Buying Foreclosed Homes as Rental Properties
Consider key factors about a foreclosed home before you buy it as a rental property.
Buying Foreclosed Homes as Rental Properties
Some investors are eager to purchase single-family homes in
Wise buyers will consider such things as the neighborhood in which the home is located, how the home has been maintained, and whether any existing tenants who rented from the prior owner will remain after the purchase. Here's a rundown of the things you should consider before you buy a foreclosed property with the intention of renting it out.
Why the Rash of Foreclosures in Some Areas?
A sad fact of sub-prime life is that in many areas of the country, whole neighborhoods are awash in foreclosures. Typically, these areas were hastily built by developers eager to take advantage of the seemingly endless appreciation of real estate, and they all came crashing down when the purchasers (and in some cases, the developers) became unable to meet their mortgages or construction loan payments. For hard numbers on the incidence of foreclosure in your area, use Realty Trac (www.realtytrac.com) to check the concentration of foreclosures by Zip code.
Will You Deal With a Bank or a Homeowner?
Purchasing a foreclosed home may not be the home-buying experience you might imagine. Instead of dealing with motivated individual sellers, anxious to showcase their home by staging it and working closely with their broker, most buyers will encounter an institution -- a bank's asset management department, where it's hard to reach and converse with an individual, let alone the same individual each time. Don't expect quick turnaround and individual attention by people who have the authority to make decisions. Instead, you may find yourself dealing with a department that knows banking but not home selling and stops answering the phone at 5 PM sharp.
However, if you are lucky enough to buy a home in preforeclosure (preforeclosure is the period after the homeowner has received a notice of default but still has months before the auction takes place), often you can negotiate a deal with the homeowner instead of the bank.
Consider the Neighborhood
A key factor in the success of your rental is the neighborhood. In general, a rental in an area dotted with foreclosures is likely to command less rent when foreclosed properties remain unsold and, more importantly, unoccupied. These forlorn properties are likely to be unmaintained and are targets for vandalism and even squatters. Few tenants will want to join the ranks in such a neighborhood, and those that do may expect the rent to reflect these negative attributes. When making a bid on such a property, factor in the realistic rent the house can command.
A neighborhood of foreclosed homes bodes ill even if they have been purchased and are in relatively good shape. All of these homes aren't going to be occupied by the owners -- many will be rented out, just as yours will be. That makes for a concentration of rentals -- in short, a glut on the market, which will drive prices down. The same property in a different part of town might fetch a higher rent simply because there is less competition.
A foreclosed property in good condition located in a neighborhood with few other foreclosures will most likely fetch higher rent. Of course, such a property may command a higher selling price as well.
Investigate the Home's Maintenance History
Buyers should next turn their attention to the house itself and its history. If they're lucky, they can find out who lived there, and whether the occupants were renters or owners (some 40% of foreclosed properties were bought as investments, making it likely that you're dealing with a home that has already been a rental).
To learn about the house, start with the neighbors if you can't locate the prior owner. Did the owners take great pride in their home and leave it in good shape? Or was the home occupied by unmonitored and malicious tenants (unsupervised by an owner already demoralized by the property's imminent loss)? Or was the home occupied by resident owners who spitefully trashed the home before moving out?
Even if the property was a rental that escaped the wrath of its last occupants, think about the extent of wear and tear suffered by this property. Often, rental properties suffer more deterioration than owner-occupied homes. Take this into consideration when setting your purchase bid.
Adjust Your Offer as Needed
The more you learn about the home, the more realistic your purchase offer can be. If you can spiff up the home with a coat of paint and some landscaping and reasonably offer it at market rates, your post-purchase expenses will be small (and you can afford a higher bid). But if you have to replace copper pipes, sheetrock, flooring, and appliances, you're looking at major expenses before you can even place a For Rent sign on the front lawn. The "bargain" you thought you had may turn into a very expensive investment.
Dealing With Current Tenants
Finally, there is always the possibility that the house you are considering will come with resident tenants who had been renting from the prior owners. Many times, the residents will have left long ago, driven off by the owner's lack of maintenance, or by the foreclosing bank's demand that they vacate (the banks often accelerate the process by offering to pay the tenants to leave, known as "cash for keys"). But sometimes the tenants stick it out and are still there. If so, most of the time you will have a choice of whether to keep the tenants. Here's the rule:
If the tenants have a lease that was signed before the prior owner recorded his mortgage, they will survive the foreclosure -- in other words, you have to honor their lease until it ends.If the tenants have a month-to-month rental agreement, or a lease that was signed after the foreclosed-upon mortgage was recorded, the foreclosure wiped out their lease or rental agreement, and you can evict them if you choose.If the home is subject to local rent control that requires landlords to have a just cause, or good reason, to terminate tenants' leases, you may not simply deliver a notice to vacate. You'll be stuck with these tenants as long as you use the property for rental purposes, or until you fit within one of the ordinance's allowable reasons for termination.
Given the choice, should you allow current tenants to stay? Because most leases are for a year and most mortgages pre-date the current lease, it's likely you'll have the option of asking current tenants to leave or letting them stay. Evaluate these tenants as you would any set of prospects. If they have been paying rent on time (admittedly, it might be hard to get the facts unless you can talk to the prior owner), and have been taking reasonable care of the property, you might decide to keep them and negotiate your own, new lease.
But if you sense trouble, think twice about purchasing this property in the first place. You don't want to be saddled with tenants whom you would never have rented to in the first place. And if you purchase the property, counting on evicting the residents, understand that if these tenants refuse to leave, you'll need to begin an expensive and drawn-out eviction. This is hardly the way to begin your new rental business.
For more information on dealing with tenants, including evicting them, get Every Landlord's Legal Guide, by Marcia Stewart, Ralph Warner, and Janet Portman (Nolo).
Copyright 2008 Nolo
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