A Window of Opportunity: Should You Invest In Foreclosed Property This Year?
The COVID-driven real estate boom of the past few years may be coming to an end, but this doesn’t mean real estate investors are doomed. On the contrary, they simply need to shift their strategies. With the right approach, savvy investors will still be able to find investment-worthy properties that result in the rates of return and passive income real estate investors love to see.
When it comes down to it, seasoned real estate investors know that economic conditions are changing all the time. And while real estate markets are typically less volatile than other asset classes like stocks and bonds, the best investors know that adapting to changes in the market is a source of opportunity rather than catastrophe.
So as interest rates rise and home prices remain relatively high, where can investors look for their next deals? I believe that based on a few recent policy changes and the economic outlook for 2023, a window of opportunity is opening for real estate investors who are prepared to take on the challenges and rewards of foreclosed properties.
Are Foreclosures on the Rise?
While we don’t yet have foreclosure data for 2023, foreclosure filings in 2022 increased significantly from 2021. ATTOM, one of the nation’s leading providers of real estate data, revealed in their Q3 2022 U.S. Foreclosure Market Report that foreclosures were up 104% from Q3 in the year prior. Meanwhile, foreclosure starts in Q3 of 2022 increased 167% from Q3 in 2021.
The most recent data we have on foreclosure activity is from November of 2022, which shows that 30,677 properties in the U.S. experienced some state of foreclosure in that month. This is up 57% from November of last year, but down 5% from October of 2022.
While these numbers may seem shocking, they don’t signify a housing bubble. Instead, the reason for this seemingly drastic increase is due to the fact that pandemic-related foreclosure moratoriums and mortgage forbearance options have ended.
In fact, the data reveals that foreclosure activity is simply returning to pre-pandemic levels. The states with the highest foreclosure activity in 2022 include my own home state of Illinois, Delaware, New Jersey, South Carolina, and Ohio.
For investors accustomed to holding foreclosed properties in their portfolios, this is good news. And while foreclosures are always unfortunate, they do offer unique opportunities to real estate investors who don’t mind putting a little (or a lot) of extra TLC into their investment properties to generate rewarding returns.
What Is Foreclosure Investing?
Homeowners face foreclosure if they can no longer make payments on their property. Whether due to job loss, wage reduction, or an unaffordable interest rate hike, there are a myriad of reasons why property owners can no longer afford their homes. Once they stop making payments, lenders put their collateral back on the market to recoup the loan balance they’re owed.
Most often, lenders will want to dispose of the property as quickly as possible, resulting in steep discounts on the purchase price. These low prices are exactly why some real estate investors choose to specialize in foreclosure investing. While foreclosed properties do come with a unique set of challenges, investors with a keen eye for promising properties and strategies for renovating, holding, and exiting from said properties stand to benefit substantially.
Foreclosure investing can be incredibly lucrative, but it’s typically not an investment strategy that works for amateur real estate investors. Investing in foreclosures requires hyperfocus, strategic analysis, and lots of perseverance. And while bargain properties do offer the opportunity to earn considerable profits, a bargain price on its own is certainly not a recipe for success.
Ultimately, foreclosure investors need to have a well-defined strategy for their foreclosed properties that includes the goals for the properties, the method they’ll use for acquiring the properties, and the manner in which a profit will be earned. For instance:
Will the properties be flipped and resold?
Will they be remodeled and rented?
A combination of both?
A foreclosure investor’s strategy should align with their future income replacement goals, overall portfolio makeup, and the market conditions of the area in which the investments are made.
What Opportunities Are Available to Foreclosure Investors?
Foreclosed properties can offer real estate investors a more affordable way to get their hands on properties. These properties are often in need of rehabilitation, so they are an opportunity to renovate and resell or turn into a rental that can pay consistent income for decades to come.
Foreclosed properties may be priced as much as 20% to 50% lower than the market value of comparable properties. Generally, the more foreclosures there are in a specific area, the more discounted the properties will be. With that said, your investments likely won’t succeed if the properties you purchase are located in declining areas. You want the properties you own to be in locations likely to experience redevelopment and economic growth.
Buying foreclosed properties usually results in a quick closing process, which is ideal for investors. To ensure the process goes smoothly, make sure you work with a real estate agent who is familiar with foreclosures and can walk you through the purchasing process, which may involve more complex legalities than regular real estate transactions.
Furthermore, there is relatively less competition for foreclosed properties than there is for properties not in foreclosure. Foreclosures can be more difficult to find, they require a ton of research and due diligence, and most are auctioned to cash bidders only. (Since you’ll be investing with money already in your IRA or solo 401(k)—you already have the cash available.)
Finally, there’s an opportunity to negotiate lower settlement costs with lenders who just want the property off their books. Reduced price points will naturally result in lower down payments, but lenders may be willing to negotiate down payments and closing costs even further to expedite the sale.
What to Consider When Investing in Foreclosed Properties
With all that said, foreclosed properties come with their own set of challenges. Investors need to ensure they’re fully considering the risks associated with individual properties they’re considering.
Required Research
Investing in foreclosed properties can be lucrative, but it’s a research-heavy endeavor. An area with a high rate of foreclosures signals economic instability. If a region is experiencing chronic job loss, population erosion, poor governmental responses to crises, or something else, you likely don’t want to invest in that area’s foreclosed properties. If you do, you risk your property sitting vacant with no interested renters or buyers.
Therefore, it’s important to thoroughly research the local real estate market and economy of any region where you’re considering purchasing a foreclosed property. Uncovering the reason for the foreclosure is paramount to understanding whether it was due to regional trends or purely an individual’s situation. In your research, you’ll want to find information about the area’s job growth, availability of disposable income, and demographic changes, among other things.
You may also want to search for information regarding upcoming infrastructure development in the city or town where the property is located. Plans for road improvements, new school buildings, community projects, incoming businesses, and government improvement projects are all factors that may reveal the economic health of a particular location.
Real Estate Savvy
Once you’ve determined a location is worthy of your investing dollars, you’ll need to draw on a wealth of real estate expertise to turn your foreclosed property into a highly desirable living space. At a minimum, foreclosure investors should be familiar with the home improvements that provide the most “bang for your buck.”
For instance, kitchen and bathroom remodels can be a good place to start, but you have to be careful not to “over-improve” your property. Over-improving can not only be costly, but can actually result in losses if the improvements outpace the values of other comparable homes in the neighborhood.
As-Is Sales
Because lenders are trying to offload these properties as quickly as possible, foreclosures are almost always sold “as-is.” “As-is” can mean many different things. Some properties may have been sitting vacant for months or even years, while others may have sustained retaliatory damage from the previous owners.
Similarly, some properties may simply have been neglected in terms of maintenance and upkeep once the owners realized they were facing foreclosure. At their worst, foreclosed properties may have severe structural damage.
When considering a foreclosed property as a retirement investment, it’s important to do your due diligence. If possible, insist on thorough inspections to uncover any issues in the home that may not be apparent upon touring the property. (However, many foreclosure transactions do not allow you to tour or inspect the property prior to purchasing it.)
One thing to note: Using your IRA to invest in foreclosed properties requires all expenses associated with the property to be paid out of your IRA—you can’t mix personal funds with an investment property that’s owned by your IRA unless you originally take title to the property in both your name and the IRA. So with foreclosed properties, you need to make sure you have enough cash available to cover all repairs and improvements.
Squatters’ Rights/Adverse Possession
Some properties in pre-foreclosure may still have occupants living in the home. Those occupants may not even be the original owners. Depending on how long the property has been vacant, it may have attracted squatters.
Squatters must be legally evicted, even if they have no lawful claim to the property in question. This can be incredibly expensive, not to mention time-consuming and frustrating. Investors should do their best to determine whether or not squatters are living in the property before they complete a transaction.
How To Invest in Foreclosed Properties with a Self-Directed IRA
While there are certainly risks involved in foreclosure investments, there are huge opportunities as well. Investing in foreclosed properties through a self-directed retirement account can be a smart way to produce consistent, reliable income for your future. Below are four tips to successfully invest in foreclosures with your self-directed IRA:
Set up your self-directed retirement account in advance
Fully fund your self-directed retirement account
Analyze the financial risks and obligations associated with individual properties
Develop a strong network of real estate relationships
1. Set up your self-directed retirement account in advance
Quick closings are the norm for foreclosure transactions. Lenders are eager to get foreclosed properties off their books and won’t wait around for buyers to get their financing in order—they’ll simply move to the next interested party. Therefore, you want to ensure you have a self-directed IRA or solo 401(k) ready to go before you start looking for properties.
Managing a self-directed IRA or solo 401(k) requires you to wade through complex regulatory requirements and obscure tax laws. That’s why finding the right self-directed custodian to help you set up the account, make the transactions, and oversee future deals is so critical. Your IRA custodian should also be familiar with foreclosure timelines and regulations so they can help you complete transactions in the fast manner you need.
2. Fully fund your self-directed retirement account
When you purchase an investment property through your IRA, the IRA is technically the owner of the property. Prohibited transactions prevent you from working on the property yourself, staying in the property (even for one night!), or using any of your own cash to pay for property expenses. All expenses must be paid out of the IRA. As mentioned earlier, an exception can be made when you partner personally with your IRA at the purchase closing.
Therefore, you need to ensure your IRA has enough liquid cash to cover the expenses of the property before you begin earning income on it. (Likewise, all income derived from the property will need to go directly back into your IRA.) At Chicago Trust Administration Services, we can help you rollover funds from other retirement accounts to ensure you have the cash you need in your self-directed IRA.
3. Analyze the financial risks and obligations of individual properties
Before you find properties you’re interested in, create a plan to analyze the financial risks and obligations of each property you find. As stated above, your analysis should include information regarding the economic conditions of the area where the property is located. Consider the area’s business growth, migration data, job growth, and community projects, among other things. Ensure you have a plan for how you’ll find this information.
Additionally, you’ll want to ensure you have a holding strategy in place to manage the carrying costs of the property before you begin earning on your investment. Whether you’re flipping the property to resell or plan to use it as a rental, you will likely face varying costs before you ever see a cent of income from the investment, including renovation costs, property taxes, and landlord insurance.
While many foreclosure sales do not allow you to tour the property or have it inspected beforehand, you should plan to roughly estimate how much repairs and improvements will cost in addition to known expenses. You’ll be limited by the amount of liquid cash you have in your IRA to make these improvements, so anticipating these expenses beforehand is crucial.
4. Develop a strong network of real estate relationships
Foreclosure sales are more complex than other real estate transactions, and they’re regulated by the state in which the property is sold. Therefore, it’s important to work with a local real estate agent who is well-versed in foreclosure transactions. Such real estate agents are often known as foreclosure agents, REO (real estate-owned) agents, or short-sale agents.
Finding a good foreclosure agent doesn’t have to be difficult. While an internet search might do the trick, consider asking around your network for referrals or attending open houses where you can talk to agents about their experience with foreclosure sales.
Furthermore, most foreclosure investors know they’ll need to renovate the properties they purchase. As stated above, IRA regulations prohibit you from working on the property yourself (or even hiring a family member to work on the property for you). Therefore, it’s important to develop strong relationships with quality contractors who can offer you fair prices on repairs and improvements to your properties.
Execute Your Foreclosure Investment Strategy With Chicago Trust Administration Services
A resurgence in foreclosure activity means a window of opportunity for real estate investors looking for their next lucrative deal. At the same time, rising interest rates and relentless inflation has many prospective homebuyers tabling their plans to buy property for the time being. These factors combined mean there is less competition for properties for the first time in years.
The team at Chicago Trust Administration Services has decades of experience helping investors self-direct their futures by investing in real estate and other alternative assets. We know 2023 may be an opportune time to invest in foreclosed properties, and we’re excited to help you execute your strategy.
We’re known for our superior customer service and swift execution of complex real estate transactions purchased with self-directed retirement savings. To see how we can help, we invite you to schedule a complimentary meeting with us by calling 312-869-9394 or emailing steve@ctasira.com.
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*The content and opinions in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
**CTAS professionals are not financial advisors and cannot provide advice or recommendations regarding specific investment decisions.