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Are Foreclosure Properties Good Deals?

Many of us remember the dark days of the early ‘90s when lenders were major players in the real estate market. Then, Los Angeles County went through its worst economic downturn since the Great Depression. At the end of the Cold War, the aerospace industry contracted violently. Jobs—and people—left the area en masse. Prices plunged, as sellers, trying to sell short, raced to the bottom.

In such a scenario, market values can drop below the amount owners owe to lenders. This phenomenon is called being “upside down”. Add in loss of income due to unemployment, illness, death or divorce of a partner and relatively high monthly payments and you have the perfect storm of a foreclosure market—and why market values dropped by half from their 1989 highs to their 1995 lows.

Is this effect what is happening now? Not exactly. So far, the local economy is stronger and more diverse than in the 1980s. Demand for certain properties continues. Interest rates and inflation remain low. Most owners still have equity in their homes. So why are foreclosure properties, known in the real estate industry as “REOs”—Real Estate Owned—in the news again?

Market contractions are Darwinian. The weakest real estate markets wilt first—and are the last to revive when a market upturn arrives. The second home market in the desert and mountains and areas where owners have inelastic financial resources are usually the most vulnerable.

All that said, are foreclosure properties good deals? The short answer is: not necessarily. The myth of the REO as a good deal derives from the lingering popular perception that REOs are priced under comparable properties. This perception was, to some extent, true in the early ‘90s, when incompetent lender “asset managers”, often in distant “cube farm” offices, processed huge numbers of properties. These asset managers were bureaucrats with little or no stake in the outcome of a sale. In a rapidly declining market, achieving a lender’s top dollar was not as important as liquidating these failed assets as quickly as possible. In hindsight, some buyers got good deals in the rush to dump.

Then, as now however, it’s important to consider a few facts. REOs are often inherently weak properties due to factors such as condition, location, quality or style. When a property is foreclosed, usually there is a “Trustee’s Sale”. Anyone can bid at such sales, so long as you have “all cash” with you to pay on the spot for the property, but usually the lender whose note is in default acquires title to the property. Remember, that if you purchase a property at a Trustee’s Sale, all sales are “as is” and final. You will not have any contingencies, nor will you get any disclosures or title insurance. Caveat emptor.

Another fact about REOs is that, when a lender sells a property acquired through foreclosure, the lender/seller is not required to provide usual seller disclosures to the buyer. Again, caveat emptor. Also remember that people who lose properties to foreclosure usually do not treat these properties kindly. If you’re lucky, the house may have suffered only deferred maintenance. Sometimes the house has been victim to what lenders term “destruction of collateral”. Major fixtures, such as cabinets, windows, systems—even toilets—may be gone.

One frustrating aspect of buying an REO is that normal contract procedures are ignored. If you want to submit an offer on an REO, have your realtor write it (sometimes on the lender’s own form) and fax or email it to the lender (personal offer presentations never occur). You will sometimes have to wait a week or longer for the lender to review your offer. In the meantime, additional offers can arrive, even a dozen or more. In today’s market, the bidding can get heady. Offer prices can rise above the lender’s asking price. Counter offers are less-frequently seen on REO properties, so make your offer one you will have no remorse over if the lender ignores it. If you are the lucky purchaser, you probably won’t see anything in writing from the lender for a while. This lack of customary procedure can be nerve-racking. When the paperwork arrives, expect to be asked to sign lots of waivers. There is little negotiation with REO sellers. It’s their way or no way—if you don’t want to cooperate, there are others who will.

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Ten Ways A Realtor Can Rip You Off

I wrote this article several years ago, and it hit a nerve locally. Then, the market was much different, however, the ideas below are still in play, as agents continue to be challenged finding well-priced, quality--and available--properties. With much equity erased by the recession, sellers today are reluctant to sell unless they must. Some realtors resort to "creative" methods in any market--but especially in an imbalanced market, as we have presently. The motive is greed, of course, but why doesn’t someone stop these realtors? The answer is that most people are not aware of how some real estate agents work. Here’s what to watch for:

1. The “Pocket Listing” (and “One-Party Exclusive Listing”): A pocket listing is no listing. Rather, it is a property that a realtor knows is owned by a prospective seller who might sell if the price and terms were right. No public marketing is done by the agent on behalf of the seller. That the seller is even considering selling is usually kept a secret, the idea being that the best chance of putting a deal together—and perhaps “double-ending” the deal (when the same realtor represents both the seller and the buyer, and thus gains both listing and selling commissions) is to have NO competition from another buyer and/or broker.
Sometimes the realtor will have the seller sign an agreement, the “One-Party Exclusive Listing”, stating the terms of representation in the event a specific buyer purchases the property. Sometimes all parties to the transaction benefit from a good deal.
So what’s the problem? It just depends… Such an agreement is not offensive in principle, but sometimes the realtor may actually favor the buyer, sometimes, a speculator who has promised the realtor that he or she will “get the listing back” when the house is remodeled. Further, in a tight market, sellers will never know how much money they may have received for their property if they had a realtor market the property effectively by inviting buyer competition. Some agents cultivate pocket listings by assuring sellers that not putting the property on the market will spare them the intrusions of open houses and showings. If you’re a seller who likes to be short-changed, this is your kind of agent. Remember: competition among buyers is always in a seller’s interest. The more competition there is for a property, the higher the price rises.

2. “Pre-Marketing” Your Property: Pre-marketing is another way of stifling competition for a property so that a small group of realtors, usually within a single brokerage, will have an advantage over the rest of the realtor community. Information about newly-listed properties is circulated within the brokerage so that the buyers represented by agents of the same brokerage will have an early opportunity to write an offer. Sometimes a brokerage will “caravan”, or tour, a property with their entire office’s agents without having the property listed for sale. The goal with any of these tactics is not to get the seller the highest price. Rather, the goal is to keep “both sides of the commission” within the same brokerage, or “in house” (a brokerage usually splits the commission with the brokerage that represents the buyer—more about this below). Some brokerages actively encourage keeping both sides of the commission in house by offering financial incentives to their agents. Other brokerages encourage doing the right thing for the seller by disseminating the information immediately to the entire broker community in a way that encourages the most competition. Which brokerage would you like to have looking out for your interests?

3. The Unequal Commission Split: Real estate commissions are negotiable between brokerage and seller. Once set with the seller, however, how much the listing broker shares with the buyer’s broker is the listing broker’s business, right? Wrong. Longstanding agreement and practice in real estate is that the listing brokerage “cooperates” with the selling brokerage by sharing the commission paid by the seller. However, there is no obligation for the listing agent to share the commission equally. What difference would that make to the seller? If a seller, for example, pays a customary six percent commission, that seller might infer that a three percent commission will be sufficient motivation for agents to bring their buyers to the seller’s property. But what if the seller’s agent decides to keep four percent of the commission and offers only two percent to the buyer’s agent? How many agents are going to be inspired to show this seller’s house, when other sellers’ agents offer three percent to the buyer’s agent? Don’t think this slick maneuver doesn’t happen. Remember: people are coin-operated. Don’t let a greedy agent short change the cooperating agent—and you. Put the exact commission split between listing and selling brokerages in the listing agreement.

4. “Hide the Listing”: The idea here is, once again, to stifle competition for the property by playing “Hide the Listing”. Here’s how it works: first, the seller’s agent will put the listing into the Multiple Listing Service (MLS) computer system on a Friday afternoon, or even over a weekend (to avoid being fined by the MLS for violating rules regarding marketing the property while withholding it from the broker community). Then, the agent will hold an open house at the property on the weekend. Most of the broker community, who have eager buyer clients, will be caught unaware of the new listing. The listing agent will have an improved chance of finding a buyer to represent at the open house—or even a chance to “poach” another agent’s buyers who may be disgruntled because their agent was lax in informing them of this new listing—thereby “double-ending” the property before competition arrives. (Some agents will even wait until AFTER a weekend open house to place the listing in the MLS—what’s a $250 fine if they can double-end a deal, right?) By the following week, when most brokers and their clients find out about the listing, there might already be an offer on the table (which can discourage some buyers), or, if the agent is really lucky, the agent might get the property sold and cancel the open house. Who needs more buyers when all you need is one? You, the seller, do. Don’t put up with this subterfuge.

5. The Quick Sale: Part of the success of many ploys of greedy agents depends upon the quick sale. The idea is to lock up a deal, especially a double-ended deal, before other buyers with possibly higher offers materialize. Again, suppress the competition. You, the seller, lose, while your agent feathers his or her own nest. Don’t be bullied or rushed by your agent.

6. Bad Timing: A variant of the two ploys above is to follow a weekend open house with the brokers’ open houses, instead of having the brokers’ open houses first, then the public, weekend, open houses. Why? The best way to foment buyer interest in a new listing is to expose the property to the broker community, give the brokers a chance to promote the property among their clients—even to send their clients to a public open house—and to announce that any offers may be reviewed at a date and time AFTER the public open house. Have your agent build momentum for your property. It’s what you’re paying a commission for. Also, review offers no earlier than the Monday afternoon following a week’s market exposure. You’ll be amazed at the difference in the number of offers—and the prices offered, if your price is well-chosen. Anxious buyers who are serious will wait a reasonable amount of time—even if they whine a lot.

7. “Just Pick One”: If you are lucky enough, as a seller, to have more than one offer (“multiple offers”) on the table, count your blessings. So should your agent, but some agents hate to negotiate. “All that paperwork—just get it over with,” they must reason. “How many offers do you need to decide? Just pick one, and let’s open escrow.” Unless there is a very wide difference in the price and/or terms of the offers, i.e., one is overwhelmingly outstanding, it is much better to make counter offers to all the serious offerors. You might be surprised at what some buyers will do when desire becomes compelling. If your agent is too lazy to write up a few extra pages and make a few more phone calls, you need another agent. It’s YOUR money, after all, that is on the table.

8. The “Numbers Game”: Nothing disappoints a person more than the surprise of a promise not kept. Many agents, to gain the listing, will over-promise and under-perform—especially if the property sits on the market too long. They will also cut commissions to a point that, economically, there is no way that the agent could, or would, do all that was promised at the commission rate that was negotiated when the listing was signed. Remember what your parent told you: “You get what you pay for”. The discount brokerages—and agents who offer deeply discounted commissions—desire one thing: to sell lots of properties FAST with as little effort and expense as possible. Aging listings are liabilities—or written off as losers and ignored by the listing agent. To these brokerages and agents, real estate is not about personal service and fiduciary responsibility—it’s just a numbers game. Is this the kind of fiduciary you want on your side?

9. The Cheapskate: A variant of the “Numbers Game” agent above is the cheapskate. Even some rather successful brokers are loath to spend their own money when it comes to marketing their clients’ listings. This is false economy for a seller. Timely promotion of the property while it is available for sale is critically important to receive top dollar. Ironically, many cheapskate agents spend lavishly on marketing materials after the sale is closed. “Just Sold” cards, and the like, serve no purpose other than to self-promote the agent. As a seller, it’s better to get a commitment from the agent as to what is to be done to promote the property while it is on the market.

10. Hiring Your Mother’s Friend’s Cousin’s In-law: When you hire a Realtor®, you have many choices, both good and bad. The best choice is to hire a local expert with a resume of successful sales, who has the best tools (personally and brokerage-wise), is professional and ethical—and with whom you would enjoy working. Even the best agent, however, has limitations. Other things being equal, an agent with better local market knowledge and more availability for showings of a property would be a better choice to represent the seller of a house in Los Feliz, for example, than an agent in Orange County, or even in Beverly Hills—even if that agent is your mother’s friend’s cousin’s in-law. Keep sound business sense foremost.