foreclosure investing

Need-to-know No. 1: The fine print associated with the type of auction you're attending. If you plan to score your bargain-basement unit at the foreclosure auction on the steps of the county courthouse, consult with a local real estate attorney and make sure you conduct an exhaustive title search before you make your bid. It's possible to purchase one of these properties and still have to contend with other liens still on the property, like second (or third) mortgages, back property taxes and Homeowners Association (HOA) dues unpaid by the former owner.



Under the law in nearly half of the states, when you buy a place at the foreclosure auction, the former owner has anywhere from six months to a year after the auction to "redeem" their rights to the property, meaning they have the legal right to buy it back from you.



If you're buying the property at an auction of REO properties (Real Estate Owned by the bank), make sure you read 100% of the terms and conditions of the auction. Many auctions will allow you to get a property inspection -- go figure -- so you should. They will also often allow you to use a mortgage to finance your purchase, which the courthouse foreclosure auctions do not.



However, most of these REO auctions do take a non-refundable cash deposit from the auction winner, and do add some sort of "buyer's premium" on top of the winning bid -- some as high as 5%. That extra cash can make it tougher to get positive cash flow out of the place.



Get clear on the fine print before you buy at any property auction.



Need-to-know No. 2: Your numbers. Many a wanna-be investor thinks, "Hey -- it's a $50,000 condo. If I get $1,000 in rent -- I'll be making cash hand-over-fist." And there ends their cash flow analysis. Seasoned investors know, though, that there are always more line items to the story. If you're thinking about investing in even the cheapest of cheap condos, you still need to create a written cash flow projection, or pro forma, to see how feasible it is that the investment will actually pay off.



If you plan to finance your investment with a mortgage, you must factor in the mortgage payment, mortgage insurance (if you put less than 20% down), and closing costs. And, even if you are able to buy a cheap condo with cash, you still need to take into account the costs of HOA dues, property taxes, landlord's insurance, any utilities landlords pay in your neck of the woods (like water and gas), a property manager and repairs.



You should also include an allowance for long-term maintenance, possible special assessments by the HOA and vacancies -- every landlord deals with occasional months where no rental payments come in. And you should definitely have a chat with your tax adviser about the deductions you should factor in, and the income tax you may incur on the rental income.



Then, offset that -- on paper -- by the average rents being received by other landlords in the complex or the area. If you're only making $3.75 per month in the projections, you might decide that other investments are more sensible.



Need-to-know No. 3: Whether the HOA and the complex are healthy. Sacramento, Calif., real estate agent Stacey Wilson thought she'd scored, big-time, when she invested in a two-bedroom, two-and-a-half bath condo for $40,000 in September of 2009, especially since the place had gone for $175,000 in 2007. After closing, though, it quickly dawned on Wilson that the complex and the HOA were both broke.



"Take a look around and see whether things are in working order," Wilson advises prospective condo investors. "When things are broken, find out how long they've been broken." Wilson's complex has two pools and a sauna, but "none of them works -- and they haven't worked in years."



Also, Wilson's unit is in an HOA riddled with a sky-high rate of delinquent dues, so it can't afford to repair the pools and sauna, nor does it have the cash to replace the wood shake roofs on all the buildings. "We only have a couple of years of roof life left, and now the hazard insurance company is threatening to drop our coverage, because they see the wood roof as a fire hazard," Wilson explains. "It's really important to read every page of the HOA disclosures you get during escrow, and make sure they're solvent. If the HOA is broke, it can create a domino effect of problems."



Need-to-know No. 4: The landlord-tenant laws and restrictions of your city or HOA. Many urban areas, in particular, have rent-control and eviction-control laws that limit your ability to raise the rent, or to evict a tenant without having a particularly strong reason for doing so -- sometimes even requiring landlords to pay tenants to move out.



And because the percentage of owner-occupied units impacts the ability of an HOA's members to resell and refinance their homes (many banks won't offer mortgages in complexes with fewer than 75% of the units being owner-occupied), many HOAs put a cap on how many units can be rented out. If you're planning to buy the condo as a rental property, it behooves you to know how feasible and how desirable it is to be a landlord in that complex and town before you buy.



Need-to-know No. 5: Where goes the neighborhood. Wilson's foray into dirt-cheap condo investing turned into a true adventure when circumstances led to her moving into the property she thought she'd never live in. Turned out, the nighttime goings-on in her new neighborhood were unlike anything she ever expected from her exclusively daytime experiences in the area. Before investing in a discount condo, Wilson advises, act like someone house hunting for their personal residence, and "go by the place at night and on the weekends. You'd be surprised at how different a place can be at night."



The fact that a condo is so inexpensive might actually be a signal that the neighborhood may not be one you want to spend much time in, even as a landlord. Wilson says, with 20/20 hindsight, "If it's really cheap, it's probably not in the best place."

As investors search for yield anywhere and everywhere, bonds are trading in uncharted territory. Please consider Obama Wins Low Yield as Markets Shrink Aiding Deficit

Bond investors seeking top-rated securities face fewer alternatives to Treasuries, allowing President Barack Obama to sell unprecedented sums of debt at ever lower rates to finance a $1.47 trillion deficit.

Shrinking credit markets help explain why some Treasury yields are at record lows even after the amount of marketable government debt outstanding increased by 21 percent from a year earlier to $8.18 trillion. Last week, the U.S. government auctioned $34 billion of three-year notes at a yield of 0.844 percent, the lowest ever for that maturity.

Spending by companies and consumers has slowed as the economy has shown signs of weakening. Companies in the Standard & Poor’s 500 Index have stockpiled a record $2.3 trillion of cash and equivalents. Company borrowing slid 29 percent in the first half of the year to $528 billion amid a dearth of business investment, Bloomberg data shows.

Piles of Cash Equates to Piles of Debt

Companies are piling up cash alright. However, the flip side of that cash is debt.

Moreover, analysts mistake that cash for willingness to expand. The reality is corporations do not want to get trapped like they did in 2008, unable to borrow.

For more on corporate cash levels, please see Are Corporations Sitting on Piles of Cash?

Individuals are also hoarding cash. The U.S. savings rate reached 6.4 percent in June, up from 1.7 percent in August 2007, the start of the financial crisis.

Are Individuals Hoarding Cash?

Individuals are not really "hoarding cash" either. Instead they are paying down debt. Most do not realize that by definition, paying down debt constitutes "saving".

For most wage earners, the savings rate is after-tax salary minus personal consumption expenditures (PCE). For a more precise definition, please see What's Behind The Soaring Savings Rate?

“There’s been a collapse in both consumer and business credit demand,” said James Kochan, the chief fixed-income strategist at Menomonee Falls, Wisconsin-based Wells Fargo Fund Management, which oversees $179 billion. “To see both categories so weak for such an extended period of time, you’d probably have to go back to the Depression.”

Food Stamps and Unemployment Insurance Mask Depression

I believe we are in a depression now. The key difference is food stamps and unemployment checks have replaced bread lines.

We also have hundreds of thousands of people living in their homes without making payments on their mortgage or home equity lines. The slow foreclosure process encourages more to do the same.

“The diminishing supply” of alternatives to Treasuries “is giving Washington an opportunity to continue with its fiscal irresponsibilities,” said Mark MacQueen, partner and portfolio manager at Austin, Texas-based Sage Advisory Services, which oversees $8.5 billion. “The only way to tell Washington and America ‘no more’ is a weak dollar, which eventually leads to higher interest rates.”

“We are slowly playing a fool’s game as rates go further down to unsustainably low levels,” said Dan Shackelford, a money manager who helps oversee $15 billion in fixed-income assets at T. Rowe Price Group Inc. in Baltimore.

Thoughts on the Fool's Game

If you are managing $15 billion thinking it is a "fool's game", then in my opinion you ought not be doing it. It seems to me there is a lack of fiduciary responsibility if one is investing client money in a "fool's game".

What the hell - Anything for a fee!

I do think corporate bonds, especially most junk is playing for the greater fool. In regards to treasuries, there is going to be an exit problem for sure, but that could be years away. In Japan, yields stayed low for a decade. Why can't it happen here?

Yields certainly might stay low for an extended period. Whether or not they do remains to be seen. I happen to like long-term treasuries right now, but certainly not as much as when the 10-year was at 3.75% and bears were foolishly shorting treasuries like mad.

The government isn’t the only one getting a good deal. Armonk, New York-based International Business Machines Corp., the world’s biggest computer services provider, sold $1.5 billion of three-year notes on Aug. 2 with a coupon of 1 percent, the lowest of the more than 3,400 securities in the Barclays Capital U.S. Corporate Index of investment-grade company debt.

Portland, Oregon, sold about $408 million in sewer-system revenue debt on Aug. 11, with utility bond yields at the lowest level on record. Yields on 10-year, AA rated tax-exempts backed by utility revenue stood at 3.02 percent on Aug. 10, according to Bloomberg Fair Market Value data. That’s the lowest since the index was created in November 1993.

“We are in unchartered territory,” said [William Larkin, a fixed-income money manager in Salem, Massachusetts at Cabot Money Management]. “We are pushing and pulling levers that we don’t understand the full implications.”

Uncharted Territory

This is indeed uncharted territory thanks to the Fed pushing and pulling levers in a manner it does not understand. William Black, a former bank regulator, is one person who does understand. Black says U.S. Using "Rally Stupid Strategy" to Hide Bank Losses - Will Produce Japanese Style Lost Decade.

I agree with his assessment.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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