By: Jay A. Brett
As a transactional real estate attorney with more than thirty-five years of “in the trench” experience, I am often asked by friends, clients and lawyer colleagues about the perils and pitfalls of bidding for property at foreclosure sales. When asked this question, I always begin with the caveat: ”You should never, ever do this without the assistance of both an experienced real estate attorney and an experienced real estate broker. My reasons are summarized below. While this would have been my response even five years ago when foreclosures were relatively scarce and the process was more orderly, that same response is now underscored in this uncertain market where the Clerk’s “Rocket Docket” has been born out of necessity, and one misstep can cost an unwary buyer thousands or even hundreds of thousands of dollars, depending upon the scope of the property and whether it is commercial or residential. So here, in no particular order, are my “top things to consider (and watch out for)” when considering becoming a buyer/bidder at a foreclosure sale”:
1. Search the Title. Having your attorney perform a thorough title search is critical to determine if there are any construction or tax liens, junior lien mortgages or other encumbrances, such as a Lis Pendens, where necessary parties may not have been joined in the pending foreclosure action and as a result, there may be claimants who are not “foreclosed out” in the foreclosure judgment. The search should include real estate taxes, governmental assessments, and federal tax liens. Show me almost any foreclosed property, and I will show you unpaid real estate taxes for at least one year, and perhaps tax certificates for several prior years. When owners default, the first thing that happens is that real estate taxes become delinquent.
2. Obtain a Market Analysis. Through your real estate broker (who you have now wisely retained), obtain a current market analysis to determine therealistic fair market value of the property. The emphasis here is on the “realistic” since you will either be rehabbing this property for sale or trying to sell it “as is”, and in either case you need to know what the range of selling prices may be at that particular point in time. I recommend using a real estate broker for this rather than an appraiser, not because I dislike or disrespect appraisers, but for the following reasons: (a) Appraisals are more expensive. (Real estate brokers will generally provide a market analysis for a nominal fee or even for no fee if they are provided a reasonable chance to obtain a listing on the property which would eventually lead to the payment of a commission); and (b) Appraisers must deal in “retrospect”, meaning that they can only take into account those sales which have already occurred to use as their “comparables”. In many cases, and in this particular volatile market, these comparable sales may be too remote in time and/or in geographic proximity to provide a true fair market value. An experienced broker, on the other hand, will know not only what other properties are currently listed for sale (appraisers can’t take this into account), and will know what is happening today and what is likely to happen tomorrow. What happened last month is, unfortunately, irrelevant in this market.
3. Estimate Your Costs. You will need to determine your “carrying costs” for the property on which you will be bidding. Aside from rehab costs (which will be addressed later), you will need to calculate what the monthly “carry” will be for at least taxes and insurance, and whether there is any realistic probability of renting out the property to a short term tenant while the property is listed for sale. You should be prepared financially to carry the property for at least a period of up to eighteen (18) months, and you should calculate the true cost of this ownership. This means that routine maintenance costs for the property such as lawn care, pool care (if applicable), security costs and cleaning services should also be estimated.
4. Check for Tenants. If the property happens to be a commercial property (or even a residential property), you will need to make sure that no tenants currently occupy the property who may claim rights under a written (or oral) lease, or worse yet, an option to purchase the property which may still be enforceable. You cannot rely on a review of the Public Records or a review of the foreclosure case to determine whether a renter is present. Either you or your broker will need to physically inspect the property to determine whether there are signs that any tenant (or even a “squatter”) is currently occupying the property. While there may be selected instances where a tenant turns out to be a blessing (see insurance discussion later), it is generally an impediment to selling a residential property which is rented. Commercial properties may be different, depending upon how large the property is and how many tenants there are. In this context, it becomes important whether there exists “subordination” “attornment” and/or “non-disturbance” provisions built either into the mortgage which is being foreclosed or the lease which any particular tenant may have in effect. For example, if a tenant exists and there is a “non-disturbance” clause in either the foreclosed mortgage or the tenant’s lease which was approved by the foreclosing lender, a new owner may have no choice but to continue to honor that tenant’s lease, provided they are not otherwise in default. Therefore, if you encounter a tenant, it becomes critical to have your attorney carefully review not only the lease, but the terms of the foreclosed mortgage.
5. Rehabbing the Property. You will need to determine (in conjunction with your broker and perhaps a reliable local contractor) the cost of returning the foreclosed property to saleable condition. Rehabbing any property can be a tricky process, and you should have some idea going forward as to what sort of work may be required to put such things as the roof, the plumbing, the electrical system, the flooring, the HVAC system, and the landscaping back into workable condition. You should also have a mold inspection performed, since the presence of mold can be a “kiss of death” for any property. Unseen items such as sprinkler systems, well systems, boat davits, pool filters/motors, and other such mechanical devices all need to be considered as well. A property which has a defaulted mortgage is typically a property where routine maintenance was the first thing to be ignored, and it is more often the case that the property will need to have a substantial amount of money invested into it in order to make it saleable. In the case of many residential properties, either the defaulting mortgagors or perhaps vandals have defaced the property or have removed all of the appliances as well as “everything that isn’t nailed down”. Unfortunately, it will all have to be replaced. In the case of commercial properties, a “Phase I” environmental audit is highly recommended. Any new lender will require one.
6. Land Use and Zoning Checks. You should (through your real estate broker) check on the local land use code to determine whether the property is zoned for its current use or perhaps whether there is some type of non-conforming use which can be “grandfathered in” should you continue that use. This issue is obviously more applicable to commercial properties than to residential properties. For residential properties, look for such things as a finished first floor in an area where houses are required to be “built up”. You should determine what the County’s current schedule of uses are under the applicable zoning category for the property so you will have an idea of what uses a new purchaser might make of the property.
7. Survey and Boundary Issues. You and your broker should make a careful physical inspection of the property by walking its boundaries to determine if there may be any suspect survey issues or boundary disputes. Looking for things such as a neighbor’s roof or concrete slab which may be encroaching over the property line; a dock which may be built too far out into the river/lake/canal; a fence line which doesn’t seem quite right; or some evidence of contamination, can all be important “red flags” in making this determination. Of course, there is no substitute for a new survey, although this is an expense that is probably prohibitive prior to the time you purchase. Once you have purchased a foreclosure property, however, obtaining a new survey is highly recommended. If you are somehow able to get your hands on a previous survey for the property, the surveyor who prepared it may be able to offer a better rate in “recertifying” it to you as the new owner.
8. Location, Location, Location. You and your broker should check out the long term viability of the neighborhood in which the property is located. If the property is residential, and is located in a subdivision which has a Homeowner’s Association, you should contact the Association or its manager (most use professional management companies) to determine how many ongoing or recently completed foreclosures there may be in that neighborhood and whether the Association is experiencing a shortfall in its collection of periodic maintenance fees. Many Associations are going through the process of assessing current and new owners for the unpaid shortfall which they have been unable to collect from defaulted properties. Obviously, the more foreclosures which exist in any particular neighborhood, the more difficult time you may have in reselling the property, due not only to more “cheap” competition, but due to a Homeowner’s Association that is strapped for cash. You should also take a careful look at whether the neighborhood is “on the way up” or “on the way down”. Sometimes this is a tricky thing to determine, but things such as proximity to schools, churches and viable shopping centers are important, as well as such things as access to public roads and proximity to waterfront. Obviously buying a property in an affluent area, whether residential or commercial is a better bet than buying a property that may be in a run down or crime-ridden area. However, this is a function of how much you will pay to obtain the property. If the property is in a golf course community, consider how many homes are already built there which would have to share in the substantial cost of operating a golf club if the developer either fails or files for bankruptcy
9. Insurance. You should also take a careful look into whether the property you are considering purchasing will be insurable. This issue is fact becoming a real “bugaboo” in Florida. Insurance underwriters are having withdrawal symptoms over any unoccupied dwelling, whether it is commercial or residential, and you may find that you have a difficult, if not impossible, task in trying to obtain an insurance binder for your new property. Sometimes having a tenant will help in this regard. If you are going to go to the trouble and expense of purchasing at a foreclosure sale, you should obviously have the property insured against fire, windstorm and vandalism. The more remote the property is (whether a property is in a gated subdivision vs. whether it is “out in the boondocks”) may determine whether an insurance underwriter will consider proving coverage. You should check on the availability and terms of insurance prior to making your bid.
10. Alternative Methods of Acquiring Ownership. By now you might be getting a little reticent to becoming a foreclosure bidder. It is not for “sissies”. Consider instead foregoing buying at foreclosure sale and working instead with banks and other lenders who may already have an inventory of foreclosed property (called the “REO” or real estate owned department. Banks are most often interested in unloading these properties quickly to avoid payments of real estate commissions and other carrying costs. As has also been well publicized, many banks will consider a “short sale” offer as long as it is reasonable. In addition, you may attempt to “low ball” a bank shortly before the end of a calendar quarter, i.e., before a non-performing asset will have to be reported to regulators. While you might pay slightly more for a bank owned property, the risks in buying it are substantially less, since the bank will stand behind the property on routine risks. However, keep in mind that very few banks will warrant the condition of a REO property, so be prepared to buy “as is”.
11. Financing. Consider your own financing potential if you are not a “cash buyer” and will need your own financing to acquire a foreclosure property. Each Judicial Circuit in Florida has its own “local rules” for how foreclosure sales are conducted. Some Clerks are even resorting to electronic sales, which can be ungodly complicated and, in my opinion, legally suspect. If you are going to bid at a foreclosure sale, you must familiarize yourself with the Clerk’s rules as to how bids are conducted, how much of a deposit you must put up in cash, and how long you have to deliver the balance of the funds. Most conventional lenders will not provide a line of credit for this type of activity, as banks are moving away from “asset based lending”. This is what got many banks in trouble in the first place. Although bridge loans are obtainable, especially on the internet, you may find that interest on this hard money can run as high as 18-25% per annum, which is pretty outrageous. Although you can refinance quickly in most cases, bridge loans can be a treacherous minefield. We always advise clients who are considering bidding at foreclosure sales to first attend several foreclosure sales in person and familiarize themselves with how the bidding process works, so they will be prepared when their day rolls around.
12. Be Prepared to Follow Through. If you decide to go through with your foreclosure sale, be prepared to complete the deal. If you place up a deposit and then acquire “buyer’s remorse”, there is no effective way to retrieve your deposit, and it will very likely be lost. Conversely, there is probably no effective way for the court system to force you to complete the sale once you have forfeited your deposit and walked away. The Clerk will just re-advertise the property for sale and sell it to the “next guy”, but you will be out of pocket for your deposit. The amount of deposit is typically enough to make you say “ouch” if you decide to walk away.