Alternative Strategies: Off-Market Properties are the Hidden Gems for Investors
Options Within the Single-Family Industry
by Rick Sharga
For those not interested in splurging on Bitcoin or fighting with hedge funds over GameStop shares, there are no shortage of alternative investment opportunities in real estate.
Typical real estate transactions involve working with a real estate agent, finding a property listed for sale on the local multiple listing service (MLS), and competing with other investors and traditional homebuyers to purchase the property, either for the purpose of renting it or re-selling it at a profit. Often someone becomes an “accidental investor,” by buying a new home and deciding to rent out their current property; or buying a vacation property and renting it out to other vacationers when they’re not using it themselves.
But for more experienced—or at least more adventurous investors, the hidden gems are often off-market properties, which are not listed on an MLS. Finding these properties requires more homework and using specialized resources; sometimes requires non-traditional financing; and these properties often take longer to transact on. But these off-market properties also provide the opportunity for greater financial return on investment (ROI).
Virtually any type of real estate investor can benefit from off-market properties, which typically have fewer potential buyers competing to purchase the home (and bidding up the sale price). Lower sales prices are critically important for fix-and-flip investors, whose ROI depends on buying at the best price, minimizing repair costs and time, and selling at market pricing. Wholesale investors have ready buyers – both fix-and-flip and buy-and-hold investors – but are lacking inventory in today’s MLS market, so finding off-market properties is critical. And investors looking for rental properties have the same issues—too little inventory, and purchase prices that are too high. So where can investors find these hidden gems? Let’s take a look at a number of possibilities.
Hidden Gems: The Distressed Property Ecosystem
In spite of the foreclosure moratoria in place today from the Federal Government (along with some state and local government actions), there are still foreclosure properties available for investors to purchase. And when the moratoria and the CARES Act mortgage forbearance program have expired, it’s very likely that there will be a surge of defaults. Historically, many of these properties have been repossessed by the lenders (bank-owned, or REO properties), and subsequently listed by real estate agents for sale. That’s unlikely to happen in this cycle—there’s more demand than supply of homes for sale, and homeowners have a record amount of equity. Even with a significant increase in default activity, it’s likely that many of these properties will be sold before the foreclosure auction.
If that scenario plays out, it means investors need to focus most of their efforts on properties in the earliest stages of foreclosure (the Lis Pendens filing in judicial foreclosure states and Notice of Default in non-judicial states). During this pre-foreclosure phase, the homeowner has a predetermined amount of time to try to cure their default; if they can’t do this, the property is scheduled to be auctioned off. But it’s during this period of time when investors need to reach out to these financially-distressed homeowners and attempt to negotiate a discounted purchase. Given the rapid price appreciation of homes today, a savvy investor should be able to work out a deal that pays off the debt to the lender, gives the homeowner cash to get a fresh start, and still represents a lower-than-market purchase price. Default notices are available in the public record and can be found in the County Recorder’s Office; published in legal journals and local newspapers; or found online in subscription sites like RealtyTrac.
When reaching out to distressed homeowners, there may also be a chance to execute a short sale—a sale where the purchase price is below the amount owed on the mortgage. This generally only happens if the homeowner can prove financial hardship to the lender, and local market conditions suggest that the lender would be better off taking a lower amount on the sale than executing a sometimes-expensive foreclosure. Investors should consider the purchase price compared to the potential resale price of the home, or the potential cashflow generated as a rental property to determine whether or not a short sale makes sense.
Foreclosure Auctions
Not all properties will sell prior to the foreclosure auction. Some are vacant and abandoned, leaving no one to negotiate with. Other times homeowners may be in denial and wait too long to attempt to avoid a foreclosure. For whatever reason, foreclosure auctions also represent an opportunity to find off-market deals. Each state has slightly different rules regarding these auctions, but generally they’re live events, often held at the county courthouse or an adjacent facility, and executed by either the sheriff in judicial states, or a trustee in non-judicial states. The properties at these auctions must be purchased with cash or a cashier’s check (sometimes 100% on the day of the auction, sometimes 10-20% on the day of the auction with the remainder due in a few days or weeks). Many of these properties are marketed on online auction websites like these (in alphabetical order): Auction.com, Hubzu, RealtyBid, ServiceLink Auctions, Williams & Williams, and Xome.
Investors should keep in mind that these auction properties often represent the highest ROI of all foreclosure properties, but also come with the most risk, since they’re sold as/is, without the benefit of an internal inspection. There are also sometimes tax or mechanics liens levied against the property, so it’s important to get a title report, and do whatever diligence is possible to mitigate the risk.
Real Estate Owned
Bank-owned homes (otherwise known as REO—real estate owned) probably will not be as plentiful this cycle as they were during the Great Recession for the reasons mentioned above, but are worth researching since they often offer relatively good ROI potential. Some of these properties are sold at deep discounts, but at various levels of disrepair, so inspections and accurate repair estimates are critically important. Check with local real estate agents to find out which of them specialize in listing REO properties in order to get a head start on the competition. REOs can also be found at the websites mentioned earlier.
For even more daring investors there are niche options that require more specific training and education, but because of that also generally have fewer competitors to deal with: tax foreclosures, tax lien sales, and note sales.
Tax Foreclosures/Tax Liens/Notes
Tax foreclosures are similar to mortgage foreclosures, but the foreclosing entity is either the Internal Revenue Service (IRS) or a state or local government that has decided to sell off a property in order to collect overdue tax payments. In some cases, these properties can be purchased for the amount of back taxes, which is often much less than the amount paid for a mortgage foreclosure. But there are a lot of rules and nuances to executing these transactions, so doing homework on how the process works is a must-do for anyone interested in these sales.
Tax liens are also slightly more complicated but can be very profitable. In these cases, the investor is actually buying the debt from the government entity. The investor then attempts to collect the past due amount of taxes, along with interest. If the homeowner ultimately fails to pay the taxes and interest, the investor may initiate foreclosure proceedings.
Note sales are similar to tax liens, in that the investor is buying a loan (usually a non-performing loan) from the original lender at a discounted price. The investor will then either work with the borrower to get the loan back on track, or initiate a foreclosure, using the proceeds of the foreclosure sale to cover past due amounts. Like tax foreclosures and tax liens, note sales have some rules and regulations that need to be followed—for example, the investor needs to follow the same loan servicing guidelines that the original lender did. So, training and education is imperative.
The bottom line is that there are off-market properties presenting many opportunities for real estate investors to improve their bottom line.
