I was talking to my favorite Realtor ™ today, and she was frustrated. She’s working with a client who insists that they’re only interested in buying a foreclosed property.

Now, in markets other than Houston’s, that’s probably a great strategy. In some sub-markets of Houston, that COULD be a good strategy. But, overall, it’s a deeply flawed strategy, and this article will explore the reasons why.

Here in Houston, several years ago, an elderly woman lost her home at the monthly foreclosure auction to the Homeowner’s Association for unpaid HOA dues of just over $2100. The winning bidder won the title rights to her home - three bedrooms, nice big lot, garage, good condition - for that pittance.

The point of this isn’t that someone got a steal on this poor woman’s house. The legislature quickly gathered itself to change the law such that this sort of bargain would not again present itself. The HOA reversed the sale, the woman didn’t lose her house, but the event made national news for weeks.

Since that time, the foreclosure auctions in the major Texas cities have been PACKED with out of town “investors,” looking to score the same kind of deal that was so heavily bemoaned on the news.

Point #1 - in Houston, the foreclosure auctions are heavily populated with out of area “investors,” who find Houston prices to be low by national standards, and who bid up the auction values to near market rate.

As is the case everywhere, Houston has had an accelerated pace of residential foreclosures. So far, we’ve avoided the big layoffs that have been announced around the country, as employers scale back for the expected ongoing slowdown (which is a self-fulfilling prophecy, if you think about it.) We’ve had a couple of large, local mortgage employers fold up their tents, but overall our employment is quite stable.

Nevertheless, there are more and more foreclosures on the MLS here in Houston.

Foreclosures are marketed, generally, by private local Realtors who have contracts with some of the large mortgage servicing companies. The properties are secured, trash hauled out, basic yard maintenance done, and then a sign put into the yard and usually, a MLS listing with one quickly taken photo.

The cachet of “foreclosure” does all the marketing for them.

The servicing companies that are the owners of the foreclosed properties have different pricing models, but all operate in a similar manner when offers start to come in - they hold and review offers, sometimes rejecting all offers, and usually during the first 90 days of the marketing period, always reject any offer that is below the listed price.

Offers that are contingent on financing, that ask for repairs, closing cost contributions, home warranty contracts are uniformly rejected.

When your offer is accepted, you have a very short time to close, and you’ll bear substantially all of the closing costs. You won’t get a property condition disclosure, a lead paint disclosure, or any sort of notice about the condition of the property. You don’t even get a warranty deed, you get a special foreclosure deed that only conveys that interest in the property that the foreclosing lender received.

Point #2 - when you successfully buy a foreclosed property, your closing expenses are higher, the property condition is not known to you other than your own inspector’s report, and you’re buying the deferred maintenance, move out damage, and vacancy damage that the house has incurred.

If you’re buying the property to “flip,” you are looking for the BBD - bigger, better deal.

Based on points #1 and #2, your basis in the newly acquired foreclosure is higher than you may like, and your costs to improve or rehab the property are a big question mark. Still, let’s assume that, based on pre-sale data, you look like you can flip this and make some money.

With the lending/credit crunch, all lenders have taken a hard line on appraisals. A minimum of three comparable sales are required, two of which have to be within a mile and support the proposed sales price. All have to be within the last 90 days.

Your purchase at foreclosure is an excellent comparable sale for what your property is worth.

Your appraiser is going to want hard data on what you’ve done to increase the property value. Your sweat equity won’t count (any more.)

Point #3: Buying a foreclosure to “flip” isn’t a sound business model in the Houston market today.

So, I sound like the Boy who cried Wolf - you’ve, after all, been to a seminar, known a friend who was flipping property like crazy in Florida, and you’re just convinced that I’m wrong.

Point #4: People who sell seminars are in the business of selling seminars. People who sell houses are in the business of selling houses, and not in the business of offering advice for free - they get paid when you close on a purchase. There are few resources out there that aren’t deeply and personally invested in your concluding a purchase.

If you’re looking for an investment property or even a property to live in, step out of the foreclosure box, and set some parameters for yourself. What price range? Flip or hold? What repairs and rehab are you willing to do? What will the market comparables actually support on a lease or resale? Run scenarios for cash flow and after-tax benefit. Assume a 2.5% to 4% annual appreciation for almost any neighborhood.

Once you’ve done your homework, share the results with your Realtor and let that professional find you a selection of properties that meet your criteria. Don’t box them in with the mantra of “find me a foreclosure.”