The Boom in Foreclosure Investing

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Kevork Djansezian / AP

A sign showing a foreclosed house in Glendale, California.

As foreclosures skyrocket, a growing number of investors are becoming enamored with the idea of buying up distressed properties, doing a little rehab, and then putting the homes back on the market to turn a tidy, double-digit profit. "We call them wannabe investors," says Rob Munn, who has been buying and selling foreclosures for eight years in Tennessee and Florida. "They watch Flip This House, and think, 'I can do that.'"

There's no denying the opportunity. In a typical year, about 1 million houses get auctioned off at county courthouses across the nation, but this year that figure is on track to double, thanks to malaise in the residential real estate market. In San Joaquin County, Calif., to take one example, there were 1,283 houses put up for auction last year. This year just through August there have been 3,158.

The mechanics of foreclosure investing, though, are the same as they ever were. That means investors have a shot at high returns only because they undertake a difficult, time-consuming and risky process.

Consider that courthouse auction. When a homeowner loses a house to foreclosure, the property is publicly auctioned on the county courthouse steps in an atmosphere that's often chaotic and crowded with lawyers, bank representatives and onlookers. A folio number is called and the bidding begins. Within a minute, the whole thing is over and the house has a new owner, who has to pay for his purchase with cash, sometimes by the end of the day.

Investors who buy houses at public auction can see a 25% to 35% return on their money — but with that comes the reality that the house is sold as is. That might very well mean that a family is still living there (get ready to start eviction proceedings), that there's a second mortgage no one bothered to mention, or that the house is in major disrepair (forget about arranging an inspection before an auction). "This isn't for novices," says Todd Beitler, co-author of The Complete Idiot's Guide to Buying Foreclosures. "There's a lot of research that needs to be done." It's little wonder that about 80% of the time, the company that holds the mortgage on a house buys it at auction.

A slightly less risky way to play foreclosures is to pounce before a house even makes it to auction. When foreclosure proceedings start, a notice of default is filed at the local courthouse and often runs in the newspaper, as well. Potential investors can also buy access to listings on web sites such as, and

Expect to make less money — maybe a 15% to 20% return — but without that much less work. With a pre-foreclosure sale, your job is to convince the homeowner to make a deal for the house. Just keep in mind that this is a person who is in financial distress and likely swamped by other opportunists like you, not to mention attorneys and real estate agents, knocking at the door. Due diligence is just as important as when buying at auction, since a homeowner can hide unsavory details like the condition of the house, liens or unpaid taxes.

An increasingly popular way to get at a house before it goes up for auction is to try for a short sale, a transaction in which the mortgage lender agrees to take less money that it is owed. A bank can easily spend tens of thousands of dollars to move a house through the entire foreclosure process, so as default rates soar, more are willing to negotiate with real estate agents representing a bid that's technically too low. (Short sales are becoming so commonplace that Beitler added a chapter about them in the upcoming second edition of his book.) The downside, from a buyer's perspective, is that even after a bank agrees to consider a short sale, it might taken months to respond to a specific offer.

The easiest, yet least lucrative, way to invest in foreclosed homes is to buy one after it has been repossessed by the bank. Many lenders list REO ("real estate owned") homes on their web sites, and large auctions run by outside companies are gaining serious traction, too. These are outfits like Hudson & Marshall and Real Estate Disposition Corporation (REDC) that come to town, advertise like crazy, then auction off hundreds of bank-owned properties in a hotel ballroom in a single day. In the current climate, business has taken off: Hudson & Marshall is selling 40% more homes now than it was at this point last year.

In these sales, you know the title is clean and clear, you can finance the purchase instead of paying cash, and you have the chance to tour the house before bidding. One company, Williams & Williams, even holds auctions at the properties themselves. The trade-off is a much lower return — 10% to 15% if you're lucky. And some shops charge a commission, like REDC's 5% "buyers premium," which eats directly into your profits, which is one reason many people use these auctions to buy homes to live in, not solely as investments.

Still, if you're new to foreclosure investing, bank-owned properties are the way to start. "We highly recommend people flip a few REOs first to get their education," says Beitler. Yet even before that, experts say to attend a number of auctions having researched specific houses — dry runs without actual bidding. And keep in mind that you'll be going up against people who do this full-time. "This is a really a hard job," says Munn. "I tell my partner all the time, if it were easy, everyone would do it." That doesn't preclude everyone from wanting to try.