as whether the owners took pride in their home and kept it in good shape, whether there were malicious tenants occupying the property, whether the owner supervised the tenants, and whether the property was damaged by tenants or other residents before moving out.

Even if the previous tenants were good enough to maintain the property, the property may have undergone a lot of wear and tear. Rental properties naturally suffer more deterioration than properties occupied by owners. You should take this into consideration when deciding your purchase bid.

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No matter whom you talk to, be prepared for disappointing news. As neighbors, brokers, banks, and eventual new owners of distressed properties have learned all too well, the prospect of losing one’s property—whether owned or rented—spurs some to acts of vengeful destruction. Refurbishing these properties will involve considerable expense.

  • Deal with previous owners: Rare but not impossible, you will find that the former owners are still living in the foreclosed property during the foreclosure proceedings and even after. Some property owners simply don’t have any other place to go and are thinking about staying as long as possible. You coming onto the property may or may not trigger their departure. If former owners stay on the property after the sale, you’ll need to evict them. Remember to never resort to self-help measures, which can turn nasty. Neither should you assume you can evict these former owners in the same way you would evict ordinary tenants. Tenant evictions under normal circumstances are relatively quick compared to other types of civil cases. In foreclosures, you may have to enter into more complex legal proceedings in order to evict a former owner. This process can cause you extra trouble and may require a lawyer.

  • Deal with existing tenants: The property you are considering may also come with tenants who were renting from the previous owners. In the past, when a rental property was put to foreclosure, most tenants lost their leases. The new owners were given a choice of keeping the tenants with a new lease or simply evicting them. This changed on May 20, 2009, when President Obama signed into law the "Helping Families Save Their Homes Act." This new law prescribes that even in case of a foreclosure, all leases remain valid. The one exception applies when the new owners intend to occupy the premises personally, in which case, the new owners need to give current tenants 90 days’ notice to terminate the lease. Under the new law, tenants under month-to-month rental agreements may be terminated with 90 days’ notice. This 90 days’ notice is effectively longer or as long as any notice period required by State laws. The Federal law ceased to take effect on December 31, 2014. Despite this, many states and municipalities enacted their own laws and rules to continue the same protection.

Therefore, if you intend to buy a foreclosed property for rental purposes, and if the property was foreclosed after May 19, 2009 and is accompanied by a tenant, it is highly possible you will have to honor the lease. You can terminate month-to-month tenants with 90 days’ notice. But you must keep in mind that some states and local rules impose rent control and could require you to have "just cause" (a good reason) before you could terminate a tenancy. For example, New Jersey and the District of Columbia have statewide policies requiring “just cause” for eviction. In those states or regions, you cannot simply give the tenant a termination notice to end the tenancy. As long as you plan on using the property for rental purposes, you will need to find an allowable reason permitted by rent control rules and regulations before you can get yourself out of the tenancy.

  • Screen existing tenants: Say your property is located in a non-rent-controlled city and you’ve inherited some tenants that are under month-to-month rental agreements. Should you allow them to stay? You would want to screen these tenants the same way you would any prospective tenants. If the existing tenants pay when their rent is due and have been taking reasonable care to maintain the property, you might want to keep them and negotiate your own rental agreement or lease with them. If you want to renegotiate the agreement or lease, you will need to give the existing tenants 90 days’ notice. However, some of the above information might be hard to find out unless you can talk to the previous owner.

If instead, you sense trouble with the existing tenants, and even worse, the existing tenants still have plenty of time left on the lease, you should think twice about whether or not to buy this piece of property. The last thing you want is to be trapped by tenants you would never have rented to if you were doing proper screening. If you insist on purchasing the property with the hope of evicting the residents after, you will bear the risk of incurring additional costs to initiate an expensive eviction proceeding should the existing tenants refuse to leave. You should think about whether you want to begin your new rental business this way.

Tellus TIP:

If you buy a foreclosed rental, you can generally get a good price. However, before deciding to buy, you should also consider the disadvantages of a foreclosed property and deal with any problems properly.