As I have shared here recently, I have been researching techniques (and some intriguing companies) for buying foreclosures at auction.  Two companies here in Seattle that facilitate this process are: www.foreclosuregroupllc.com and www.foreclosurepoint.com.

I went to an info session with Foreclosure Group LLC and spoke on the phone with an agent from Foreclosure Point, and found out that both of them have a similar premise:  We will provide you information about homes going into foreclosure and if you buy one, before the auction, at the auction, or after the auction – as an REO – you will pay us a 3% commission as your buyer’s agent.

In exchange, you get free access to our database and we’ll help you to the extent we can on due-diligence information like finding out what other liens are on title, looking up comps for you, etc.

No Interior Inspections Available Before Closing

The challenge with both of these services is that when you buy at auction, you don’t really have the opportunity to perform any due diligence on the premises – you can’t have your property inspector come by to give you a report nor can you even get in and walk around the interior of the property.  In many cases these properties are vacant and locked up/winterized by the foreclosing bank.  In some cases they are occupied by homeowners who don’t want to be losing their homes.

In a few cases, the homes are on the market with a real estate agent.  In these cases, you could enter the home with the lock box (if you are a realtor, or can get your realtor to bring you through) to do a visual inspection of the home.  You could even pay for a property inspector to do a report, but you’d have to invest the $350 with no confidence that you would end up actually being able to close on the property.

Lots of Fees Will Eat Up Your Profits

I also looked into the fees that an average "flipper" might expect to incur in the event of buying a house at auction with the intention to resell it on the open market.  My conclusion is that these fees will add an additional 22% to the cost of acquisition for the property.  That is – if you buy a home at auction for $200,000 – you’re really going to be into the property for about $244,000 before you are able to dispose of it, so you’d have to be able to sell it for more than that in order to make any profit.

Let’s look at where the fees come from:

Buyer’s Agent Fee	3%	Acquisition cost on any foreclosure property bought through this service
Loan Points	2-4%	To buy at the auction, you must have ALL CASH in order to close.  Working through the recommended hard money lender will cost you 2-4 points to get the deal funded.
Holding Costs	6%	Each month you’ll have to pay interest on your loan (and property taxes, but we’re not counting those).  The hard money loan offered is at 12%.  I’m using a 1%/month loan cost, for a 6-month holding period.  If you could sell faster or have a lower interest loan, this could be reduced.
Resale Commission	7%	When you resell the house, you’ll incur a 5% realtor commission.  When we buy at 70 cents on the dollar – our purchasing goal, the selling commission represents about 7% of that amount.
Excise Tax	2%	In Washington State, when you sell a property you incur a 1.78% excise tax.  This is like a sale tax. Ouch!
TOTAL	20-22%	% of purchase price to add in additional costs.

What kind of prices are folks getting on their property?

So…now you know what you’re looking at going in…

1. The risk of no inspection period
2. The cost of paying all cash for the property (and getting a hard money loan to do it)
3. The fees that will eat into your profits once you do find a deal.

Frankly, all of that is well and good – a cost of doing business you might say – assuming that the numbers work otherwise, let’s check that out.

I went to the weekly foreclosure auction on Friday to see what homes were selling for there. 

Going into the morning, 14 homes were scheduled to go to auction, and about half of them were "saved" from the auction block at the last minute – sales were postponed, owners declared bankruptcy, etc.  There are a number of last-ditch efforts folks can make to spare their property from going to foreclosure auction.

(Note, this frustrated many buyers who had done their due diligence, brought their certified funds, and were prepared to bid on those properties.)  It’s frustrating to have the deal go away just when you have decided to try to buy it!

I was able to stay for four of the remaining auctions – the others were delayed to later in the day…

In two of the auctions, nobody bid because the banks were not letting the properties go for prices that were suitably attractive for investors.  (The bank’s minimum bid is usually determined by the outstanding principal balance, plus arrears and fees – this is where the bidding starts in most cases.  Then, second mortgage holders and other junior lien holders can step in as well to raise the prices even more.)  In these cases where no one bids on the property, the bank takes ownership of the property again, and it goes into their REO portfolio, to be re-marketed to the rest of the public through their real estate agents.

In the other 2 auctions, the properties sold.  Only about 5-6 of the 37 people in attendance registered to bid on these properties and actually put their paddle in the air.  The properties ended up selling with about a 60-70K spread between the purchase price and the "comparable sale" value of the home.  Sales prices were in the $300,000 range.

On the surface, it looks like that’s a decent spread, but if you factor in the costs I mentioned above for reselling the home, these properties looked like they would have very little profit margin for an investor who hoped to flip them.

Is it Worth It?

My conclusion is that this could be a profitable business, if you treated it like a fairly serious 30-hour/week occupation.  You could probably make $50-100K/year pretty easily (with some risk of getting burned on the occasional mold- or earthquake-damaged "surprise" property if you had the following course of action:

1. Had 25% down to work with for your purchases (that’s $75,000 for a $300,000 home…  many people apparently get this from a line of credit on their own residence.)
2. Were willing to drive around the county in advance of every auction to inspect the properties and the neighborhoods and figure out what the homes were worth.  (And assess inspections needed, when interior views were possible)
3. Were willing to draw out your down payment money in certified funds each week (thus necessitating keeping those down payment funds in a liquid account), attend weekly foreclosure auctions knowing that the properties that you were bidding on may or may not be for sale, and be ready to close if something became available that met your criteria.
4. Relax your "buying criteria" from 70 cents on the dollar, to maybe seeing a spread of $100,000 – $150,000 on houses that you planned to flip.

Personally, I haven’t decided to pursue this method of buying yet.  It may be a good deal, especially if I can partner with a lender I know personally who would front the funds at a lower rate.  I don’t have the desire to maintain the liquidity in my investable assets that investing in this type of project would demand.  I also don’t know if I would enjoy the "job" of driving around to inspect all these homes, taking the risk on the repairs, overseeing repairs after the purchase, etc. etc. 

When you’re looking at investment programs that take a fair amount of time to implement, I think it makes sense to determine whether you would LIKE spending your time on the activities demanded to be successful at that program.

I may continue to pursue this if I can find a good vein or niche in buying pre-foreclosure or REO properties.  I like having the certainty of an inspection period before closing on a property, and I like being able to fund deals with a lower required down payment and a traditional (less expensive) loan.

I will keep you posted on what I decide, but that’s my report from the field on what’s involved in buying foreclosure properties at auction.

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