Purchasing a foreclosed property or acquiring a property through short sale has the same factors associated with it as that for single family home. The only additional step is to make sure that the property has not been tampered with in any shape or form. In most cases short sales and foreclosures are sold “as is”, which means the seller will not make any repairs to the house before selling. You need to factor in the cost to fix those issues in determining the offer price.
Some distressed home owners may attempt to destroy the home or cause trouble. Again, if you hire a good inspector, they can help you evaluate the property. An additional factor to consider with short sales, is that typically the home owner is still living in the property. You run the risk that they may damage the property after you have done the inspection but before you get possession. You need to factor in this possibility when dealing with shot sales. You also need to remember that the time required to acquire a foreclosed or short sale is longer due to their process. It is also better to work with a real estate agent who has experience in handling distressed properties so he can help close things faster and smoother.
As usual, the number one thing to consider is the price of the property. You must determine whether the rental income of the area would be enough for you as an investor to be cash flow positive. Don’t buy a property unless you are sure about being cash flow positive. The last thing you want to do is pay the mortgage from your own pocket.
You also need to look at the neighborhood. Is it safe, is it a growing market in terms of job and economy and companies? Would renters prefer staying in this area versus other areas of the city? Are the schools of this neighborhood good enough? Are there groceries stores and malls accessible from the rental property?
We didn’t consider this option in our acquisition of single family homes but recently this option has become quite lucrative and many investors are seriously looking to acquire properties by this route.
Example of cash flow calculation
Let’s say a single home property in pristine condition is going for $140. However, a similar property is listed for $120K in foreclosure. You determine that it will take $5000 to fix the property. You are getting this property for less but have some risks since it is a foreclosure. Your cash flow numbers will work better on a monthly basis but you need to come up with the additional $5000 to fix the property since banks will typically give you loan on $120k. Let’s assume, the investor pays 20 percent down payment. The loan is going to be for $96,000. Let’s say, the loan is 15 year fixed with a mortgage rate of 4 percent.
For rent calculation, let’s assume we will get a round about 1 percent of a typical purchase price of $140,000 as monthly rental, for example, $1400 monthly rental in this case is a good solid number to shoot for.
Monthly Rental income = $1400
Monthly Mortgage payment = $710 (Principal + Interest)
Monthly HOA fees = $25
Monthly property tax = $115
Monthly insurance expense = $75
Cash Flow = $1400 - $710 - $25 - $115 - $75 = $475
In this example, the investor is making a good profit on the rental property. He purchased it for a good price as result of it being a foreclosed property and therefore his cost basis is low. If he is able to rent it out throughout the year, his yearly cash flow will be $5700. But recall, he had to spend $5000 to fix it, therefore he need not pay any taxes for the first couple of years to offset the cost of capital additions.
