Acknowledging The Risk Of Buying A Foreclosure

Back in November I wrote a post about due diligence when contemplating real estate investing, focusing on how I attempt to mitigate the risks of purchasing a foreclosure.  Besides looking at single family residences instead of multi-family ones not much has changed since then.  I’ve looked at dozens of additional properties since that time and feel like my skill of evaluating a home for potential purchase has improved.  Since my due diligence phase is over, a contract has been signed, and a closing date is just around the corner I thought it would be a good idea to consider the risk of actually purchasing a foreclosure.  The risks are real, but just as in stock investing there are ways of limiting those risks.

Compared to purchasing a traditional home buying a foreclosure brings about a few unknown variables and when it comes right down to it the potential buyer has to be ok with moving forward without complete knowledge.  Sure, you do get a home inspection with both types of purchases, but when a home has been sitting vacant for a year or longer the utilities are no longer on and completing an inspection can be challenging.  I’ve had more than one person who has experience in these types of investments tell me that it’s a “gamble”; not really what you want to hear when you are looking at laying down a large sum of capital for an investment.  The key for me has been acknowledging  these unknowns and assuming a worse case scenario instead of hoping that everything will be ok.  After assuming the worst case scenario and estimating the cost of a compete repair I then compare the additional cost of the total rehab to what the estimated resale value will be once the house is ready to sell.  If the numbers don’t work out, then I walk away.  Let me give an example of potential problems with my current purchase.

During the inspection process of the current house I’m purchasing two problems were found.  The first was with the electrical system of the house.  When I called the utility company to have the electric turned on to the house so I could get the inspection done they informed me that due to the house being empty for so long that I would need to get the county inspector to improve it before power could be turned on.  After calling the inspector I was told I would need to have an electrician come out first and do any repairs then the inspector would come and check the residence and sign off on the permit.  Now we are on to the third phone call, actually the third, fourth, fifth attempting to get an electrician to come out and tell me what needed to be done.  Finally, I got a guy to come out at 9:30 at night and give me an idea of what the house would need to have the electrical system up to code.  The repairs are not extensive, a couple of hundred dollars but here is the catch, the repairs can’t be completed until I close on the house therefore the electric can’t be turned on.  This means that the heating and air system could not be evaluated.  I’m assuming a complete replacement for this system.  If it doesn’t need it great, but I would rather assume the worst and be pleasantly surprised than to hope for the best and be pissed off.

The second (potential) problem is with the plumbing system.  When you purchase a HUD home you get a property condition report (PCR) which is the initial inspection HUD does when they take possession of a property.  On this particular property it is noted that the plumbing lines will not hold pressure, inferring a potential leak in the plumbing.  At first this sounds really bad and I was fist notified of this when I was signing the purchase contract, not really what you want to hear when you’re signing your name to a large purchase right?  My real estate agent was very patient as I spent an hour making calls and gathering information.  In the end I decided to accept the risk for this potential problem and here’s why.  Looking at other HUD properties I noticed that several other homes have the same problem, “plumbing system will not hold pressure”.  I then found out no actual leak was ever detected, the way they go about testing the system is by hooking a compressor up to the system and running 30-40psi of pressure in the lines.  If it hold pressure then it passes the inspection, if not it fails.  My initial assumption was there was an actual water leak in on of the pipes from them freezing and bursting, not unheard of in this area.  However, what it actually means is the system is just not able to hold air pressure which could mean anything from an actual burst pipe or something as simple as leaking valve from a faucet, which seems much less intimidating.

Again, I’m assuming worst case scenario.  This house sits on a slab foundation, meaning there is no crawl space to access pipes under the house.  The pipes are covered with concrete when the floors were poured.  This means that if there is a leak under the slab it will have to be cut up and replaced, which is bad because that will raise the cost of rehabilitating this residence.  As with the heating and air system I’m assuming the worst case scenario and moving forward with the knowledge of what could become a costly repair, but damn I’m hoping it’s a leaky valve on a faucet!

Obviously each residence offers in own unique set of challenges.  I’ve listed mine here, but you could run into foundations issues, roofing problems or any number of other problems.  I think the way of navigating these risks is to:

  • Assume the worst and only move forward if you are absolutely certain you are ok with the worst case scenario.
  • Have advisors.  I know my limits and if I didn’t have some knowledgeable people in my corner who I know I can trust I would never tackle a project like this.

Anyone else attempted to invest in foreclosures or real estate in general?  I would love to hear your experiences with it.

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2 thoughts on “Acknowledging The Risk Of Buying A Foreclosure

  1. Great information here. You’d have to assume that if the prior residents couldn’t keep up on the mortgage, they couldn’t keep up on repairs either. Wow the pipes in particular sound pretty scary. I imagine the purchase price was low enough to absorb any extra costs that might be incurred.

    Please update us on what happens. This is interesting.

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