How I bought a foreclosed house

REPORTED FROM HIS HOUSE —  I did not set out to buy a foreclosed house.

Earlier this year, I wrote about selling my condominium unit in 2005 to rent, rejecting the hyped promise of an always-rising real estate market. Now I’ve purchased a foreclosed home -- but that doesn’t mean I’ve bought into the new wave of hype in real estate, the idea that cheap, repossessed houses are a sure bet.

There’s usually good reason many foreclosed houses languish with no buyers. They may be badly damaged or situated in places that seemed attractive only in the frenzy of a real estate bubble.

The foreclosure inventory is loaded with properties far from job centers, stripped or even vandalized by previous owners or in abandoned developments with no parks, schools or even neighbors nearby.

As a result, finding a decent house amid the wreckage of the real estate crash can be a long, tedious process. Then, actually buying one can also be tricky. When a foreclosed house in good shape and in a desirable location gets to market, it often attracts multiple offers, even in this struggling real estate market.

But a foreclosed house might still be an easier way to get what you want than trying to get stubborn individual sellers to lower their list prices. In both my day job covering the housing market and my own search for a house, I’ve seen what has worked for many buyers of foreclosed homes.

This is what worked for me.

Why a foreclosure?

Some purchasers think foreclosed houses and condominiums are so cheap that they can make money flipping them -- just like in the old days of the housing bubble.

But the reality is that people who buy now are still taking a big risk. The median home sale price in Southern California has fallen close to 40% from its peak, and chances are good, to say the least, that it will keep declining.

That was OK with me, though. I was not counting on price appreciation. After three years in our rented house, my family basically wanted to get a place we could decorate as we pleased, and one with at least some of the features we had been living without -- a two-car garage, air conditioning, a kitchen sink with a garbage disposal, maybe even a dishwasher.

When we began looking for a place early this year, though, the prices set by individuals on their homes seemed ridiculous in light of the market crash. And sellers wouldn’t budge, even when they got no offers.

But there’s hardly a more motivated home seller than a bank trying to unload a house it had to take over when its owner defaulted on the mortgage. So it seemed as if foreclosed properties might be the best if not the only choice for us. There were plenty of them out there: Half the homes sold in Southern California in September had been foreclosed, and they will probably make up the majority of homes sold in the region for at least the near future.

I began to check foreclosure listings online and signed up for a paid tracking service. RealtyTrac and ForeclosureRadar are among the choices. These services list houses in default -- ones on which owners have missed mortgage payments but that are yet to be repossessed -- as well as properties seized by lenders. They also indicate the dates the homes are to be auctioned.

For a house in the early stages of foreclosure, a potential buyer can send a letter or knock on the door of the homeowner in default and offer to buy the house directly. I tried this with one house we particularly liked, but the owner was too far underwater to sell the house at a price I could pay.

I continued to track the house, which we felt was the perfect size for our family. It was also just a few blocks from my daughter’s best friend’s house, and close to her school and my office. We called it “the red-door house” because of its crimson front door, and dreamed it might be ours. I soon learned from the websites that the house was headed for auction.

Buying a foreclosed house at a “courthouse steps” auction requires a good amount of knowledge -- and cash. State law requires that foreclosed properties be offered at a public auction, to give buyers a level playing field. Opening bids are typically the amount owed on the house plus an additional sum to cover processing fees.

In today’s depressed market, that amount is often more than the house could be sold for on the open market. Consequently, many houses receive no bids at auction, and the lender ends up putting the house on the market through a real estate broker.

If a house is up for auction with an opening bid far below its current market value, it’s likely to be snatched up by professionals who regularly attend the auctions, armed with stacks of cashier’s checks to pay the full amount. Houses must also generally be taken as is, with no inspection.

For those reasons, I didn’t bother going to any courthouse auctions. It would be easiest, I figured, to simply wait for the houses to be listed for sale through brokers.

Strike one

Sure enough, no one bought the red-door house at its auction price. I began to check the real estate listings online several times a day, ready to put in an offer as soon as it came to market.

I knew from my reporting for the paper that the “vulture” investors who bought foreclosed houses followed several rules. If a house was listed at a low price -- and banks now usually list them low for quick sale -- one should offer at least 90% of the asking price. Just as important as the price are the terms. An offer of a speedy escrow, say 15 days, is an added sweetener. The house has to be bought as is.

An all-cash offer is best, or one with no loan contingency. Remember, the lender-owner doesn’t have time to haggle over the price and does not want to risk a buyer’s backing out after being denied a loan. It’s also best to put in an offer as soon as the house is listed for sale.

The red-door house came to market at a price about two-thirds the amount of its previous loans, and about $250,000 less than what nearby houses had recently sold for.

The day after it was listed for sale, we offered $10,000 above the list price, with no loan contingency. We didn’t get it.

I smell a rat

The selling agent told us we lost out to a buyer who offered a lower price but agreed to an all-cash purchase. Win some, lose some, I thought.

But after a couple of days, it all seemed strange to me. I had not put in an all-cash offer, but my offer did not have a loan contingency, which was in effect the same.

Then I remembered something else vulture investors had told me. Sometimes, brokers selling houses for banks tell favored agents in advance about houses they are about to list. This allows the favored agent to submit a can’t-miss offer immediately after the house is listed.

I suspected my offer was never shown to the bank selling the house. When I called the selling agent to ask, he wouldn’t answer my questions directly and quickly hung up.

I sent an e-mail to the head broker of the firm selling the house, telling him I wanted proof that my offer was shown to the seller or I would file a complaint with the California Department of Real Estate.

The broker, who had recently come off suspension by the department, phoned me and pleaded with me not to file a complaint. He offered to find me another house and said he could even put my agent on his list of those he notified of upcoming houses for sale. But he didn’t provide proof he had presented my offer to the seller.

I filed a complaint with the Department of Real Estate and am awaiting a hearing.

If you believe you have encountered an illegal practice by a real estate broker, you can check the complaint procedure on the department’s website at www.dre.ca.gov.

It won’t act as a court, so it can’t award you damages, but it can discipline the broker or agent.

Strike two

The next house we bid on wasn’t a foreclosure but would certainly count as a distressed property. It was an absolutely gorgeous Pasadena Craftsman house purchased by a group of investors in 2007. They restored it with great attention to period details, using restored light fixtures that matched its 1908 origins, for instance. My agent and I guessed they had spent at least $100,000 on remodeling.

The house was on the market for several months at about 40% above what the investors had paid. But in the midst of the housing crash, there were no buyers.

After several price cuts, the sellers threw in the towel and listed the house for about 7% above what they had paid. They would be taking a sizable loss owing to the transaction fees and remodeling expenses.

Again, we offered full price, figuring the house would easily sell for that amount.

Unfortunately, we were right. We were told that another, all-cash offer beat ours. It came from an English couple who were buying vacation houses near their favorite horse tracks, and this was to be their Santa Anita getaway.

Score!

Just a couple of days later, in my routine check of listing websites, I saw a house that fit our size, price and location needs perfectly. I had not noticed it on foreclosure websites, but property records showed it had sold in the summer for about 60% of what places in the neighborhood had been going for.

This house was an example of a new phase in the real estate cycle: A vulture investor had snatched it (I believe at a courthouse auction), did some modest remodeling and had it on the market within three months. The asking price was a little more than 20% over what the investor had paid.

Doing the basic math in my head, I figured that after transaction and remodeling costs, the seller was seeking only a very small profit. The seller had to move quickly in the rapidly sinking real estate market or the margin would be eaten up by mortgage payments.

We wrote an offer the next day. I thought the house might sell at full price, but even if that seemed fair, it was more than I could afford. I felt low-balling wouldn’t work, so I came up with an amount I could afford that was close enough to the list price to at least draw a counteroffer. Speed, I hoped, would offset any reluctance from the seller to take a lower price.

I offered what I thought was a bit below the seller’s break-even point, about 11% less than the asking price. The seller quickly replied, asking us to come up to a price 9% less than the listed amount, and to agree to take the house as is. It was a deal.

Rebound

While in escrow, I got more news about the two houses we’d lost. The red-door house fell out of escrow, then was bought by a flipper. After a remodel and staging, it has been back on the market for more than a month, priced 32% above what the flipper paid.

The second house also saw its deal go awry. The couple from London got caught up in the global financial meltdown in September and October, and the deal fell through.

Their agent asked whether I was still interested, but I had already committed to the third property.

I’m happy with my new house, whether it drops in value or not. But my buying experience, and seeing the outcome with the two other houses, only reinforced my view of the real estate market. When people are saying the market is full of ways to get rich quick, they are probably full of something else.

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Strategies for buyers

Foreclosed properties are piling up faster than they can be sold, but that doesn’t mean buyers can snap up a great house with little effort. Quality properties in good locations now draw multiple offers when priced right. Here are some tips for extracting gems from the rubble.

Know when to lowball

If a home you want has been on the market for several weeks, it is probably overpriced, says Sean O’Toole, chief executive of ForeclosureRadar, an online seller of default data. Banks may be willing to accept a lowball offer on such properties to get them off their books, especially at the end of a quarter. The end of December is an especially good time for buyers, says O’Toole, who has bought and sold more than 150 foreclosed houses.

Be ready to compete

When an attractive -- and attractively priced -- property hits the market, lowballing can backfire, O’Toole said. Banks selling houses generally follow a formula that allows for substantial price reductions only when houses don’t sell for a specific number of weeks or days. Experienced foreclosure buyers say that for high-quality homes, it’s best to offer close to list price or a quick escrow, perhaps 15 days. A fast escrow can prevail over an offer with a slightly higher price. For an especially desirable house, it might be necessary to offer both a strong price and a quick escrow.

Take auctions for what they’re worth

Auctions -- the kind you see advertised aggressively these days -- might be a convenient way to see many properties quickly, but they aren’t necessarily full of screaming bargains. Many of the houses sold by auctioneers had failed to sell on the open market. They may be fine homes that were marketed poorly, but they could also simply be duds. Sellers are hoping the competitive auction atmosphere will get buyers to bid up prices. You’ll have to decide whether it’s a game you think you can win.

-- Peter Y. Hong