There are many factors to consider when buying a home to flip at a foreclosure auction. One key factor is estimating the right price when buying houses at foreclosure auction, regardless of whether you’re in a rising or a falling real estate market.
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Contrary to common wisdom, it’s not always best to buy foreclosed houses when the real estate market is rising. It all comes down to the math and your ability to accurately estimate the future sales price. Then bid appropriately.
Knowing Your Market Values
To identify the right conditions for buying a foreclosed home to flip during a rising or falling market, you should focus on several factors.
To flip houses profitably, you must start with the After Repair Value (ARV) of the home. Of course, this is only an estimate this early in the game. Generally speaking you can expect the ARV to go up in a rising real estate market. But ARV is tricky to estimate when the market is falling. More on that later…
Set a Baseline Price
Your starting point are equivalent homes in decent condition that have sold recently in the area — preferably within a mile or two of the foreclosed house you’re buying at auction. Picking a few similar properties and averaging their sale prices will give you a baseline starting point of what your finished property would likely sell for now (assuming no major market movement).
Guesstimate an Expected Increase or Decrease in ARV During Your Holding Time
House fix & flips (or even just flips) take time to purchase, rehab and sell. The time you purchased the home to the time you close the deal with a new buyer is your holding time.
When markets are rising you have the luxury of price increases the longer your holding time is. This gives you leeway on the purchase price at the foreclosure auction, because you can bid higher and still expect to make a profit.
When markets are falling, your purchase price of the home at foreclosure auction becomes critical. If you overpay — or even pay based on today’s market value — you’re going to be in financial trouble from the get go.
What you need to do is estimate the ARV in the future at the point you expect to flip the house after holding it. This is a bit of art and a bit of science.
House Flipping Hold Times in Up and Down Markets
Next, you want to estimate your property hold time for a pure flip (no fixes). Most foreclosed properties need lots of repairs, but for this step you want to estimate the pure flip holding time with no rehab. Hold times depend a lot on the location of the property and the market conditions now and in the next 6 months.
When markets are rising quickly hold times can be very short — as little as 2 weeks in a place like Southern California and 4-6 weeks in some Northeast states like Connecticut for a pure house flip (no fixes).
When markets flatten out, hold times go up. You start to see price equilibrium and buyers getting more choosy and negotiating prices. Houses sit for longer. If your real estate market is flat, a good rule of thumb is to extend the estimated hold time by 3X.
When real estate markets go down, hold times can get very long — sometimes as much as 10-20X. As a rule of thumb, when house supply goes up and real estate prices are dropping, you should multiply your flip-only hold time by 5X to be safe.
If the housing market has crashed — say after a long recession with huge price drops and lots of foreclosures — rules of thumb no longer apply. You need to look at the average time houses have been sitting on the market unsold for the last 6-12 months. This is always important to research. Rules of thumb simply don’t hold up against actual evidence.
Estimate Your Time to Secure and Rehab the Property
Buying a house at a foreclosure auction is only the first step. From that point the clock starts ticking. You need to make all the payments, get title to the property, deal with any liens, etc. before you can invest further.
Then you may need to deal with the existing homeowner or tenants. This can take 1-3 months. If there are tenants with a lease this can take longer.
If the house needs significant rehabilitation, you will need to estimate the time to complete the fixes and make the house marketable. It is difficult to make accurate time estimates for this in most foreclosure auction situations, because there is little or no right to inspect the property before the auction. Expect to run in to structural, permit and contractor issues along the way and build in at least 1 month of additional contingency time.
Average time to rehab a house ranges from 30 days to 9 months. A simple rehab that includes a new kitchen, bathrooms, flooring, paint and roofing will generally take 45-60 days.
If you have to gut the home, re-plumb it, run new wiring, replace sewage lines, bag the house for termites, redo the foundation, remediate mold, replace the chimney or roof, etc. the rehab can take 6 months or longer.
Make your rehab time estimate then get a second one from an experienced rehab contractor. Try to form a solid idea of the time required to fix up the house and make it marketable. This needs to be done before bidding at the auction.
Add Your Flip Time Plus Rehab Time for Estimated Total Hold Time
Flip Time + Rehab Time = Total Hold Time
This formula gives a good estimate of the length of time between buying a foreclosed house at auction and flipping it.
Project Your Future ARV After the Hold Time
This is where price estimation becomes an art.
Chart the prices for similar homes in the immediate market over the last 2 years. Then project the last 3-6 months of comparable house sales prices forward. You can draw a straight line through the middle of the past sale prices and just carry that forward.
Where this line intersects your future sale date, this is the estimated future ARV.
Reduce Future ARV by Your Costs and Target Profit Margin
If you want to sell the house at a 30% net profit, subtract your estimated rehab, legal and transaction costs plus 30% from the future ARV. This will give you an estimated price to bid on the house at auction.
Future ARV – Rehab Costs – Legal Costs – Transaction Costs – 30% Profit = Auction Bid Price
Determining the Rise or Fall of the Market for your Foreclosure Flip
A rise or fall in housing market values affects the bid prices of foreclosure properties. You can determine the rise or fall of the housing market by looking at various indicators.
These three factors are reliable indicators of a local housing market’s rise or fall:
- Building permits
- Housing starts
- New home sales
Monthly building permits help forecast the number of new housing starts. New housing starts help predict the amount of new home supply. New home supply determines the available inventory of new housing, which contributes to total housing inventory.
Other market indicators you can consider are:
- The state of stock markets. Particularly housing, building materials and home improvement stocks.
- The state of housing-related commodity prices. If there is a decreased demand for construction materials, you can expect the market to suffer a stagnant house price growth, as well.
- Unemployment rate. If there is a low unemployment rate, it is likely the housing market is improving.
- Low or dropping time on market. Homes sell quicker when demand and prices are on the rise.
- More buyer activity and realtor inquiries. If more buyers are in the market, it is a sign the housing market is improving.
Buying a Foreclosure Auction House When the Market is Falling
As a house flipper you do not want to get caught not being able to sell a house in a falling housing market. A falling market results in a drop in demand and a rise in supply.
Buying a home in a market that is falling will turn your flip into a long-term investment if you’re not careful. You could get stuck with the house after purchasing and renovating it, and will have to rent out instead of flipping it.
Hang Lots of Low Bids
The key in falling markets is to bid extremely low at the foreclosure auction. This means you will lose a lot of the time. But when you win, you will have plenty of price buffer to make the flip profitable, even at a low sales price.
Remember, the 70% Rule is a formula used by many real estate investors. The formula helps to determine what price to pay and still make a profit after all the time and costs you must invest. In a down market you can tweak the 70% to 60%, 50%, even 30% and end up with lots more profit by picking up “low hanging fruit”.
Down Markets Give House Flippers Options
If you do end up buying a home when the housing market is at a bottom, you could soon be “in the money” as the market swings back up.
You can rent out the home to generate cash until the next up-cycle in the market.
Interest rates tend to drop significantly to counter recessions and get the economy back on track. This allows you to get cash-out financing at great rates if you hold onto the property instead of flipping it.
In a falling market, you can also expect many more short sales, or financially distressed homeowners selling their homes for less than the amount due on their mortgage.
There are more foreclosures, foreclosure auctions, and real estate owned (REO) properties. It’s much easier to pick up good deals in a down market.
Buying a Foreclosure Auction House When the Market is Going Up
On the other hand, if the market is rising, you can expect to see an increase in the number of auction foreclosure home buyers. A lot of these buyers will be looking to fix and flip the houses.
Rising Markets Can Be Risky, Too
In rising real estate markets auction competition rises, driving bid prices up. Investor money floods into the market, arming professional buyers with lots of capital and a mandate to “buy at all costs”.
Even though the market is rising, you can easily end up overpaying at auction and earning low returns on your flip. Otherwise, you may not win at auction at all, since you will be outbid often.
Rising Markets Protect Foreclosure Auction Buyers
However, rising markets do help protect buyers that might pay too much for a foreclosed home at auction. If you estimated the market growth accurately, you can then take advantage of the rising market by holding on to the property longer and selling for a bigger profit.
Buying a Foreclosed House When the Market is Flat
If the housing market is flattening out, it is very smart to find a buyer before you even purchase the house at auction. This mitigates the risk of having to hold the property and spend money on it in a slow-moving market.
The idea is to find a buyer who is willing to commit to buying at a price agreed beforehand, and paying for it after the house has been renovated. In this way, both parties benefit. The house flipper generates profit in a flat market and the buyer gets a newly-renovated house for a reasonable price.
This article should give you plenty of information to decide if it’s better to buy foreclosure auction houses to flip when the market is rising or falling.