Do Foreclosed Homes Make Good Rentals?

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It’s common knowledge that one way to get a good deal on a home is to buy one that is in foreclosure. The current owner has defaulted on their mortgage payments and their bank has repossessed their house. Since the bank wants to recoup their money quickly rather than become homeowners, they are willing to sell the home at a price below market value.

Investors like to purchase foreclosures since they feel they are getting a good deal by starting off with equity already built in. Shrewd property investors find that foreclosed homes are generally a bargain in the real estate investing business. But is a foreclosure always the great buy it appears to be at first glance?

When a Good Deal is Not So Good

An ideal foreclosure has been kept up by the owner. There are no damaged walls or fixtures. The windows are not broken and the yard is in good shape.

Unfortunately, the opposite is more likely to be true. Since the owners could not afford to keep up their mortgage payments, they most likely did not keep up the house either. Foreclosed properties are often in very poor condition and may require extensive and expensive renovations. Someone who has been unable to pay their mortgage payments most likely could not pay for the maintenance on their home. There may also be structural issues or water or mold damage; some homes may be in violation of building codes or other standards.

People who are made to relinquish their homes to the bank may be so resentful that they do extensive damage to the property, including removing appliances and fixtures and vandalizing the house inside and out. If they were made to move out before they could take all of their belongings, they may break into the house to retrieve them, doing more damage before they leave. The previous homeowners might remove items of value from their foreclosed home, including appliances, fixtures, doors, copper pipes, and more. In worst-case scenarios, anything that the homeowner does not take might be taken by thieves.

When buying a real estate owned (REO) property, you are purchasing it “as is.” This means that the property will most likely be in a distressed condition. As a result, you will have to perform repairs and improvements before renting it out.

If possible, insist on a professional walk-through inspection before you commit to purchasing a foreclosed home. It will provide you with estimated repair costs and eliminate any hidden expenses. In addition, it will help assure you that the home will ultimately yield you a high rate of return as a rental property.

What Are the Benefits of Buying a Foreclosed Home?

Because foreclosures can be great deals, they are attractive to investors looking to flip properties or use them as rentals.

Aside from the opportunity to purchase a foreclosed home at a bargain price, there are also financing advantages to consider. You should extensively research financing options for foreclosed homes.

If you buy a home directly from a bank, they might be willing to give you investment property financing in order to quickly remove the property from their books. This happens when the bank finds it in its best interests to sell the investment property as quickly as possible. Also, since you are buying the property with a loan, you won’t have to borrow as much since the foreclosed residence is already priced below market value.

However, there may be problems with lenders who don’t want to fund the purchase of foreclosed homes. Purchasing with all cash may be a buyer’s only option.

Since investors can make all-cash offers with fewer or no contingencies and fast closings, their offers may be more attractive to the bank than those from would-be owner occupants. As a result, when buying foreclosed homes, you could end up with lower closing costs, interest rates, and mortgage payments.

The low purchase price of the property will also come into play when calculating your return on investment (ROI). ROI is the amount of money you will get in return for the cash you invest in the property on an annual basis. Any improvements you had to make to correct damage done to the home by the previous owner will significantly increase the property’s market value and lead to high appreciation. That appreciation will result in your selling the foreclosed home for a higher price.

Generally, the lower the property purchase price, the higher return on investment the property investor receives. Therefore, since foreclosed homes are bought for a low price, they have a high potential for generating a greater ROI.

How to Turn Your Foreclosed Home Purchase into a Successful Rental

Before making a bid on an REO, consider the neighborhood. Regardless of whether you’re thinking of buying foreclosed homes to rent out or to fix and flip, someone is going to be living in the property. So, if you want to invest in a foreclosed house as a rental property, then you need to make sure it’s in a good neighborhood where tenants will want to live. That is, you want to be buying foreclosed homes in an area with strong rental demand.

Choose a location with a low number of past or current foreclosures and without a large number of rentals. Too many foreclosures, rentals and vacancies in the neighborhood will lower the rent you can charge, so calculate the current average rent in the area. The rent that you expect to charge for your income property will be the main determinant of your profit, so it is important to know the average rent for this kind of property. By looking at what similar rental properties in the community are charging, you’ll have an idea of what rental income you can expect to earn from buying foreclosed homes there.

Foreclosures are often referred to as “distressed properties” because of the bad condition the homeowners have left them in. As mentioned above, they will often stop doing repairs and maintenance on the home and vandals may have further damaged the property once it was vacant. For this reason, foreclosed homes are often in bad shape when they are finally repossessed and sold by the bank. So, be sure to completely assess the damage and get realistic estimates of what it will cost to return the property to a rentable condition.

As homes in your area increase in value, your property will appreciate, and your equity will expand. Any repairs or improvements that you make to the property will only accelerate this process. Foreclosure can give you the opportunity to invest in a market or neighborhood that would otherwise be out of your budget. By making a few repairs, you may be able to match the value of homes in a good market and charge higher rent accordingly. And of course, higher rent means more passive income.

Since foreclosure laws vary from state to state, you should seek the advice of a real estate agent who is familiar with your local laws before buying a foreclosed property.

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