How to purchase distressed homes and property

Many of the houses coming on the market today are foreclosure sales, which usually sell "as is" and are often in poor condition. This may create a buying opportunity for some buyers, but it may be a hazard for others.

Purchase opportunity

A purchase opportunity arises because many potential buyers don't want the hassle of fixing up a house in poor condition, which means that there are fewer competing buyers. In addition, those who sell houses "as is" are frequently in a hurry to get it done, which means that they are disinclined to wait for a higher offer.



The buyers in the best position to take advantage of such opportunities are those with the skills and knowledge required to assess what needs to be done and how much it will cost.

Risk of value uncertainty

But purchasing a house in poor condition has serious risks. One risk is the greater uncertainty connected to its value. The worse the condition, the more costly the improvements required to make the house livable, and the larger the potential error in judging in advance what these costs will be.

The appraisal may reduce but not eliminate the uncertainty connected to the property's value. Appraisers mainly rely on the sale prices of comparable properties, after adjusting for the differences between the subject property and the comparables.

But because information on the condition of comparables is often difficult for appraisers to obtain, the error in making price adjustments is relatively large when the property is in poor condition.

Risk of not finding a mortgage

But today the greater risk in buying a property in poor condition is that the buyer will be turned down for a mortgage or forced to find a lender who will make the loan but at a premium price.

This problem seldom arose before the financial crisis because there were very few foreclosure sales, and lenders generally operated on the assumption that valuation errors would be erased by property appreciation. Today, those looking to buy a house in poor condition need to consider this risk very carefully.

Fannie Mae, Freddie Mac, the Federal Housing Administration (FHA) and the Department of Veterans Affairs (VA) recently developed a classification system for housing condition ranging from C1 (the best) to C6 (the worst), but only C6 is unacceptable to the agencies in "as is" condition. Nonetheless, many lenders require a C4 or better.

Rationale for condition requirement

It is understandable why the agencies that bear the risk of default would either require that the condition of mortgaged houses meet some minimum standard, or base their purchase prices or insurance premiums on house condition.

As noted above, the potential error in appraisals is larger for houses in poor condition, which would result in greater losses on loans that default. When defaults occur early, furthermore, the house that was in poor condition when the loan was made is very likely to be in poor condition at default, which increases marketing costs.

Why some lenders are stricter than the agencies, however, is not clear. Presumably the servicing of loans on properties in poor condition is less profitable, perhaps because these loans have relatively short lives. It is also possible that the cost to servicers of managing foreclosures of properties in poor condition is relatively high.

Whatever the reasons for lender caution, homebuyers looking for bargains in the sale of distressed properties need to take it into account in planning their purchase strategy.

A purchase strategy for distressed properties

An inspection report from a licensed expert will help in the decision as to whether to buy the house but will not eliminate uncertainty regarding how an appraiser will classify the condition of the house. If the house is classified C5 or C6, a loan may not be available.

If the sales contract has a mortgage contingency clause, which is a standard provision in some states, the buyer who can't get a mortgage because the property is classified C6 or C5 will get his earnest deposit back and the deal is canceled. However, the thwarted buyer will not be reimbursed for the cost of the inspection or the appraisal, which might total about $700.

If a property is being sold "as is" and the standard sales contract does not have a mortgage contingency clause, I would pass unless the seller agreed to return my earnest deposit if the property is classified C6 by the appraiser. You could be more conservative and require the return of the deposit with a C5, which would avoid a mortgage problem because most lenders will accept a C4 or better, but it may substantially reduce the number of sellers who will deal with you.

While accepting a C5 will give you access to more houses, you must find one or more lenders who will accept a C5. You would be well advised to do this in advance of purchase.

Jack Guttentag is professor of finance emeritus at the Wharton School of the University of Pennsylvania.



Contact us with any questions you may have about purchasing any distressed property
www.oc-coastalhomes.com

Douglas Pemberton
White Water Realty Inc.
608 Avenida Victoria
Across from the San Clemente Pier
dougpemberton@gmail.com
949-273-0018

The Pros and Cons Of Rent To Own

The Pros and Cons Of Rent To Own

By Gil Gross - Real Estate Today Radio · April 16, 2010

In last week’s post we talked about credit recovery and how a rent-to-own agreement may be an option while you work towards getting your credit back on track.

So, we thought this week we would expand on the rent-to-own scenario and talk about the pros and cons of entering into such an agreement. Keep in mind, entering into any rent-to-own agreement will require the services of a lawyer and a contract that is agreeable to both parties.

For Buyers

Let’s weigh some of the pros and cons from the buyer’s perspective. Looking at a rent-to-own agreement objectively will give you a better feel for what you can expect and perhaps how to avoid some of the pitfalls that can be associated with a rent-own-scenario.

First and foremost, rent-to-own gives you the benefit of building a down payment towards the home you are currently renting. Financially, this is a great benefit to you, the renter, as you now are building a nest egg towards the eventual purchase of the home. Your agreement may require that you pay higher than market value rent but the extra will come back to you when it comes time to purchase the home.

An additional benefit is that you are able to “test drive” the home, the neighborhood and what it would be like to own a home in the area. This is a benefit that a regular home buyer does not have.

However, there are some things to be aware of when entering into a rent-to-own agreement.

Probably the number one concern with any home buyer is price and this is where having an agreed upon written agreement is most important. Locking into a price early on can be a double-edged sword. If you agree on a price now, and then the home’s value goes up? The landlord might not want to sell to you. But if he does, you’ll be getting a great deal.

If the price falls, you are not going to want to pay more than the house is worth. In addition, your financial institution will not provide you with a mortgage on a home that you are paying too much for. You are better off to agree to a professional appraisal down the road, when you are ready to buy.

Lastly, keep in mind that you will still need to qualify for a mortgage when you decide to buy the home.

For Sellers

In the rent-to-own scenario the seller’s pros definitely outweigh the cons.

In today’s tough real estate market a rent-to-own agreement may be able to attract buyers you might otherwise not get.

One of the key benefits to such an agreement is your renters now have a vested interest in the property and it is in their best interest to take care of the home they are currently renting.

Additionally, if the renter decides not to buy at the end of the lease you will have still earned significantly higher rent during the tenancy.

There are very few scenarios where the seller would lose in signing a rent-to-own agreement with a current tenant other than locking into a price early on in the agreement and selling the home below market value. However, this could easily be avoided by not determining a price on the home and agreeing to a professional appraisal down the road, when the tenant is ready to buy.

How To Make It Work

As a buyer or seller it is imperative that you speak to a REALTOR® and your attorney to insure the contract is fair for both sides.

Buyers will need to approach their mortgage lender and be sure they will qualify for financing when the time comes. Remember, if you cannot qualify for the mortgage at the time of purchase it is more than likely any money amassed towards the down payment will be lost.

Make sure that the agreement covers maintenance and repairs as these are common points of contention, for both the buyer and seller, in rent-to-own scenarios.

Whether you are buying or selling, a rent-to-own agreement can be a creative solution in a tough real estate market. Just remember, consult an attorney before you step into any agreement.