I notice a lot of people interested in foreclosed properties tend to have this belief that they are really cheap and priced at below market values.
While it would be a big mistake to assume that ALL foreclosed properties are good deals, there are obviously real and valid reasons why foreclosed properties MIGHT BE real bargains.
But why are foreclosed properties so cheap (at least some of them)?
Here are just 4 reasons why I personally believe that bank foreclosed properties can be priced at below market values:
1. Foreclosed properties are owned by motivated sellers
Banks are not in the business of selling real estate, they are primarily in the business of making money through interest earned through loans. A foreclosed property is a non-performing asset because the loan is non-performing (obviously), hence they need to get their cash back as soon as possible by selling their properties. The longer their cash gets tied up in non-performing assets (NPA’s), the longer they are unable to earn money on the same
In a nutshell, the banks that own foreclosed properties can be considered as motivated sellers for the following reasons which I’ve heard from a lot of people I know who work for banks out there (and I believe them!):
- “Bangko Sentral ng Pilipinas (BSP) regulations require banks to sell their Real Properties Acquired (ROPA) within five (5) years; and
- a significant amount of ROPA has a negative impact on the financial ratios and financial statements of banks”.
2. Banks only need to recover the outstanding loan amount plus foreclosure costs, etc.
Another reason why it is possible for banks to sell their foreclosed properties at a price below market value is they only need to recover whatever amount was owed to them at the time the property was foreclosed, along with some incidental expenses like foreclosure costs, legal fees, costs for the caretaker(s), if any, and other miscellaneous expenses.
To begin with, the maximum loanable amount is usually only up to 70% to 80% of the appraised value of the property used as collateral, and it is very likely that the former owner already made a lot of payments which would further reduce the loan principal before he or she defaulted, thus the amount the bank would need to recover is usually less than the market value of the property. Some would refer to this as the book value of the property, although I am not a hundred percent sure this is the correct term to use.
Tip: Get a traceback of the Transfer Certificate of Title (TCT) or Condominium Certificate of Title (CCT) of the foreclosed property at the local Register of Deeds to determine the mortgage amount annotated on the TCT/CCT. The mortgage amount plus incidental expenses the bank may have incurred should give you a good idea how much the bank needs to recover/how much you can offer.
Thus, some banks may either indicate a low indicative price on its foreclosed properties for auction, or they may be more willing to accept offers below the indicative price for properties that are for negotiated sale, .
3. Foreclosed properties need a lot of repairs
You can expect that a lot of foreclosed properties need repairs, and this is another reason why one may be able to acquire a foreclosed property at a discount. They can be in pretty bad shape because they have been neglected for a long time and/or they might have been cannibalized, they are very old, etc. Because of the need for repairs, banks would naturally have to sell them at a lower price compared to similar properties that require little or no repairs. Otherwise, no one would buy any of their foreclosed properties.
I believe a lot of real estate investors out there (including me), are afraid of foreclosed properties that need a lot of repairs. However, having much needed repairs can be a big advantage for investors because it can give plenty of room for profit, assuming its After Repair Value (ARV) is significantly high.
Of course, even with a discount, a prudent real estate investor should check and verify if a property is still a worthy investment inspite of the renovation costs. Get a quote from reputable contractors and check if the discount can offset the cost to renovate the property, and will result in a good enough ARV.
4. The foreclosed property has been left unsold for a long time
Think about it, if a foreclosed property is left unsold for several years, and it is located in a nice neighborhood that has experienced a steady increase in property values, then it follows that its market value has already increased. Of course, the property could have also deteriorated and it would need renovation for it to have the same market value of comparable properties around it. Again, one needs to check if the numbers make sense when the renovation costs, and other expenses, are considered.
By the way, some banks also give discounts for properties that are left unsold after an auction and you will notice a price reduction at the next auction. Imagine if a property is left unsold after several auctions, the cumulative discounts can turn a previously bad deal into a good one.
But why are foreclosed properties not as cheap as before?
Before, I used to ask myself “Why are foreclosed properties so cheap?”. But now it’s different. If you’ve been into foreclosed real estate investing for a long time, you should have also noticed that foreclosed properties are not as cheap as before, even with the reasons I have stated above.
I can only assume that this is because some banks have started to base their selling price on actual appraised values of comparable properties, instead of book values.
Understandably, seeing foreclosed properties priced very near or at actual market values of comparable properties is generally a turn-off for would be investors.
Nevertheless, I still believe foreclosed properties that can be considered as “good buys” are still out there, and it’s just a matter of finding those that are really priced below market value.
What do you think?
In your opinion, do you think banks are still selling their foreclosed properties at below market values? Why or why not?
To our success and financial freedom!
Text by Jay Castillo and Cherry Castillo. Copyright © 2008 – 2012 All rights reserved.
Full disclosure: Nothing to disclose.