Today, we continue our series on the “10 Commandments of Foreclosure“.  (See Part One Here) (See Part Two Here). Not written in stone, but you ignore these rules at your peril:

1. Know thy Process
2. Know thy Property
3. Know thy Title
4. Know thy Parties
5. Know thy Occupant
6. Know thy Judge
7. Know thy Repairs
8. Know thy Exit Strategy
9. Know thy Buyer
10. Know thy Closer

We covered #1-#3 in Part One.

#4-#6 was addressed In Part Two.

Part Three (this post), covers #7-#10 (Repairs, Exit Strategy, Buyer and Closing).

When we are done with this series, you should be fully prepared to bid at a foreclosure sale… or you should be too scared to bother.

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PART THREE

#7- Know thy Repairs

Estimating repairs is the single most important profit factor… and helps determine your maximum acquisition price.

How to Estimate Repairs

First, be honest about the extent of repairs needed to flip or rent a home.  That is really the most critical step in your estimating process.

Honesty means you are looking at the repairs from your end user’s viewpoint.  You never want to leave something undone that turns a buyer off.  But on the other hand, you don’t want a bunch of upgrades that won’t increase the value to that buyer.  You can’t be an optimist, or your budget gets trashed when reality hits.  But a pessimist will never buy a house, because every deal looks bad.  You need honest, realistic, end-user based estimates.

Make sure the repairs or improvements you are looking at are justified by the property.  I love the patina of hand-scraped wood floors….  but I’d be insane to put them in a rental house.  At the same time, upgrading laminate counter-tops to granite might be just the ticket to sell a high-end house.  Again, the key is to focus on the expectations of your end-user.  NOT what you would want if you lived there (CLASSIC rookie mistake)– but rather what your buyer or tenant wants to see.

Add for Contingencies

What are contingencies?  The unexpected things.  The hot water heater that doesn’t heat.  The pool pump that craps out the day of closing.  The mold the last owner painted over.    The amateur wiring up in the attic.  The surprise things that pop up, despite your best efforts to put together a realistic budget.

The other contingency to budget for is the basic tendency of contractors to over-promise.  It always seems to cost more and take longer than they originally thought.  Especially when they realize you are new to the game.   But even with the most honest contractor, every job is going to contain a few hidden surprises.

When we estimate repairs, we automatically tack on an extra 10% for contingencies on new construction (less than 10 years old) and about 25% for older homes.  This covers most of the surprises that were lurking beneath the surface, provided we did a good job of being honest about what repairs went into our initial budget.

Contractors vs DIY

Until you have been doing this a while, you will pay at least 25% more for contractors and laborers than someone who does this full time…. AND it will take twice as long.  When we call our AC guy, we are asking him to put in three new units this week.  Our electrical contractor is going to one of our job sites every week.  So whose call is the electrician returning first? A first time customer asking about a price quote… or the guy who is making his boat payment?  The best price is always going to the loyal, proven repeat customer.

Contractors are expensive.  So lots of investors are tempted to do it themselves.  But doing it yourself can be even more expensive that hiring a pro.  Sure, there are some things where a little sweat equity might pay off… painting or putting out mulch. And for your first few houses, doing all the work can be a source of pride and accomplishment. But even if you are experienced AND competent, is it really the best use of your time?  Or would you be more productive hiring someone else to paint so you can concentrate your time and energy on finding the next house you want to buy?  If you enjoy doing rehabs, then by all means, knock yourself out.  But time is money too.

Also consider the impact of permits, insurance, compliance with code… all things your pro will take care of for you.  And consider the liability… the waiting lawsuit… if something isn’t done right.

Repairs determine acquisition price

When I am bidding on a foreclosure house, I pretty much know exactly how much the house is going to sell for once it is fixed up… and so do all the other experienced investors (we are all likely within 3% of each other).

And of course I know my minimum required return to be involved in a deal.

So that leaves just one variable: repairs.

If I plan on rehabbing and flipping a house, I’m going to base my maximum foreclosure sale bid price on what I think I can sell the house for once I’ve fixed it, less any expenses I plan on incurring, less my required profit.  Easy math.

So if we are bidding against each other and we have the same notion of value and repairs,  and we both plan on rehabbing and flipping, we are really just bidding to see who is willing to take less profit on the deal.

That repair number is really the most important factor in the equation, and even experienced investors will have wildly different estimates on repair bills.  I’m not often wrong on the value of the home, but my repair number is often way off base.  Sometimes too high… sometimes too low.  And errors either way cause problems.  If I overestimate the repair costs, then another investor is buying that house at the sale.  If I underestimate repairs, I make less than I needed.

Extras

Years ago, I read an article by lawyer/investor William Bronchick that he now calls “10 Easy Ways to Spruce Up your Rental or Rehab“.  Great read.  We swear by this list…. we always look at each of these as possible extras when doing a rehab.  These are things that rarely NEED to be done, so they are easy to overlook when estimating repairs.  But the money spent on these extras always pays dividends when your first buyer or tenant walks into the house.

1. Replace electrical plates
2. New six-panel interior doors
3. New door handles
4. Paint trim
5. New front door
6. Tile Foyer Entry
7. New Shower Curtains
8. Paint kitchen cabinets/New faucet
9. Add shutters
10. New mailbox

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#8- Know thy Exit Strategy

Begin with the end in mind.  Always good advice.  So what are you looking to do with this house you are buying at the foreclosure sale?

Once you buy the foreclosure for cash, what is your exit strategy… your end use?  Different investors might specialize, or you may be open to multiple end uses, such as:

• Flipping Wholesale
• Flipping Retail
• Renting
• Lease Option
• Contract for Deed
• Owner Finance

It’s a good idea to know what other investors are primarily interested in doing with the homes they buy.  You may find a bargain outside the sale that is perfect for the foreclosure investor who likes rentals.  More importantly, it helps explain why someone bidding against you thought the property was worth a lot more than you did… they may have a different end use.

I have four different exit strategies when buying foreclosures, which give us a fair amount of flexibility (especially when bidding against other investors interested only in a quick flip):

• flipping to other investors who want to do the rehab (wholesaling),
• rehabbing and flipping to an end user
• rehabbing and renting
• rehabbing and selling to a buyer who needs owner financing.

Obviously, the exit strategy for a specific property depends on the age, condition, neighborhood, needed repairs, etc.  But we always know our exit strategy BEFORE we bid on the house.

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#9- Know thy Buyer

Who is going to buy or rent your house?  What are they looking for?

Take the time to picture your typical buyer or tenant for a particular house, preferably before you buy it, but at the very least, before you start working on it.

• What repairs, improvements, upgrades or extras will they expect?
• Do they care about local schools, nearby shopping, public transportation?
• Will your buyer shop on their own or through a realtor?
• How does your buyer make the decision to buy?
• How are they financing (Conventional, USDA, FHA, owner financing)?
• What concessions or costs will they need?

Obviously, you are not going to discriminate against someone other than your typical buyer.  You aren’t going to exclude anyone.  But by targeting your rehab and marketing to your intended audience, you stand a much better chance of making them happy.

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#10- Know thy Closer

Most people refer to the person at a title company or law firm who handles the contract closing paperwork as the “Closer” or “Closing Agent.”

But my definition of a “Closer” is anyone who can make or break a deal.  Here are a few of the people involved in the sale or leasing of your rehabbed property:

• Listing Agent
• Selling Agent
• Home Inspector
• Appraiser
• Mortgage Broker
• Mortgage Lender
• Mortgage Underwriter/Guarantor
• Title Underwriter
• Title Agent or Lawyer

Any one of these people can scuttle your deal… or help make it go through.  As an investor, you need to know what each of these people are looking for in the process.

A closing has many working parts, and getting everyone involved to work together ultimately falls on the shoulders of the person selling the home.  After all… you don’t get paid if just one thing goes wrong.

So get to know ALL the closers, anticipate what they need, and make sure they have what they need to move your deal on to the next step.

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Today, we continue our series on the “10 Commandments of Foreclosure“.  (See Part One Here) (Part Three Here). Not written in stone, but you ignore these rules at your peril:

1. Know thy Process
2. Know thy Property
3. Know thy Title
4. Know thy Parties
5. Know thy Occupant
6. Know thy Judge
7. Know thy Repairs
8. Know thy Exit Strategy
9. Know thy Buyer
10. Know thy Closer

 Part One covered #1-#3

This post (Part Two) covers  $4-#6

Part Three cover s#7-#10. 

When we are done with this series, you should be fully prepared to bid at a foreclosure sale… or you should be too scared to bother.

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 #4- Know Thy Parties

Judicial foreclosures have at least one Plaintiff (the party bringing suit) and one Defendant (the party being sued).  But often there are many names on both sides of the case.

PLAINTIFF SIDE

On the Plaintiff side, you might see:

• The lender
• The successor in interest
• The servicer
• The nominee
• The trustee
• The certificate holder
• The securitization pool number, etc.

All of this is valuable information.  But primarily, you just want to know the party bringing the foreclosure has the legal right to collect.  When you do your title search, you will usually find the Plaintiff bringing the lawsuit is not the lender on the original note and mortgage (credit unions and small local banks are the primary exceptions).  The first step in your title search is to link the original lender to the party foreclosing.  This can get very confusing, but it is critical to ensure you are buying a property that has been properly foreclosed.

Think about your own home loan.  You may have gone to your local bank, closed on a loan… then that loan was sold within hours.  The next month, you got a notice to send your payment to a servicing company… a different company than the one that bought the loan from your bank.  And that servicer may have then been acquired by another company, and you suddenly had to send the payment somewhere else.

Well, things were WAY crazier with the low quality, high risk loans that proliferated during the boom (and which still make up the majority of foreclosures).  Go read about collateralized debt obligations, mezzanine tranches, GSEs and  credit default swaps, and you might see why the big banks started playing shell games with the mortgage note.

Despite these bankster shenanigans, you have to track the note from the party bringing suit all the way back to the original loan.  If the assignments are not recorded in the official records at the county level, they might be in the court file as an attachment to the complaint or motion for summary judgment.  Or they may not exist at all, in which case the judge never should have signed off on the foreclosure sale.  Shockingly, when you ask a judge to handle several thousand additional cases a year, some things fall between the cracks. 

If you don’t see a trail of ownership on the note, proceed with caution.  We’ve taken the gamble before, and been able to track down the right documents later… but that’s incredibly risky.  Sometimes you can connect the dots without recorded assignments– if you have a working knowledge of which banks are successor by merger or acquisition to other banks. GMAC is now Ally.  IndyMac is OneWest.  Wachovia is Wells Fargo.  And so on….

One plaintiff name you won’t see as often as you did a couple years ago is MERS (Mortgage Electronic Registration Systems).  Back in the early 1990s, the banks created MERS as a “nominee”, so they could get around the traditional assignment recording requirements at a county level.  The basic idea was lenders could buy and assign notes as part of their pools without having to record the assignments.   Then MERS would simply file the foreclosure if required.  Shockingly (heavy on the sarcasm there) the big banks misused MERS, and as the inadequacies of the model were exposed, states started requiring the actual lender or servicer of the note to bring suit as the Plaintiff.  But you will still see MERS named as a defendant on second mortgages pretty regularly.

You will also learn, with time and experience, which Plaintiffs tend to discount foreclosures below the judgment amount.  After months of spreadsheets, I gave up  trying to predict which Plaintiffs will discount with any precision.  But over time you will start to spot trends.  Keep in mind a single servicer might represent numerous investor pools, and every pool has a different set of discount guidelines– the same reason mortgage modifications and short sales are a huge time suck.  Even when the servicers and pool are identical, you may have different asset managers just making different decisions.  The BPO may have come back on one property and not another.  Or the foreclosure attorney forgot to give the bidding representative updated numbers. So you will get used to seeing two similar properties, with the same plaintiff, and the bank bids all the way to full judgment on one case, while discounting heavily on the next.

Defendant Side

On the Defendant side, you might see:

• The Borrower
• The Borrower’s spouse
• The Tenant
• Jane Doe/John Doe (unknown)
• Estates/Guardian/Successor
• Lienholders/Creditors
• HOA/Condo association

On the Defendant side, you start by making sure anybody with an interest in the property or a lien against title has been included in the lawsuit.  If your title search shows a lien and the lienholder is not a defendant, that lien is not getting wiped out by the foreclosure.  If the property is owned by a husband and wife, and the wife isn’t named… you have a problem.  Buy that property at a foreclosure sale and you do not have marketable title.  You can’t sell the property with title insurance (which eliminates flipping to somebody borrowing money).

The sneakiest of these liens is when the first mortgage and second mortgage are held by the same bank.  The bank doesn’t have to name itself to wipe out the second mortgage if it already owns the second mortgage– the two loans can simply merge when the bank marks the second mortgage satisfied.  But if YOU buy the property at the foreclosure sale… well you don’t own the second mortgage, now do ya’?

On the other hand, you will often see the same bank as both Plaintiff and Defendant– why would that happen if they can just disregard a second mortgage?  Well, if the bank services the first mortgage for one pool and holds the second mortgage on its own, the bank is required to wipe out its own second mortgage to give clear title to the owner of the first mortgage that it services.  Yup— often the Plaintiff is hurting its own interests to fulfill its fiduciary obligations to a client (You are not permitted by law to feel sorry for them, though…).

You also want to carefully note any tenants listed as defendants, as tenants have a variety of protections under federal, state and local laws, as discussed in the next section (Know thy Occupant).

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#5 – Know Thy Occupant

Ideally, you pull up to the house and see a “Field Asset Services” sticker on the window or garage door telling you the property is being maintained …. and it’s vacant.  The house is empty, the carpets are vacuumed, the yard is mowed, and the key you took from the lock-box on your last foreclosure purchase fits the lock on the front door.  Perfect.

For the past few years, that actually happened more than you would expect.  Now, things have changed.  Increasingly, the banks are keeping the cream-puffs to sell on the REO market.  They discount the crappy houses at the foreclosure sale.  They also discount the occupied houses.

If the house is occupied, the next step is to determine if it is occupied by the owner, a tenant, or someone else.  Your occupant determines how long it will take to get possession of the property after the sale.

• Owners.  Usually pretty easy to kick out.  Depending on your judge.  Some judges require a separate case to evict any occupant.  Others will automatically issue a Writ of Possession to kick out an owner, since they have already gone through the process.  IF they don’t file an appeal, a bankruptcy, a sale objection, etc.

• Squatters.  Happens more than you would think.  People move into an abandoned house, pay no rent, but don’t seem excited about leaving once you buy the house.  A surprising number of Squatters think they get the same protection as a Tenant.  And a surprising number of judges don’t seem to understand the difference either.  Your mileage will definitely vary with Squatters.

• Tenants. Tread with Extreme Caution.  Used to be, tenants got kicked out just like owners.  Not any more.  In 2009, Congress passed the Protecting Tenants at Foreclosure Act.  Then in 2011, the Dodd-Frank Act amended and clarified the Act.  Tenants also may have state or local rights (or even judge-specific rights with no basis in any law….).  This is a complicated topic, deserving of its own  post… or more likely its own textbook.  But the quick version is that “bona fide” tenants get at least 90 days notice before eviction.  Tenants with a written lease get the entire term of their written lease.  So you might think you get the house immediately as the new owner.  Not true if you have tenants in place.

So how do you know who is occupying the home? Ask.  Knock on the door and say “I was wondering if the home is occupied?”  The answer to that is always a puzzled look– I came to the door didn’t I?  Then ask “are you the owner”?  Tenants will tell you right away they rent.  Owners may waffle a bit, but usually tell you they are the owner. 

I know…. you can’t imagine a stranger knocking on your door and getting a polite answer from you.  But the owners and tenants of foreclosure houses know “the knock” is coming.  Sure, you can call the electric company, talk to the neighbors, or do some online research.  But asking is a lot simpler.

While you are talking to the occupant, what else can you find out? What shape is the home in?  Any major problems?  Ask a tenant what the landlord hasn’t fixed that is really bugging them…. and expect an earful.  Landlords who keep collecting rent during a foreclosure have a nasty tendency to put off all repairs and maintenance.

We also ask occupants if they are aware of the foreclosure  sale and what their plans might be.  Just to see if they lie.  And a bunch of people do lie. When the occupant of a foreclosure house tells you they don’t know anything about this foreclosure thing… that’s a lie.  You  just can’t ignore the volume of legal documents getting mailed to the house and posted on the front door.  The occupant who lies to you about even knowing about the foreclosure is going to require extra effort to evict later on… count on it.

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 #6- Know thy Judge

I don’t mean you have to be friends with the judge.  I mean you (or your lawyer) have to know how a specific judge will react to certain situations and arguments. And I want to know who our judge is on a particular case BEFORE I buy the property at the foreclosure sale.

Here’s an example of why I want to know the judge assigned to the case. In our judicial circuit, one judge handling foreclosure cases automatically has the Clerk of Court issue a Writ of Possession, without further court order, as soon as the Certificate of Title is issued.  With this judge, tenants have to go to court and obtain an order to stop the possession action, otherwise it happens automatically.  And this judge doesn’t readily give the benefit of the doubt to someone who has already received umpteen notices about the foreclosure case over the past two years.  So in all but rare circumstances, we have automatic possession of the home within several days of getting title.

However, a different judge, in the same circuit, will not allow the Clerk to issue a Writ of Possession until the buyer of the foreclosure property files a motion, and the judge holds an evidentiary hearing. And then this particular judge is very sympathetic, labeling anybody in the home a Tenant, entitled to at least 90 days notice, even if they don’t meet the definition (you know…. somebody who is actually PAYING RENT…).  So you may not get possession of the home you bought for 3-4 months after you expected.  Hope you weren’t actually trying to make a profit on that foreclosure…

Same circuit.  Different judge.  VERY different results.

We also often face objections to the sale.  The borrower has one last chance to save their home, and they use it regularly.  In Florida, the law allows 10 days for pretty much anybody associated with the case to object to the sale.  Legally, the objection is supposed to be about a technicality of the sale itself- like the published notice had the wrong date… or wasn’t published at all. In practice, the borrower isn’t objecting with a valid reason… they are just buying time.

Again, different judges will deal very differently with these objections.  One foreclosure judge in our circuit will overrule a defendant’s objection the same day it hits his desk… no response needed, and no delay at all in getting title or possession.  But another judge requires a hearing on every objection, and for some reason this judge’s docket is always full (with objection hearings?)  So depending on the judge, you face a delay of a month… or no delay at all.

Different judges will give you very different results. Judges have wide latitude and discretion in deciding the issues involved in a foreclosure case, because these are cases heard in equity.  So a judge’s sense of fairness really comes into play.   And the judge assigned to your case can be the difference between making money and losing money on a particular property.  So know your judge.

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SUBSCRIBE NOW AND DON’T MISS:

10 Commandments of Foreclosure –PART THREE–

#7- Know thy Repairs

#8- Know thy Exit Strategy

#9- Know thy Buyer

#10- Know thy Closer

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