The best deals may not make sense
Foreclosure investing isn’t rocket science. It’s harder. Science has to make sense, but foreclosure laws, human behavior and government intervention doesn’t. Sometimes seasoned investors miss opportunities that are counterintuitive. Don’t dismiss something just because it seems to be illogical. Dig deeper.
In this section and the next there are two tales from the trenches that show the importance of taking a closer look.
Tales from the Trenches: Denial
When I got my start in auction investing, the guy who taught me the business showed me lots of files and the profits he was making. I couldn’t believe the discounts the properties were selling for. Early on I found a property that had received a Notice of Trustee Sale and the owner had $200K in equity. I drove by the house, the owner was out front and I talked to him. He seemed very reasonable but when I asked him about the foreclosure, he insisted that the trustee sale would not happen. “No way this is going to be foreclosed on,” was his mantra.
A few weeks later I bought the house at auction. I couldn’t understand how a guy with this much equity in a house would lose it to foreclosure. At the time, lenders were writing loans for anyone with a pulse. He could have refinanced, or he could have sold it, paid off the loan, and walked away with money in his pocket.
Over the years of investing in foreclosures and seeing seeming inexplicable circumstances salted in with the understandable ones, I derived The Five Ds of Foreclosure to attempt to explain what seems like illogical behavior. This situation was a clear case of the fifth D of foreclosure – Denial.
Given the volume of foreclosures on the market, triage is an essential skill to avoid wasting time on unprofitable properties. Efficiency is especially important in auction investing. If you begin evaluating a property too early, you may be wasting your time. The owner could cure the loan or another investor might help them do a short sale.
The auction investor doesn’t jump when a NOD shows up, and maybe not even when the NTS is first recorded. Timing is based on the scheduled sale date. The exact lead time for you is based on your risk tolerance and screening efficiency.
There are essential steps in a screening process that are covered in the chapter on Analyzing Opportunities, but you will develop your own process as you learn by trial and error what works for you.
Understanding title research is a core competency for a foreclosure investor. Some of the best auction-investing opportunities turn on points of title that others have missed. Read the story below and see Checking Title for details on title research.
Tales from the Trenches: When the First is really a Second
Once I found a property valued at $550K foreclosing on a $150K loan. Naturally my interest was piqued. Things that are too good to be true usually are. But a possible upside this big warranted a deeper look. The $150K loan turned out to be an SBA loan the owners had taken out to start a hair salon. There were also two Wells Fargo loans, one for $400K and another for $200K. Obviously they were the first and second with the SBA loan being junior. It made no sense that Wells Fargo would have put $600K at risk by being subordinate to the
SBA loan, which could foreclose and leave them with nothing.
I could have dismissed it and continued looking. That’s what all the other investors did. But I continued researching to discern the true order of a long line of over half-a-dozen loans.
First was an initial purchase money loan from Bank of America. The SBA loan came sometime after and was junior to the BoA loan. But within a few days of closing the SBA loan, the owners refinanced the BoA mortgage, getting a $300K first and a $100K second with CountryWide, the BoA loans being reconveyed. The title company missed the SBA loan in their search and assumed the new loans were in first and second position. If they had caught the SBA loan, CountryWide would have halted the refi until they got a signed subordination agreement from the SBA. But they didn’t catch the SBA loan and everybody assumed they were good.
Later, as values rose, the owners refinanced again to pull the equity out of the house, this time with Wells Fargo, the $400K and $200K loans that everyone assumed were now first and second. This happened because the title company for Wells Fargo didn’t do a full search. They assumed that CountryWide had done the due diligence and just did a date-down search from the last refi. At this point I realized that a $550K property really was being foreclosed on for $150K and all other liens were about to get wiped out. And I was pretty sure nobody else knew, none of the other investors and certainly not Wells Fargo. But I didn’t go to the auction.
Auction investing tip: If you’re known as a savvy investor, don’t show up among the regulars to bid on a deal that makes no sense.
If I had bid on the property, the other investors would have realized something was up and would have jumped in, running up the price. Instead, I sent someone else to bid on the property and she got it for the minimum bid. The other investors stood around laughing at the newbie who was about to lose $150K. And I bought a $550K property for $150K.
The most important detail about an investment property is the value. It distills all the other information – age, size, location, condition, amenities – into a single number. And it determines the profitability of the investment. Use multiple sources of information to inform your final estimation of the value.
See Market Value Determination in Determining Value for more detail on assessing value.