I left off talking to you about how to find foreclosures and who the different type of bidders might be.  However, you also need to do your homework to know what properties you should or should not bid on as an investor and how much to bid.   Potential homeowners do not follow these rules.  Purchasing the foreclosure becomes emotional, and I often see them bidding nearly market price for the property.  

This does not make a lot of sense because you cannot usually see inside the foreclosed property before you own it.  It may be occupied, and in need of a lot of expensive repairs.  The potential homeowner could have been better off working with a real estate agent to see inside similar marketplace properties and making a bid for one of these properties.   

Remember, there is considerable risk in buying a foreclosed property. As an investor, you need to avoid the herd mentality at an auction.  Just because everyone around you is bidding like mad on a property does not mean it makes economic sense.  Have your homework done in advance, know when to stop your bidding, and, if you have to, take a partner along to remind you of what you decided your maximum bid was going to be. 

Your homework should involve a drive by of the property at night.  See if the lights are on and there is movement inside.  This could mean that there will be a tenant in your property if you win at foreclosure, and you will have to go through a long and expensive eviction process.  Remember, even the former owner can become your tenant and continue not to pay you.  Also, after the foreclosure, you are responsible for the interest and taxes on the property from the date of the foreclosure sale.  The court might take 6 months or more to validate the sale and you are responsible for the costs of owning the property during this long period.  You may even have to pay for utilities from that point.  All these potential costs need to be a component of you cost estimates that make up your maximum bid. 

You also need to know when the property was purchased by the current owner.  This helps you determine the potential for equity in the property.  A short ownership period of 1 to 3 years is likely to yield no equity barring a large down payment.  You usually want to avoid these properties at the foreclosure auction.  So a long ownership period will likely imply more equity – say, 5 years or more.  These are not hard and fast rules, just indicators.   

You still need to look at the tax record to see the property assessment over time, and what the owner paid for the property.  Find the sale information from the local multiple listing service or an internet provider, comparable sales in the neighborhood, and rental data for the neighborhood.  This information helps evaluate the value of the property.  Here is where working with a licensed real estate professional can be very useful.   

Now you want to think about your costs.  The legal and settlement fees due for the foreclosure, potential upgrades to the property (carpet, appliances, kitchen cabinets, hardwood flooring, crown molding) and cosmetic fixes (paint, carpentry), potential structural problems, and the minimum discount off market value you expect ($10,000, $20,000?).  After all, if you are going to pay retail for the property at auction, you should be looking at properties on the regular real estate market.   

If all of these estimated costs equal $60,000 and the value of the property on the resale market is $200,000, you cannot bid more than $140,000 for the property no matter what those around you are doing.  Any amount over this limit eats into your discount (profit).   

Check back next week for more on bidding strategies, and what happens after you win the foreclosure auction.

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