Secrets of Pre-Foreclosure Investing

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Warren Gold of Tampa created success in the pre-foreclosure market.

One-foreclosure expert says a new federal law will change everything, and short sales and short payoff sales will become the new trend in the marketplace.

Another claims that developing a series of “systems” in your business is the key to success.

A third warns that accurate data and timely information is essential to survive.

All agree on one thing: The pre-foreclosure market is a highly specialized area of the foreclosure business that is not for amateurs.

“Most people in foreclosure today have zero equity in their homes,” said Warren Gold, a Tampa Bay real estate investor.“That’s why the passage of the new debt relief act is going to change everything. It’s going to make short sales more appealing to investors.”

On December 18, Congress passed new legislation to eliminate taxes on mortgage debt. The legislation was signed into law by the President on Dec. 20 and will provide a temporary, three-year change to the tax code to eliminate any taxes homeowners might face when banks renegotiate the terms of a home loan and forgive a portion of the outstanding mortgage debt. The change in the tax law will cap untaxable forgiven debt at $2 million and apply only to principal residences.

Gold said that the Mortgage Forgiveness Debt Relief Act (H.R. 3648) removes the tax burden on mortgage indebtedness, encourages loan restructuring between lenders and homeowners and discourages foreclosures.

Gold believes the key to successful pre-foreclosure investing is developing “a series of systems” that are used again and again in the business. He uses the Internet, scripts, form letters, call sheets, check lists, direct mail campaigns, objection handling techniques and other “systems” that help him locate, track, negotiate, purchase and sell pre-foreclosures.

“The first deal I put together was a cash-to-walk deal in Hawthorne,” said McManus, co-owner of Dream Big, an El Segundo, Calif. real estate training company. “The homeowner was getting ready to move out. When I showed up at the door, they were packing. The auction was scheduled a few weeks down the road. I offered the owner a couple thousand dollars to walk. They deeded the property over to me. Then, after five days, I hired a local agent, listed the property, flipped it and made $31,400.”

McManus said the borrower got out of a painful situation, the bank got rid of a non-performing asset, and McManus bought a discounted house for pennies on the dollar.

“Sometimes, we do equity sharing deals, where we bring the defaulting homeowner current and then sell the property and split the profit with the owner 50/50,” added McManus. “Other times, we do lease-option deals, where the seller sells the house to you (the investor) and you lease it back to the seller.”

Frequently, folks in foreclosure are often angry, anxious and in denial. Many times, says Randy Siems, a Missouri pre-foreclosure investor who made over $1 million in pre-foreclosure equity deals last year, the person answering the door isn’t aware that they are in foreclosure because their spouse hasn’t told them.

“I once put together a deal where the wife didn’t tell the husband that they were in foreclosure,” said Siems, who engineered the deal at the couple’s kitchen table. “I had to break the bad news to the husband when he got home from work. It was a horrible scene.”

Gold also said there are many opportunities for pre-foreclosure investors. Nationwide, millions of strapped homeowners – many of them in default or about to enter default – are desperate to sell their homes before the bank repossesses their property.

In November, a total of 201,950 foreclosure filings were reported nationwide, according to RealtyTrac. Not all will end up confiscated by banks; many distressed homes will end up in the hands of budding pre-foreclosure investors like McManus, Gold and others.

Buying pre-foreclosures has two main advantages over buying at the auction or purchasing bank-owned properties, according to Gold. First, a homeowner facing foreclosure may be motivated and willing to do almost anything to avoid losing property to the bank. Secondly, investors can inspect the property before purchasing it.

Office on wheels
Gold said that pre-foreclosure investors should be prepared to spend a lot of time in their vehicles conducting drive-by visual inspections, door-knocking and driving to appointments with distressed homeowners. The front seat of Gold’s vehicle doubles as a sort of “office on wheels.” When he’s out door-knocking, Gold carries a suitcase filled with a laptop computer, lists of deep-equity pre-foreclosure prospects, maps, a portable printer – along with all the real estate contracts, disclosures and forms needed to close the deal at the owner’s kitchen table. He also uses a special filtering software he developed to target the best deals.

“I’m only interested in deep-equity deals,” said Gold, noting that he only pursues pre-foreclosures with 60 percent equity or higher. “After my mailing campaign narrows down my prospects to a handful of pre-foreclosures owners, I pre-qualify them on the telephone and then go visit them in person a couple of days before the auction.”

Rob Shalante, a pre-foreclosure investor from Tampa, Fl, who occasionally works on pre-foreclosures deals with Gold, believes the key to success in the pre-foreclosure market is having accurate information.

“Having accurate data and a software system that filters out the best properties is very important,” said Shalante. “Instead of knocking on 20 doors, you want to zero in on one or two properties that you know are good deals in good neighborhoods.”

His software, he claims, separates upside down deals from equity-rich properties.

“On one deal, I knocked on a door of a homeowner who had a small mortgage, but there was a balloon payment due on a private money lender,” said Shalante. “We paid off the balloon, took title to the property for $20,000, and then we brought in some wholesale investors, who purchased it for $28,000. Within an hour, we had made $8,000.”

Buyer beware.
While investing in pre-foreclosures is appealing and profitable for many investors, there is a downside. Most residential properties in pre-foreclosure – especially in bubble states like California and Nevada – are not worth pursuing because the defaulting homeowners have drained the equity out of their homes. Moreover, pre-foreclosure investors need to investigate hidden liens, unpaid federal and local taxes and other undisclosed title problems.

“If you miss a lien or a second mortgage, you might acquire a property over-encumbered and in debt,” warned McManus, the book author and pre-foreclosure trainer. “You’re asking for trouble when that happens.”

Lucier, the Tampa Bay real estate investor and author, says the secret to being a profitable pre-foreclosure investor is “specialized knowledge.”

“In this business, you cannot afford to rely on the expertise and advice of so-called real estate professionals such as real estate agents and title escrow agents who may or may not know what they are doing,” says Lucier, a 24-year veteran of investing in pre-foreclosures. “When buying a pre-foreclosure property, you can have a myriad of problems that must be solved quickly before the property’s loan is foreclosed on and sold at public auction.”

In his book, Lucier asserts that investors need to study the local foreclosure laws and regulations in their state. In California, for example, sellers in foreclosure are protected by both the California Home Equity Sales Contact Act (California Civil Code Sections 1695-1695.17), which was enacted in 1979, and the California Mortgage Foreclosure Consultants Act (California Civil Code Sections 2945-2945.11).

One of the most notable contractual provisions of the California law is that the seller, among other things, has a five-day right to cancel the purchase agreement.

And real estate agents in California face formidable challenges with pre-foreclosure deals.

For example, when buyers of a property in foreclosure are investors (who will not live in the property) and the property is a one-to-four unit property – one of which is owner-occupied – the real estate licensee representing an investor must be bonded for twice the value of the property. The catch: Bonds for that amount aren’t available, so a real estate licensee cannot represent an investor-buyer, only the seller.

If the contract and the sale are not done according to the law, the seller has the right to rescind the sale and could, long after the sale, sue to have the sale reversed. There are extreme penalties for violating the law. In California, violators of the home equity sales law can face serious consequences. Equity purchasers who violate the law may be convicted of a crime punishable by one-year imprisonment, plus a $25,000 fine, for each violation.

“The most important element of the pre-foreclosure business is the information you gather and what you do with it,” explained Warren Gold. “The key to success is due diligence. You’ve got to be on the ground and know the value of homes in your market. This business is not for amateurs. Moreover, you’ve got to be careful. We are in uncharted waters. I’ve never seen it so bad.”

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Steve Hertole
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