One of the more popular types of deals that fix & flippers like to work with is foreclosures (Foreclosure Home Purchase )! These are properties where the owner hasn’t been able to keep up with the payments and the bank unfortunately has to take it back.
These are sometimes called REO properties as well.
Why Do Foreclosures Make Attractive Fix & Flips (Foreclosure Home Purchase)?
First and foremost, banks are NOT in the business of real estate! They don’t want to take your house. They’d rather collect the interest from you over the 30-year life of your mortgage. When they take on your property, they have to engage in a business that has nothing to do with banking.
So they usually hire a local real estate agent, often called an REO agent, whose job is to sell these listings…and to sell them fast.
Because they want to be rid of them, they’ll often list them at lower prices.
Plus, REO listings are sold as-is, which is great news for you as the real estate investor! You want properties that need a bit of work that you can buy at a discount. Many foreclosure properties need a nice renovation before they can be sold for market value.
How to Determine the Right Area to Invest in Foreclosure Properties (Foreclosure Home Purchase)
So now you’ve decided that foreclosure (Foreclosure Home Purchase) properties are the way to go…but now you’ve got to decide where you’d like to invest! The right neighborhood, city, or even state go a long way in determining your ultimate success.
So what do you need to take into account?
Enough Movement in the Area
A real estate investor’s best friend is movement. It doesn’t matter if it’s a buyer’s market or a seller’s market…whether prices are going up or down…it doesn’t matter. You can find a way to flip foreclosures in any market…but it’s much harder when there’s no movement.
One of the biggest reasons for this is that you’ll need to do some price comparison on other similar houses in the area—more on that later.
Low Crime
It’s pretty simple, right? You’re trying to fix & flip a property. If you can’t sell the property for a good price in a reasonable amount of time, you’re likely to lose money on the deal because of holding costs.
That’s why you must take crime into account. Even if you can find other comparable properties in the same crime-riddled neighborhood, and you’re value estimates take it into account, it’s still harder to find people to buy the property. Holding onto a property costs an estimated $50/per day. If it takes you an extra two months to sell a property in a high-crime area, that costs you $3k, as well as the opportunity cost of having to worry about that deal instead of putting all your energy towards your next one.
My rule of thumb is pretty easy:
If I’d let my wife walk the neighborhood by herself at night, then I’ll do a deal there.
No or Few Boarded up Homes
Similar to the crime issue, you don’t want to be investing in an area with boarded up homes because it’s simply undesirable to be near them. If 80% of the people who might come check out your finished property say no because of nearby boarded up homes, then that’s going to get expensive for you.
My goal is to not find a single boarded up home on the same street as my property. There can be 1 in the nearby neighborhood, but if you find a few, I’d walk away.
It’s really the same for other issues too. Even if there aren’t boarded up windows or doors per se, but you can tell a nearby property is in severe disrepair and looks abandoned, the same principle applies.
High Percentage of Owner-Occupied
You want the surrounding neighborhood to be a majority of owners living in the properties, as opposed to rentals. Most families looking to buy a house are looking for a community along with it. If they see mostly rentals (or townhomes or condos as well), then they’re going to see a high turnover neighborhood and not see it as a great place to settle down.
Watch for Undesirable Features Nearby
Keep an eye out for things like:
- Busy roads (double-yellow lines)
- Railroad tracks
- Trash-riddled parks
- Bad smells
- Loud noises
- Standing water that attracts bugs/pollution
Close, But Not Too Close, to Commercial Areas
Jobs, entertainment, and groceries. Those are the three things people will likely want close to them.
Jobs – Ideally, there should be a nice, easy drive that’s under 40 minutes to many places where well-paying jobs would be. In a perfect world, you’d be about 20 minutes away from a major city, without being right in it.
Entertainment – Can you drive to movie theaters, golf courses, shopping, etc. without having to hit the freeway for long periods of time? Those are things that many families will take into account when deciding to buy your property.
Groceries – Your new buyers are going to want to be able to pop over to the store to pick up eggs, and they’ll want a short drive. Hopefully there’s a grocery store within 10 minutes, because that will be a black mark against your property for many prospective buyers.
How to Find Foreclosure Properties
There are a couple of different ways.
One of them is through websites that specialize in REO properties, such as RealtyTrac, Foreclosure.com, and Remax.com.
Another way, and one that’s my personal favorite, is to build a relationship with an REO agent! In the typical foreclosure process (Foreclosure home purchase), the REO agent knows well in advance of when the property is going to become available.
With a typical REO deal, the bank can’t do anything with personal property left behind for 30 days. During that time, because your REO agent contact notified you, you can go check out the property, estimate repairs, get your bid together…all that sort of thing.
Then the same day it goes on the market, you’re the first bid in there!
So how does this work with an REO agent? It starts by just reaching out to them and talking to them. Letting them know that you’d like to form a business partnership. If you close a deal that they notified you about, you pay them a finder’s fee of $500 or so!
I actually had an REO agent named Aaron who passed me 20 deals! That one single relationship made me hundreds upon hundreds of thousands of dollars…and I did very little work finding the deals other than maintaining that relationship.
Determine if Flipping the Foreclosure will be Profitable ((Foreclosure Home Purchase)
Next, it’s up to you to figure out if that property you’re looking at will actually be profitable for you.
The rule of thumb that I teach (and what our company lends on) is that you should try to find deals where all of your costs come in around 70% of the After Repair Value.
So if you have a property that you think you can resell for $200k after fixing it up, then you’ll want to try to keep the purchase price + rehab costs + loan costs under $140k!
If you can do that, you’re all but guaranteed to walk away with a big paycheck.
However, it’s also just a rule of thumb. If your costs will be 80% of the ARV, you’ll likely have to bring more cash-to-close, and you’ll have less wiggle room should other costs arise. Of course, it gets even worse if you get up to 90% or so, and you’ll find that the cash-to-close will probably be too high to justify the potential profit on the deal.
Estimating ARV
Many new investors will pull up Zillow, hunt around for 5 minutes, and then believe they’ve got a dead-on ARV that they should base all their deal numbers on. I’m telling you that’s not the way to do it. There’s a science to it, one that I’ve honed over decades, and all of my borrowers have to do it this way.
First, you’re going to go find 3 recently sold and 3 on-the-market properties that are similar in size and quality to what your property will be after it’s fixed up. If it has two bathrooms now, but will have 3 when you’re done, your comps should have 3 as well.
Once you’ve found those properties, take the lowest value and use that as your ARV!
Yes, you heard me: the lowest. Not the highest, not the average, not some pie-in-the-sky number you think you can sell it for (boy do I see this a lot).
Real estate investing is all about risk/reward. If you’re going to start your entire deal based on an inaccurate ARV, you’re doomed to fail in many of your deals even before you’ve really started!
Here’s a few things to note:
- ½-mile radius – Look for comps that are close. The farther away you get, the more likely properties will carry different values and won’t be good comparisons. I’ll push this out to 1 mile if I have to.
- Look for natural/artificial barriers – Even within that ½-mile radius, you’ll sometimes find vast fluctuations in pricing. Be wary of properties in different neighborhoods, or on the other side of a busy street, railroad, or even a river.
- Adjust if necessary – It’s pretty common that you won’t be able to find 6 perfectly comparable properties. In that case, you can make some simple adjustments—such as calculating the average price per square foot, or how much an extra bed/bath typically adds in value in the area. These “adjusted” properties are usually best served to verify other values you’ve received, not to give you a new standard to work off.
How to Get Funding For a Foreclosure Property (Foreclosure Home Purchase)
Okay…so now you’ve found your foreclosed property, ran the numbers, and decided it was a good deal to pursue! So then you’ll place your offer, and let’s assume that it’s been accepted…
Yay!
At this point, you know there is profit to be had…so how cool is that! Of course there could still be surprises that hurt your deal, but you should have enough wiggle room in your profit margin to be able to handle those.
So…now is the big question…how are you going to get funding for your deal?
The reality is that by this step you’ll often already have someone or a company in mind that you’re going to be working with, and perhaps you’re already prequalified.
So let’s run through the most common (and I think the best) ways to get your foreclosed deal funded!
Hard Money Loan
In my opinion, you should start your funding search with a hard money loan. If you’re unfamiliar, these are loan specifically designed for fix & flippers!
They’re short term loans with high interest rates, and they lend based on “hard” assets as opposed to “soft” assets.
The hard money lender will lend you based on the profitability of your deal—your “hard” asset. They’ll check your comps and verify your rehab estimates to make sure everything’s on track. Many hard money lenders will require at least 1 successful flip and a minimum credit score, but it’s less stringent than a conventional lender.
A conventional lender wants to have your loan for as long as possible, so they make tons of interest over the life of the loan. That’s why they look at “soft” assets and focus more on your ability to pay back the loan for the long haul.
Hard money loans do charge much higher interest because you’re only in the loan for 6-12 months. If they charged conventional loan rates, they wouldn’t profit enough on your loan to make it worth the risk.
Now, some hard money lenders (like The Investor's Edge) offer up to 100% financing! In this situation—that is, you can fit all your costs under 70% of the ARV—you don’t need any other source of funding.
However, make sure you don’t leave great deals on the table because they don’t quite qualify and you have to bring a little bit of money to the table.
In those situations, you can still find other sources of funding other than your own bank account. Let’s talk about those next.
Home Equity Line of Credit
This is perhaps the easiest and best way to get the rest of the funding needed for your deal! A HELOC is a low interest line of credit that’s backed by the equity in your house. With a line of credit, you can take out only the money that you need, and therefore only pay interest on the money you withdraw.
Another neat aspect of a HELOC is that you can make your payments by withdrawing MORE money from it! That way, you can avoid using any of your own money, and then just pay everything back out of your profit.
If you can qualify for a HELOC, it’s nice because you don’t have to find a partner and split the profit with them.
Find a Partner
In this scenario, your partner is likely going to be the one bringing money to the deal, or using their superior credit to access more funds.
There are TONS of ways that you can structure a partner deal! Perhaps you just want a one-time partner on this deal you found, or else you can form an LLC with the anticipation of doing many deals together in the future.
Then, you can decide if you’re going to repay your partner as if it were a loan and just give them interest, or you can decide on a profit split. If you go the loan route, you’ll also need to decide if you’re going to pay monthly interest payments, or pay it all back once you profit from your deal!
Just be sure to put everything in writing…even if your partner is your best friend! It’s all too common that friendships are destroyed or familial relationships strained because of a deal where terms weren’t specified and people left unsatisfied.
Take a Loan Against Your Retirement Account
Did you know that you can borrow money against your 401(k) or your IRA? Just simply get in contact with your provider and they can let you know the terms, but they’re usually conducive to doing a fix & flip deal. You are allowed to borrow up to 50% of your savings, up to $50,000—usually plenty to get your deal off the ground.
Bonus points because the interest you pay on the loan goes right back into your account!
Self-Directed Retirement Accounts
Boy do I love this one….
Did you know that with a self-directed retirement account, you get to decide how your money is invested?
With a standard 401(k) or IRA, you put the money in, and it’s invested in a pretty standard portfolio for you. However, with a self-directed, you can choose to invest your money in a standard portfolio OR invest the money yourself in assets such as precious metals, cryptocurrency, or real estate!
Then, any profit you make goes directly back into your retirement account so that the money can keep growing!
Also, I highly recommend Roth retirement accounts. These are accounts where the money you put in has already been taxed, as opposed to traditional retirement accounts where the money isn’t taxed until you withdraw it.
With the Roth accounts, any growth seen within your account happens completely tax free! So if you complete a deal with $40,000 in profit, that money goes back into your retirement account…and will NEVER be taxed! Woohoo!
Also, Roth accounts allow you to withdraw contributions you’ve made (because it’s money that’s already been taxed) and they can also be passed down to your kids. That’s a bit more complicated, but talk with a financial planner and they can help you work that out.
Wholesaling
Okay, it’s not necessarily a funding strategy, but it’s a way to flip your foreclosure property (Foreclosure home purchase) without having to get a loan or fix up the property.
With wholesaling, you’ll go out and find a profitable deal—just as if you were looking for a good fix & flip property—and you put it under contract. Then before the closing date, you’ll assign that contract to another investor who’s going to fix & flip the property. They pay you a nice finder’s fee, and you move on to the next deal!
These are popular for a variety of reasons:
- Don’t have to get a loan
- Don’t have to do the rehab
- Don’t have to deal with a contractor
- Fast profit – Often can complete a deal in less than two weeks
- Decent profit – typically you’re going to see $2,500 – $10,000…but I’ve seen $50k+ as well!
Alright, I’ve covered a few of the most common funding strategies, but know that there are definitely other ones out there! I recommend learning and using many different ways to fund deals. That way, you can pull out the one that makes the most sense for the deal—a little like Batman’s utility belt.
Rehab your Foreclosure Property (Foreclosure Home Purchase)
Now that you’ve found a great property, put it under contract, and secured funding through a hard money loan and perhaps another source for the down payment, it’s time to actually finish the rehab project!
Now, you’re not going to be doing the rehab yourself—unless you’re a contractor, but even then I’d argue that your time is better spent finding more deals—so then the key is that you need to find and work with a general contractor who’ll do the work!
If you haven’t flipped a home before, you might be surprised to know that this is the step where most deals fall apart. Since you’re already on the hook for the money and the property is yours, having problems arise now can be particularly catastrophic.
Here are a few of the pitfalls that I’ve seen with contractors:
- They decide for whatever reason they don’t want to do the project, so they leave it half done.
- They give you a single bid for everything in the house, and then nickel and dime you for other projects, saying those weren’t part of the bid.
- They just don’t do a good job.
- They slow play it, not respecting your loan deadlines, and spend their time on other projects they have going on.
Let’s address some of these issues, and I’ll give you some tips for finishing up your foreclosure property (Foreclosure home purchase)!
Picking a Contractor
Take your time on this step. Before you even talk to the contractor, I want you to be reasonably sure that he seems like a good option.
Hopefully you’ve gotten a recommendation from a friend and/or read a bunch of reviews online.
Next, you’re going to vet them yourself. Take him out to lunch. Pick his brain, ask him what his qualifications are and why you should hire him. Treat this part like a job interview, but if they’re not willing to participate, drop him and move onto the next one.
Keep Your Contractor On Schedule and on Budget
There are a few good ways to do this.
To keep them on schedule, be sure to visit the site at least once a week and chat with the contractor. Ask them straight out how things are looking, what the budget is looking like, and of course if they’re still on schedule.
One trick I like to do is to offer them a bonus for every day they finish ahead of schedule, but penalize them every day they finish behind schedule.
Typically, I give them $25/day that they’re done ahead and charge $50 every day they’re behind. Every time I’ve done this, the contractor jumped at the chance to make some money, and finished ahead of schedule.
Another way to help you stay on budget is to line-item every single project in the rehab! When you’re walking through the house with your contractor before closing, don’t let them give you a single bid on the entire rehab. Instead, have them point out each individual project and attach a cost to it. Make sure to write everything down and also use a tape recorder so you can refer back to it if needed. Then you’ll be the one to create the proposal, submit it to the contractor, and he’ll sign it. They’ll actually appreciate this—contractors aren’t usually smiling when having to write up a proposal themselves.
Don’t Over or Under Build the Neighborhood
It might seem enticing to add some extra features to the house, but if you’re putting in features nicer than every other house in the neighborhood, buyers won’t pay extra for them. Or if you want to save money by underbuilding the quality, the buyers will notice that too.
Use the same quality as the neighbors, especially when talking about flooring, counters, crown molding, and windows. You can upgrade one single thing above the neighbors to help you sell the house faster, but don’t expect to be able to hike up the price.
Conclusion
There you go! The simple steps to fix & flip a foreclosure.
I’ve been able to close many homes that were in foreclosure (or even better, preforeclosure) (Foreclosure gome purchase) and there’s a lot of profit to be had.
Learn how to make money flipping real estate with us by attending our next webinar.
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