(This advanced blog summarizes real estate investing tips and insights Lofty AI has acquired from working with thousands of investors and institutional funds.)
What does pre foreclosure mean?
A pre foreclosure home is a distressed, off-market property that has yet to be repossessed by a lender and sold at auction.
Pre foreclosures are typically still occupied by their owners who have fallen behind on monthly mortgage payments.
Seasoned real estate investors will often target desperate owners in pre foreclosure, pay the amount owed by the owner to their lender, and then buy the off market property directly from the owner for a steep discount.
When a pre foreclosure house is listed on the market for sale, it is called a short sale, not a pre foreclosure.
Most pre foreclosure homes are not listed for sale
Real estate investors love buying pre foreclosure homes for two main reasons:
Pre foreclosures are off market properties and are not listed on the ML, meaning less competition from other buyers
Since pre foreclosures are usually sold below market rates, they tend to be exceptional deals
Now that you know what a pre foreclosure house is, let's walk through the steps you should take to successfully buy pre foreclosure homes.
1. Neighborhood analysis
The first step to take before learning how to buy pre foreclosures, is to make sure you're looking for pre foreclosure homes in the right neighborhoods.
Investing in the right neighborhood allows you to capitalize on appreciation. It can make the difference between achieving normal returns and achieving exceptional returns.
When searching for neighborhoods primed for appreciation, you want to look for a few signs:
Trendy retail like coffee shops and juice bars
Airbnb nightly rates spiking alongside an increase in 5 star reviews
Artists & hipsters
2. Find leads
If you are interested in buying pre foreclosure homes, you first need to generate potential leads.
There are a few common methods for finding pre foreclosure leads, but they're much more manual.
These manual methods include:
Driving around for hours - Investors will often drive around searching for signs of a motivated seller. Signals they'll look include newspapers piling up in the front yard, an overflowing mailbox, a neglected front lawn. All of these signs point to the fact that the owner doesn't care much about their property, and is probably motivated to sell for less than market price.
Direct mail and email campaigns - This involves putting together a list of potential sellers found through public records found at their local county assessor's office. Real estate investors look for certain kinds of information to help determine a motivated seller. These hints include the recent death of a joint tenant, owner is of old-age, the owner lives out of state, absentee owners, and the property has been on the market for a significant number of days. There are many issues with using public record data to find leads. The main issue being that they're infrequently updated and everyone has access to them, so there's no competitive edge. Once investors have a list of a couple thousand leads, they'll then send out letters and emails asking them if they're looking to sell their property. A 1% response rate is considered a successful campaign. That should tell you everything you need to know right there.
Cold calling - Similarly to direct mail campaigns, some investors will go through public records, compile a list of potential motivated sellers, find their phone numbers, and cold call them. As you can imagine, this converts at a similar rate as direct mail campaigns.
These lead generation methods, as I'm sure you can tell, are manual and outdated.
How to find leads instantly
Lofty AI lets you discover motivated sellers in 40 US markets in seconds.
We do this by automatically sifting through property page listings in search for specific keywords included in the listing descriptions.
We've found that when any of these 100+ keywords are included in the listing description, properties usually sell for much less than they were originally listed for.
A few examples of these keywords include:
Bring all offers
Owner will carry
Many agents will include keywords like these to try and be sneaky about the underlying issues of the property.
What they don't realize is, they're giving away crucial information telling us their client is desperate to sell.
Most people don't know to look for these keywords, let alone automate a process that instantly searches for these keywords on every single listing.
3. Perform due diligence
Once you've found a pre foreclosure property you're interested in, you'll want to do your due diligence.
When conducting due diligence for a pre foreclosure property, especially if it's distressed, you want to make sure to be extremely thorough –– much more than you would be for a listed turnkey property.
These properties are in pre foreclosure for a reason. The last thing you want is to skip a few due diligence steps and find yourself in a worse position than the original owner you bought the property from.
Due diligence falls into 3 categories: Financial, physical and legal.
Financial due diligence
The first step, which may seem obvious, is to make sure you have enough funds to make the down payment and pay the monthly mortgage payments.
For pre foreclosures, you probably won't be able to get a conventional loan (mortgage). Because of that, you'll want to find a hard-money lender that you trust to acquire a loan.
Make sure you get a copy of the past year of utility payments and other expenses.
Make sure you receive a copy of the lease & rental history.
Conduct diligence on the tax history of the property.
Physical due diligence
The first step of physical due diligence is a home inspection. Unless you're a very, very experienced investor, you're going to want to hire a professional. Although things might look okay, there are potential foundation issues, mold, and other problems you may not uncover which can turn a great deal into a nightmare deal.
You should typically expect to perform minor cosmetic renovations. These aren't a big issue, as it’s the bigger-ticket items you want to look out for.
These expensive items include the HVAC, foundation, and roof.
Major repairs like this can have a huge impact your cash flow, so you want to find out about them as soon as possible.
Legal due diligence
You want to make sure there aren't any liens or judgments placed against the property you're interested in.
If you miss a lien, and you end up purchasing the property, it becomes the new owners responsibility –– which is now you.
You may want to consider hiring a professional title company to perform research on the title and ensure it is free and clear. This is a guaranteed way to make sure you won't miss anything and is highly recommended.
You do not want to take legal due diligence for granted especially when buying a distressed property.
4. Get a loan
Before you buy a pre foreclosure property, you need to get a pre-approval letter for a lender.
This letter will show you what your maximum borrowing amount is.
A pre-approval letter also gives the seller of a pre foreclosure an indication that you are a qualified, serious buyer. Most agents will not even want to associate with you if you don’t have this letter.
When buying pre foreclosures, instead of making the conventional down-payment, you’ll instead cover what the current homeowner owes.
That means you’ll be responsible for the loan balance, any potential liens on the property, and any unpaid mortgage and homeowners insurance.
You’ll pay those funds to the seller of the pre foreclosure home and take over the property from them. This process always goes more smoothly if you're able to pay fully in cash.
If you aren't able to pay in cash, you'll need to take out a hard-money loan as you will most likely not be approved to buy a pre foreclosure with a conventional loan
What is a hard-money loan?
Hard money loans are different from conventional loans (mortgages) in that they're secured by the property itself.
Conventional lenders are more concerned with the borrower's credit score and income
Conversely, hard money lenders are less concerned with a borrower's credit score and income, and rather with the property’s profitability.
The profitability of a property is estimated by utilizing the after repair value (ARV).
ARV = how much a property will be worth after it's been rehabbed.
It's much easier to qualify for a hard money loan than it is for a conventional loan.
Another plus is that you're typically able to get a hard money loan in a matter of days compared to a conventional loan which can take a few months to get approved.
Despite the quicker turnaround, hard money loans are substantially more expensive than conventional loans.
Hard money loans can go up to an 18% interest rate and you generally have to pay them back within a shorter period of time as well.
5. Make an offer
The final step to buy a pre foreclosure is to actually put an offer in on the home.
The most straightforward way to buy a pre foreclosure property is to actually pay the amount owed by the current owner to their lender, and then buy the home directly from the current owner.
Often times, sellers of pre foreclosures will be taken advantage of by more seasoned investors. This is because because most sellers don't actually know how much their home is worth on the open market.
Experienced investors will typically try to buy pre foreclosures for significantly less than the market value by low balling the seller.
Because of this, certain laws have been put into place allowing the seller of a distressed property the right to back out of a sale even after they reach a deal.
These laws differ from state-to-state, so you want to make sure to look into that as part of your diligence process.
Once you've closed on a property, there are a few steps you should always look to take.
Many investors will skimp out on these steps, and it usually works out for them. But, all it takes is one bad situation to completely flip your life upside down for a period of time.
Here are the steps you should take immediately after closing on a property:
Change the locks - Don't assume that the only pair of keys for the property was given to you by the owner. It's entirely possible that one of their family members or friends also has a key, and the last thing you want is ta stranger casually strolling into your new property during the middle of the night.
Transfer the utilities to your name - The utility payments will still be under the previous owner's name until you transfer ownership to yourself. You better be sure the previous owner will be cancelling utility payments for a property they don't own anymore, so make sure you make the transfer as soon as possible.
Rehab immediately - If you're going to rehab your property, take care of it right away. Don't procrastinate, as the issue you're looking to fix may get worse over time and you'll have to pay even more because you decided to wait.
Buying a pre foreclosure home is a great opportunity to pay lower-than-market price for a property.
You'll also face less competition than if you were looking to buy a foreclosed property at an auction, because you'd be bidding against other investors.
If you're a first time investor, you're going to want to learn the ropes before diving into distressed pre foreclosures.
There's a reason that buyers of pre foreclosures are almost always seasoned investors.
To be successful, you need in-depth knowledge of the industry, negotiation skills, and cash-on-hand.
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