Buying distressed or foreclosed real estate at a discount and then either fixing and flipping or renting it out as a long-term income property is a tried and true investment strategy for both conventional real estate investors and real estate IRA owners. Real estate IRA owners have the advantage of tax-deferred rental income (within a traditional real estate IRA) or tax-free income (for Roth Accounts.)
But it’s getting trickier in recent months for real estate IRA investors in many markets to find a promising deal at a meaningful discount to intrinsic value – one of the keys to long-term profits at acceptable risk, according to no less an authority than Warren Buffet, chairman of Berkshire Hathaway and one of the most successful investors in history.
The reason things are getting dicey: As the economy improves, the supply of distressed and foreclosure deals is drying up. Fewer people are losing their jobs, more people are getting back to work, and naturally fewer homes are falling to foreclosure, and fewer homeowners are forced into short sales. Banks are also less likely to agree to short sales, because they are more assured of getting a decent price for them if they go to auction.
In all, distressed sales, including foreclosures, short sales, third-party foreclosure auctions and direct SEO sales now comprise 12.5 percent of all home sales, as of the end of the third quarter. That’s the lowest level we’ve seen since Q3 2007, according to the Q3 2017 Home Sales Report from ATTOM Dada Solutions.
So it’s critical for real estate IRA owners to understand this and go into an auction with all their ducks in a row. Here’s why:
- Discounts are narrower. This means that auction participants have to bid higher prices to pick up properties.
- Less margin for error. A few years ago, foreclosure properties were selling at relatively large discounts compared to the level of expenditures needed to bring them up to a rentable condition, or to prep them for sale to a retail homebuyer. That left a comfortable margin for mistakes. If you anticipate spending $10,000 to fix a new investment property up and the real number turns out to be $20,000 by the time all is said and done, you wouldn’t be happy about it, but at least you still had a fighting chance to make at least some money on the deal. In today’s market, making a mistake like that can mean the difference beween profit and loss.
- More competition for a limited number of properties. The total number of distressed/foreclosed properties is down. But there are still lots of investors out there bidding on them! When you show up to an auction, you may find quite a number of other bidders there. The more bidders there are, the more you will have to sweeten your offer, in most cases, in order to maximize your chances of winning the deal.
If you’re out there bidding on foreclosed properties in this environment, consider making these adjustments to improve your odds of bidding and winning on quality properties at a reasonable price.
- Show up with proof of funds. Either have a cashier’s check from the bank or a letter verifying funds ready to go when you come to the auction. If you win the bid but can’t prove you have funds that same day (and in many jurisdictions by lunchtime that same day), the auctioneer will cancel your bid and contact the next highest bidder.
- Be ready when the high bidder backs out. Sometimes the high bidder can’t show proof of funds, or gets cold feet for some other reason. In any case, be ready to answer your phone for a few days after the auction – especially if you’re the number 2 or 3 bidder.