Even though most experts expect overall home values to drop further, the time could be nearing for aggressive investors to pounce on residential real estate foreclosures. Among those with homes already reported in foreclosure proceedings: Ed McMahon, famed sidekick of the late Johnny Carson, and former heavyweight champion Evander Holyfield.
Blaring television ads in Florida call interested buyers to convention centers and hotel lobbies in major markets for vast residential real estate auctions. Two years ago, real estate auctions were frequently a tool of those seeking an added marketing twist in a sluggish market. Today, auctioneers move nationwide to sell the inventory of lenders and the excess inventory of condo developers and home builders.
Lenders and sellers (sometimes as part of the same institutions) are more receptive to lowering their prices. Don't always expect auctioned homes to go to the low bidder, though. Typically, winning bids still requires confirmation by sellers.
"Foreclosures have picked up in all markets," says Jack McCabe, a Deerfield Beach, Fla.-based real estate consultant. "In California, so far this year, almost one in three sales for the entire state have been foreclosures." Two in three sales were foreclosures in Sacramento and Stockton and in a section of Orange County. In many cases, McCabe says, properties are selling for 30% to 55% below retail value.
Nationwide, there are also growing opportunities for short sales, in which an interested buyer offers the seller less than the outstanding mortgage balance. Then the deal is presented to the lender. In many cases, banks, long reluctant to budge, are accepting those lower offers. Clients can often find these deals privately, on property signs, in ads or through real estate brokers. Borrowers who can convince the bank to forgive debt on a primary residence no longer owe income tax on the forgiven debt, thanks to the Mortgage Foregiveness Debt Relief Act of 2007.
McCabe concedes that in certain markets like Palm Beach, Fla., real estate prices are still breaking records. A beachfront home owned by Donald Trump was recently contracted to a Russian investor for a record $100 million. Even in wealthy Palm Beach, though, RealtyTrac.com recently listed four properties for auction and 21 in pre-foreclosure. Another six were bank-owned.
The National Association of Realtors reports that existing home sales-including single-family homes, townhomes, condominiums and co-ops-rose 2% between April and May. But they're 15.9% below May 2007. The National Association of Realtors may be the only forecasters to predict a rise in existing home sales into 2009. "Foreclosures and short sales appear to be a larger part of the market, particularly in California, and are creating a drag on current home prices," acknowledges Lawrence Yun, NAR's chief economist.
Although McCabe had been planning to get involved with an investor fund to buy up distressed properties, he says, that plan was put on hold. "Truthfully, the majority of the larger deals are still yet to happen," he believes. "Even though we've seen a ton of foreclosures already, the wave in the next year is going to make what's happened so far seem pretty minimal."
Real Estate Disposition Corp. (REDC) of Irvine, Calif., which claims to be the nation's largest real estate auction house, has been around since 1990. But it largely went dormant in 1996 and stayed that way until May 2007. "In the past 12 months, we sold over $2 billion of inventory," says Michael Jansta, senior vice president. That's close to 15,000 houses.
Priority at its auctions is given to those who obtain bidder numbers, which requires a $5,000 cashier's check made out to yourself and a picture ID. A 5% deposit is required of winning bidders. Financing with favorable terms is made available by lenders, Jansta says. The company holds a series of open houses in advance so that interested parties can carefully inspect properties. REDC suggests that potential bidders get prequalified financially. (More than 80% of those buying homes at auction are planning to live in them, according to Jansta.)
The winning bidder also must pay a buyer's premium of 5% of the winning bid amount. Jansta says that this is standard in a real estate auction, though that's not necessarily so, counters Tommy Williams, the president of the National Auctioneers Association, Overland Park, Kan., and a founding partner of another top real estate auction house. Williams' company, Williams & Williams, Tulsa, Okla., charges no buyer premium, he says. Instead, he gets paid by the lender. Unlike REDC, he conducts auctions at property sites rather than in large convention halls because he says it leads to better prices for his clients.
As Williams sees it, U.S. foreclosures in March 2008 were up almost twentyfold since March 2005. Even the nation's largest banks are starting to unload properties. "It might almost be up double from March 2007 to March 2008. It's unbelievable!" He figures that while the number of foreclosures nationally runs 150,000 to 200,000 monthly, the number being auctioned by the three largest houses-his, REDC and Hudson & Marshall in Dallas-runs only some 4,000 monthly.
The remaining foreclosed properties often sit empty, left to deteriorate, he says. Empty homes are taking a toll on neighborhoods, compounding the downward real estate price spiral. Price declines generally are proportional to the annual growth of a market and then some. So areas that saw prices rise 11% annually, saw prices drop 12% in 2008. Places like Tulsa, Okla., which always has had 2% to 3% appreciation annually, has had very gentle depreciation. Florida condos, he notes, have depreciated 50% from their high.
He says that so far, the foreclosure climate may be only slightly worse than it was in the 1980s, when the nation's savings institutions started dumping properties. But this time auctioneers have become more aggressive in their marketing and advertising.
Plantation, Fla.-based financial advisor and CPA Benjamin Tobias was planning a trip to Naples, Fla., in June, in search of a property on the state's Gulf Coast. He seeks both a getaway and a rental during the high tourist season.
Tobias says he hopes to find a condo in the range of $500,000 to $1 million, which he had learned was some 50% of what they were listed at four years ago. A realtor previously wouldn't have even talked with him in his price range. "That doesn't mean the price is a great buy right now," Tobias stressed. "The bubble was so severe."
Tobias spent hours trying to talk clients out of the risky business of flipping properties during the real estate boom. "We were very successful," he says. "Now we go back to the same clients and say, 'Hey. If you're still interested in (buying), now may be the time-especially rental property.'" He still thinks flipping is too risky.
Michael Dalton, a CPA and financial advisor in Stockton, Calif., says one client, who has been in the rental business for a number of years, was able to pick up rentals off the courthouse steps. But that client was very liquid, he says. For example, one of the rentals was less than five years old, and the client paid a little less than two-thirds of the price some one-and-one-half years ago. "He didn't know if we were at the bottom," Dalton says. "He thought the price he got was going to be good, holding it over the next five years or so. If you've got time to hold out at least for a five-year horizon, you should do well on these buys you're doing right now."
Dalton says his realtor clients became busy in December, getting multiple offers-primarily foreclosures and short sales. Banks realized a tsunami was about to hit, and late last year began getting realistic with prices, he says.
McCabe says hedge funds are buying distressed property, too, driving down prices.
But although foreclosure deals are getting better, experts warn the business is not for amateurs. Property taxes and insurance can dramatically add to costs-particularly on both coasts.
"Buy on the courthouse steps, and you can find the previous owner-unhappy at losing his home-has destroyed the interior, taking all appliances, and in some cases, even the kitchen sink," McCabe says. There have been cases of copper plumbing lines and other commodities stripped because of their scrap value. "The bank may not have kept the air conditioner on, so you have mold growing," he says. Swimming pools might be ruined.
Anytime you buy at auction, you need to make certain the properties are free and clear of all liens and encumbrances, he stresses. Title searches are essential. In some cases, vendors may have placed mechanic liens on the properties.
McCabe says clients often are safer buying from the bank because banks generally take care of these issues. Also, "If you buy in a neighborhood or condo building that has a lot of other foreclosures, you may think you're getting a great deal," he says. "In fact, prices may continue to drop over the next couple of years."
Even if the building is nice, a client could be subject to a future assessment if home owners aren't paying dues. "Study the neighborhoods," McCabe advises, "not just the property, but everything going on around it."
Check the licenses of auctioneers and real estate agents. Although this might seem like a routine step, Thomas O'Bryant Jr., director of the Florida Division of Real Estate, says unlicensed activity is so widespread that he has investigators on his staff dedicates strictly to unlicensed activity.
Often, those auctioning real estate must at least have a real estate license, and in some states, an auctioneer's license may be needed, too. Fraud is another issue that needs to be considered everywhere-even if a client's deal seems legitimate. Investors should take their cue from the state of Florida's recent actions.
On July 1, Florida adopted two laws that you might not think would necessarily affect investors. Yet, they well could. One deals with mortgage fraud issues and the other deals with foreclosure fraud.
O'Bryant says it was too soon to determine what impact those new rules might have on investors, but one thing is certain: The state is bent on halting mortgage fraud, which often is perpetuated by inflated appraisals and by appraisers using those inflated prices in comparables to inflate prices further. The state also is concerned about the rights of consumers whose homes are in foreclosure.
"If you are an investor and you're going to look at property, you better check the sales record for that piece of property quite a ways back," he advises. On the mortgage side, pay attention to the real estate appraiser. "It's very difficult to separate the players between mortgage fraud and foreclosure fraud."
No matter what state you are dealing with, don't expect real estate deals to happen quickly if mortgages are involved. It can take as long as six months to track down a lender who currently owns a seller's note. Plus, there can be more than one owner.
Clients may have a tough time finding a bank to lend on a condo hotel or even a condo. Cash talks. Banks also may not make loans if there are a certain proportion of rentals or foreclosures in a development.
Published reports have indicated that buyers, over their heads in debt, are abandoning their homes to buy lower-priced property. Dalton says he has seen this in California-particularly with unmarried couples living together. The owner of the old house abandons the property, and his partner buys the new one.
It's "the old buy and bail," agrees Tom Pool, spokesman for the California Department of Real Estate. "The problem: If you make willful misrepresentations to a lender, it's considered fraud."
There have also been reports of tenants getting evicted by lenders when landlords went delinquent on mortgages-even though the tenants had a lease and faithfully paid rent.
In addition, Pool warns that, at least in California, "rent skimming" is a misdemeanor: Someone can't acquire a property, collect rent during the first year, and fail to use it to pay all or part of a mortgage.
Growing Investment: Distressed Mortgages
Seven-foot-plus NBA basketball star Shaquille O'Neal wants to buy up home mortgages of Floridians facing foreclosure.
Curtis Cooper, a friend of O'Neal who is involved in such deals, is a real estate agent and licensed mortgage broker. He says he has been doing these sorts of deals since 1994, as have other real estate agents who specialize in short sales.
O'Neal's program would be different from others, however, because most others fail to cut the loan balance to the borrower, Cooper says. By contrast, O'Neal truly hopes to help distressed borrowers by reducing their debt and their costs.
However, Jack McCabe, Deerfield, Fla.-based real estate consultant, said that other "savvy investors" have already embarked on similar deals. It's a growing trend to buy packages of mortgage notes from lenders and work out mortgages directly with home owners. Investors are already dropping mortgage balances to distressed borrowers, he maintains.
McCabe says investors will buy a package of, say, $100 million of mortgages from a bank for 38 cents on the dollar or $38 million.
They'll analyze each mortgage and figure out which are savable. Then they'll call the borrowers and lower the principal and interest rate. Say the principal is $300,000. They might drop it to $200,000. In addition, an adjustable rate of 8.75%, for example, might be lowered to 6.25%-the borrower's original start rate.
Even though this is a risky proposition, investors using this strategy are still apt to be in a positive position. Then those loans that are unsavable and nonperforming can be packaged into a separate tranche and sold for less than the 38 cents on the dollar paid.
McCabe expects even better opportunities for buying mortgages as federal bank regulators pressure banks to move nonperforming loans off their balance sheets.
"Right now, and for the near future, there's incredible opportunity in residential (mortgages)," McCabe says. "However, you can make a strong case that we also are overbuilding the commercial sector in a number of U.S. markets. Many analysts see a bubble beginning with a number of U.S. markets beginning in 2009."
Gregory Seals, CFA and director of fixed-income behavioral finance for the CFA Institute in Charlottesville, Va., doesn't believe these deals will affect a large portion of the mortgage market.
That's because most subprime mortgages are in structured securities, which are subject to terms that would be difficult to modify.
"It may be viewed as an attractive investment for some individuals, but not on the large-scale types of trades I've seen across the market," he says.
"It's very much at the risky end of the spectrum," he adds. "Whether it works as intended depends on the fact that people don't default on those mortgages and you help them to stay out of default."