What To Expect When Buying Foreclosed Properties

Updated on October 19, 2013 by 19 Comments
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Terence Ong of Real Estate Philippines News Blog came out with this great article on How to Choose: PRE-SELLING vs FORECLOSED vs SECONDARY PROPERTIES where he created a chart that shows what one should expect when buying pre-selling , foreclosed, and secondary properties. With this post, I’ll add my own insights which should give you an idea of what to expect when buying foreclosed properties, and how they compare with other properties out there.

100s of Bank FORECLOSURESImage by Michael Slatoff via Flickr

It’s good to note that foreclosed properties win hands down in terms of price in Terence’s article. Interesting points were also raised in terms of the disadvantages that foreclosed properties may have as compared to the other types of properties one can buy.

I did some deeper analysis on these disadvantages and I would like to share these along with my opinions below:

Quality: Foreclosed properties usually have plenty of repairs to be done

These are very true in a lot of cases. In my opinion however, having the need for repairs can actually give investors plenty of room to make money. The selling price of foreclosed properties that need repairs are often way below market value and it’s a given that the repairs may cost a lot.

After repairs are done however, the property’s market value should also go up, which is what we can refer to as the After Repair Value (ARV).

The ARV is more often than not equal to the current market value of similar/comparable properties at the same location. Though repairs may cost a lot of money, did you know that if done properly, for every peso spent on repairs, one may realize returns from 2 to 5 times of the money invested?

To illustrate, lets say a 53 sqm. foreclosed condo unit in Makati that needed repairs was bought for Php1,000,000 from a certain bank. It turned out that a similar/comparable unit at the same building that was ready for occupancy (RFO) has a current market value of 1,800,000 or about Php35K,000 per sqm. (this appraisal value came from banks as shared to me by a fellow real estate investor).

Estimates for repairing the condo unit range between Php100,000 to Php200,000, as given by candidate contractors.

Since I want to calculate for Profit (projected), and the property was already bought for 1,000,000…

Profit = ARV less Cost to buy property less cost of repairs less cost for acquiring, carrying, and selling a property (I’ll assume this as 10% of the ARV or 180,000)

Profit = 1,800,000 – 1,000,000 – 200,000 – 180,000

Profit = 420,000

As you can see, Php200,000 was spent on repairs but the projected profit was Php420,000 which is a return of more than 2 times or 200% of the money invested for repairs. I hope you can see my point here. Take note that these are conservative estimates.

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What if the investor already had a reliable contractor that does repairs at a very reasonable cost and it went down to Php100,000? The Profit would have been Php520,000, which is more than 5 times or 500% of the Php100, 000 spent for repairs.

Availability Of Use: After Repairs (unless it needs none which is very very rare)

In my opinion, an investor just has to make sure that they already have repair estimates that include duration of repairs before deciding to buy a foreclosed property.

I personally would stay away from properties that would take a long time for repairs to get completed. Ideally, repairs should be finished in 30 days or less. Anything beyond would require one to consider the additional holding costs one may incur like additional monthly amortizations, property management costs, etc.

Worst Traits: Tons of Repairs, Time needed.

I for one would avoid these types of foreclosed properties. I’ve seen a lot of properties like these and it scares the hell out of me just thinking how much and how long repairs could take. Maybe I should start saving pictures of properties like these so I can post them here just to give you an idea of what we all need to avoid.

Obviously, properties that needs tons of repairs would take months to finish, which translates to high holding costs and long periods of negative cash flow, which is not what investors are looking for. Instead, one must focus on finding those diamonds in the rough that require some repairs that can be done in a reasonable amount of time and cost.

Let me summarize my insights below:

  1. Foreclosed properties may often need repairs but these may actually provide a greater opportunity for investors to make money as the  repairs can add value many times over the amount of the money spent. Come to think of it, even home-buyers could benefit from this as they can get significant savings if they are willing to have repairs done and once completed, the property’s market value increases which translates to greater equity.
  2. Due to the time it would take for repairs to be done, a foreclosed property may not be available for immediate use, but the key is to find foreclosed properties that can be repaired in a reasonable amount of time. Most people would usually have some minor repairs done anyway if they buy a property, new or otherwise.
  3. For foreclosed properties that may require extensive repairs, one just has to be on the lookout for them so that they can be avoided. These are the so called money pits and if you see a property like this, just walk away and move on to the next.
You may also refer to my posts Top 5 Things to Consider when Buying Foreclosures where property condition and the need for repairs is considered as one big consideration when buying foreclosed properties and Why Is Investing In Real Estate So Much Better Than Investing In Stocks? (Part 3: Control) which will give you more ideas how repairs can add significant value to a foreclosed property.

Conclusion

I can’t help but say that investing in foreclosed properties can hold its own as a worthy investment as compared to pre-selling and secondary properties, especially from the eyes of an investor like me. Investing in foreclosures really makes sense if done right and if one knows what to look for, and what to avoid. The opportunities are out there, so what are you waiting for?