How to Research An Auction Property - Buyers Beware
By Rick Sharga, RealtyTrac Vice President of Marketing
Buying a property at a public foreclosure auction is not for the faint at heart. It usually requires patience, persistence and a fair amount of cash, since most state foreclosure laws stipulate that the winning bidder pay all or part of the winning bid on the spot.
But for those willing to do the work and able to front the cash, auction properties can yield bargains of 20-40 percent below the market value, and sometimes even more. Like any high-yielding investment, foreclosure auctions come with a certain amount of risk. Managing that risk successfully depends on first doing thorough research on the properties you plan to bid on—perhaps the single-most important step in a successful and profitable auction purchase.
“You’ve got to know the property inside and out and you’ve got to know that the party who is auctioning the property is, in fact, in the first lien position,” said T.J. Marrs, a real estate investment trainer and author based in Vancouver, Wash. Since many properties may have multiple liens (first and second mortgages or tax liens, for example), this is a critical piece of information to have before the auction begins. Marrs added that if the party auctioning the property is not in the first lien position, the winning bidder may have to pay off other outstanding loans against the property.
It helps that researching properties has become much easier with advances in information technology. In the past, home buyers and real estate investors sifted through piles of documents at the local courthouse to properly research properties. But thanks to online services like RealtyTrac, you can accomplish extensive property research from home or anywhere else you happen to be, as long as you have an Internet connection.
That doesn’t mean you will feel comfortable interpreting all the data available from this research. First-time auction buyers or investors may be wise to rely on a local real estate agent or real estate attorney to ensure they’re making good decisions about which properties to bid on and how much to bid. Contact an Agent using RealtyTrac’s Agent Network.
Whether working with a real estate professional or not, you can follow this property research checklist to make sure you’re fully prepared when you attend an auction.
Research state laws and observe a local auction
Each state governs how the foreclosure process – and specifically the auction – works in that state. The process can vary widely from state to state, so aspiring buyers or investors should study the foreclosure process in their state. Important factors to consider are how quickly a property can go to auction after the owner defaults, how much cash is required at the auction and if the owner has any redemption period after the auction.
In some states a property can be sold at auction less than a month after the owner defaults, while in other states the foreclosure process can stretch out more than a year, not including any redemption period. The length of the foreclosure timeline certainly influences how quickly you need to research a property and secure the necessary cash to bid at the auction.
If there’s a redemption period, the former owner can typically buy back the property by paying the full amount of the winning bid (plus any applicable fees and penalties) during the redemption period. If you’re the winning bidder, you should wait until the end of the redemption period before sinking any additional capital into a property purchased at the auction.
RealtyTrac’s state foreclosure summaries provide specifics about how the foreclosure process works in each state.
First-time auction buyers should attend a local foreclosure auction to observe how state foreclosure laws play out in the real world. RealtyTrac provides a daily updated list of properties nationwide that are scheduled for public foreclosure auction. Auctions are often postponed or canceled, so it’s a good idea to call the trustee or attorney listed on the day of the auction to confirm.
Before bidding at an auction, you’ll need to evaluate the cash you have available to spend on an auction purchase. In addition to considering liquid assets such as bank accounts, stocks and bonds, you can apply for a home equity loan to cash out the equity in your home or other real estate assets.
Once you calculate the cash you have available, you can determine how much of that cash you feel comfortable using to purchase an auction property. Of that amount, you will need to set aside some for estimated repairs and some to pay off outstanding liens that survive the auction purchase (although if you purchase the auction property below market value, you may be able to take out a home equity loan on the newly purchased property to fund repairs.) The remainder of the cash can be used for bidding at the auction.
Some states require as little as 5 percent of the purchase price in cash at the auction. Others require the entire purchase price in cash. Either way, you will need to present the necessary cash at the time and place of the auction, usually in the form of a cashier’s check. That means you should be ready to withdraw your cash quickly when an auction opportunity arises.
If the winning bid is below the amount of the cashier’s check presented at the auction, the trustee at the auction should reimburse the winning bidder for the difference, although reimbursement may take several days or longer. Many bidders bring several cashier’s checks in incremental amounts so they avoid having to wait for a substantial reimbursement.
Analyze market value
Once you’re comfortable with how the foreclosure process works in your state and your spending limit, you can dive in and start pursuing specific auction properties. For any property scheduled for auction, the first step is to compare the property’s estimated market value to the opening bid.
The opening bid is the total amount owed to the foreclosing lender and is the minimum amount the property will sell for at auction. This amount is included on the public auction notice and on each auction property listed on RealtyTrac. In addition, RealtyTrac arms subscribers with each property’s estimated market value and a list of up to 15 recent comparable sales.
If the opening bid is higher than the estimated market value, that particular property does not present a bargain-buying opportunity. But because of the hot real estate market in most areas, the opening bid is usually far below the estimated market value, making for the possibility of a profitable purchase.
A quick market value analysis is just the beginning, however. You need to dig deeper to find a property’s true investment potential.
Check lien and loan history
Before bidding a dime at the auction, it’s important that you carefully research a property’s title for any liens and loans that won’t be cleared out by the auction sale. All liens and loans affecting a property’s title are available at the local recorder’s office or online through RealtyTrac.
Unlike typical real estate purchases, auction sales don’t always transfer ownership of the property with a clear title; therefore, it’s possible for a buyer to purchase a property at an auction and still have to fork over additional funds to clear out other outstanding debts secured by the property. You might be willing to do this, but you need to know about any outstanding debts before the auction so you can set your maximum bid appropriately.
To determine which liens and loans will be cleared out by an auction sale, you should look at the priority of the liens and loans taken out by the current owner. Priority is typically determined by the date when the lien or loan was recorded. The first recorded takes highest priority and the most recently recorded takes the lowest priority.
The defaulted loan that triggered the auction sale typically clears out any “junior liens” that have a lower priority. There are a few exceptions such as property tax liens, which take priority over all other liens and are not cleared out by an auction sale. Any “senior liens” that have a higher priority than the defaulted loan will usually continue to encumber the property after the auction.
Property title research is probably the most complex and technical part of the auction-buying process, and it’s impossible to overemphasize its importance to a profitable auction purchase. First-time auction bidders should seriously consider enlisting the help of a local real estate agent, attorney or Title Company for this part of the research.
Estimate needed repairs
Estimated repairs should be factored into any property purchase, but there’s an added twist with auction properties: in most states, auction bidders don’t have any opportunity to view the inside of the property before they bid, let alone hire a professional inspector inspect the property. You may be able to approach the current occupants and ask permission to view the inside, but that permission is not guaranteed.
While this makes it difficult to pinpoint exact repair costs, you can obtain a ballpark estimate just by viewing the property from the outside. You will be able to infer a lot about the property’s overall condition by observing the condition outside. Serious buyers will park their cars and walk by the property and around the neighborhood, also looking for neighbors as potential sources of information. You can also check natural hazard reports to see if the house is located in a zone that makes it more prone to flood, fire or earthquake damage.
Still, the exact cost of repairs is unknown, and you should leave some extra margin for profit in your maximum bid in case repair costs escalate above your estimate.
Calculate your maximum bid
The maximum bid is simply the amount a buyer is willing or able to pay at a public auction. It’s important that you set a maximum bid before the auction to make sure you don’t get caught up in the emotion of a bidding war and end up overbidding.
Marrs, the real estate investment trainer and author, recommends setting a maximum bid of 60-70 percent of the property’s market value as a general rule of thumb. This amount may vary based on the local real estate market conditions. From this baseline bid amount, you should subtract estimated repair costs and any outstanding liens and loans that aren’t cleared out by the foreclosure sale.
At the auction, stick to your maximum bid and don’t be influenced by other bidders. Sometimes the foreclosing lender or junior lien holders will bid at the auction to make sure all of their debts and costs are covered by the winning bid. This can sometimes inflate the winning bid close to market value, eliminating any chance at a great bargain.
Of course, the bidding will go up incrementally, so you shouldn’t immediately jump to your maximum bid. Continue to go up incrementally until you reach your maximum bid or are declared the winning bidder.
You should consider foreclosure auctions, whether you’re looking for a great bargain on a home for yourself or entering the real estate investment arena. Auctions aren’t for all buyers, but with the proper resources and the right research they can be a prime opportunity to purchase property below market value.
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