So you want to be a real estate investor. You’ve been up at 2:00am watching infomercials about guys buying property for little or no money down and then selling that property for 5x or 10x returns. You watch those property flipping shows on HGTV where attractive couples from California or Nevada buy homes at foreclosure auctions, fix them up, and sell them for massive profits. How hard could it be? You’re smart, handy, and have a good eye for what’s fashionable. You could definitely do this.
A lot of people think that buying property at foreclosure auctions is a good way to get into the real estate investing game. The reality is that like anything, you have to put in the work in order to be good at this. Here are a few things you must know before attending a foreclosure auction.
Before you decide you’re going to be a real estate investor who buys property at foreclosure auctions, I suggest going to a few auctions to observe. Each county around here has its own day and time at which foreclosure auctions are held. In Brooklyn, auctions are held on Thursdays at 2:30pm. In Queens, auctions are held at 11:00am on Fridays. The auctions are held in the largest courtroom in the building. They are usually filled to capacity with dudes that smell like they take baths in onion soup. You might have to leave your ID with a court officer if you want to bid. Watch as some properties are the subject of fierce bidding, with the eventual winner bidding into the millions of dollars, and watch others get sold back to the bank for $100. Think to yourself why this might be.
All right, you’ve been to a few auctions and you decide that you want to make a serious go at this. Here is your checklist:
1. Identify the targets. Usually you can get a list of properties going up for sale at the county website. There are for-pay websites that aggregate these properties for you and give you a “street view” type picture of the property. If you’re planning on doing this for a living, or buying property this way at least one time, I would recommend signing up for one of these sites. I’m not going to give a plug for the website here, but if you give me a call, I’ll give you the name of it. You could also just google it and I’m sure you’ll find it.
2. Value your targets. Once you know which properties you’d like to own, figure out how much they’re worth. This is important. If you don’t know how to value real estate, real estate investing is not for you. You can’t just guess at this.
3. Figure out what the “upset price” is. Banks will bid up to the amount that they’re owed at the auction. If you value a property at $500,000 but the bank is owed $600,000, the bank will bid $600,000 for the property. That means that if you want to buy it at auction, you’ll have to spend $600,001 for the property, which leaves you in a $100,001 equity hole immediately. That will probably be the first and last property you buy at foreclosure. It may lead to you being foreclosed on in the future.
a. You won’t find out the actual upset price until you’re at the auction, but you can make a fairly good guess based on the information that’s in the public record. You will have access to the judgment amount from the judgment of foreclosure and sale. The amount on the judgment is good only through a certain date. Check the referee’s report to see what the interest rate was and add interest at that rate from the good through date until the date of the judgment. Then, add 9% from the date of the judgment to the day of the sale. Check the public records for tax information and add the property tax amount from the “good through” date on the judgment to the day of the sale. Add $20/month for inspections to that amount and you’ll have a pretty solid estimate of the upset price. If the property is worth less than the upset price, you’re not bidding.
b. A caveat to this: You might have some very shrewd reasons for overpaying for property. If you own adjacent property, you might be able to knock the whole thing down and develop the property into something super valuable. You might have some illegal inside information that a developer is lurking and wants to buy the block, and that developer will pay you a premium to buy the property. These are really rare situations, so the rule is that if you value the property for less than what the upset price is, don’t bother.
c. Another sneaky way to figure out whether the upset price is low is to watch what the demand is when the auctioneer calls out the property. Since the foreclosure auctions take place in the biggest courtroom in the building, the people bidding will run to the front of the courtroom to get in on the action. If you see a bunch of folks running up to the front, you can take the hint that the upset price is low and that this might be a good opportunity. This is super risky, but if you’re just looking to get in the game without putting in the work, it may end up working for you.
4. Figure out how much to bid. Just because you value property at a certain amount doesn’t mean you should bid that amount. There are going to be closing costs. Buyers at the foreclosure auction pay transfer taxes (that’s the opposite of what happens in a usual real estate transaction) and you’ll probably be paying an attorney. You may also have to pay for issues that might arise with the property. In order to knock your risk down a little bit, you should walk by the property and check it out from the outside. See if it looks like it’s decently maintained, run down, or completely vacant. You’d be surprised how much a property deteriorates when it’s vacant. Anyway, if you bid at your max value, you will find yourself in an equity hole in the amount that you’ve overspent.
5. Get your money right. You need to bring 10% of the purchase price in cash or certified funds to the auction, and you need to have either cash or financing lined up such that you can close in one month following the auction. There are ways to delay a closing while you’re trying to set up financing, but they’re shady and the bank attorney will know what you’re up to. The last thing you want to see is a letter from me declaring time of the essence on you. Don’t let litigation eat into your potential profits.
6. Pray. You’re buying this property sight unseen. There could be mold, cockroaches, rodents, or worse – tenants. It’s a toss up as to whether black mold or tenants is the costlier problem. If you’re trying to fix and flip property, the non-tenant issues might cost some money up front, but they’ll be eradicated quickly. In New York City, you have 6-12 months of court costs and headaches to get rid of a tenant who doesn’t want to leave. After spending a year in housing court, you may be best served by offering the tenant some cash to go away. That’s going to eat into your profits as well.
As you can see, buying property at a foreclosure auction isn’t for the faint of heart. However, if you have money that you can afford to gamble and are willing to put in the work it will take, you can make this your business.