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Simple steps anyone can follow to understand how money is made investing in distressed real estate

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CASTLE ARCHREAL ESTATE INVESTMENT COMPANY

Distressed Property InvestingA foreclosure and REO snapshot for financial advisors and their clients

A user guide to understanding the opportunity underneath the foreclosure crisis in America

TABLE OF CONTENTSDistressed Real Estate Primer 1. Introduction 2. Real Estate Value 3. The Distressed Real Estate Market 4. The Opportunity in Distressed Real Estate Finding 5.StartWithFinancingandaProfile 6. Which Rocks to Look Under Due Diligence 7. Inspection 8. Professional Inspector? 9. Rehab Estimates 10. Occupancy 11. Appraisal/Valuation 12. Valuing Income Property Contract and Close 13. How Much to Offer? 14. Liens 15. Taxes 16. Creating a Holding Company 17. Financing 18. Negotiating With the Seller and Submitting an Offer 19. The REPC 20. Closing, Title and Escrow

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1 3 3 7 10 11 19 19 20 21 22 24 31 33 35 35 36 37 39 40

COPYRIGHT 2009 KIRBY COCHRAN. ALL RIGHTS RESERVED

Rehabilitation 21. Finding a Contractor 22. What You Should or Shouldnt Do Yourself Exit 23. Lease to Own (Seller Financing) 24. Owner Occupancy 25. Sale 26. Income Property Conclusion Appendix Bank and Lender REO Resources Government Websites Additional Finding Resources Asset Management Companies Sample Home Inspection Checklist Sample REPC (State of Utah) Sample Sellers Disclosure Form (State of Indiana) FTC Real Estate Glossary

44 47 48 48 49 50

I IV VII VI VIII X XVI XVIII

COPYRIGHT 2009 KIRBY COCHRAN. ALL RIGHTS RESERVED

DISTRESSED REAL ESTATE PRIMER

1. Introduction Real Estate investing is the ultimate mixed bag. On one hand, the rich all seem to have a portion of their wealth that stems from owning property. Historically, land ownership has almost been synonymous with wealth. Likewise, home ownership has been inseparable from the American Dream since the beginning. Yetafloodofinfomercialsand get-rich-quick personalities have preached real estate investing to the masses and left scores of broken failures littered in their wake. Everyone seems to know someone

who got rich in real estate and someone else who went broke. How can people new to real estate investing hope to make sense of it all? Like any investment process, participants become more competent with experience. The problem is that real estate transactions are big. Stock market investors can invest almost any amount, large or small, and can tailor their risk to losses they can afford (that is not to say that they always do). With real estate, the ante is bigger. This means many players endupgoingallinonthefirst hand.Theirfirstopportunitytogain

COPYRIGHT 2009 KIRBY COCHRAN. ALL RIGHTS RESERVED

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experience requires everything they have got. If they survive, they go on to play againif not, the tuition they paid ends up being very high. Iboughtmyfirstpropertyin1981 and have been involved in real estate development and investing for most of my life. I have done well, and I have been burned. Our company has systematized and perfected many of the techniques I discuss here. When appropriate, I will add insights about the methodologies we have developed as well as the approaches typical for individual investors. When I was a boy, one of my teachers told me, the trick in life is to get wise before you get old. He meant that to the extent that I could learn from the experiences of others, I would not have to pay the price to gain that experience myself. That is what this book is all about. I want to give you the opportunity to learn from my experience without paying the dumb tax along the way. Rather than throw you in at the deep end and watch you sink or swim through the various (and often very sophisticated) elements of the deal, or givingyouinstructionsonaspecific methodology that leave you helpless when the terms of a deal change in ways the methodology does not anticipate, instead, I will give you the

building blocks, the tools that form a solid foundation to get you started. Now, I need to include a caveat. There is nothing that substitutes for gaining your own experience and there is no guarantee that you will profit,nosafetynetotherthanyour own understanding when it comes to investing in distressed property. There are not really any shortcuts and the last thing you want is to become a foreclosure investor whose bad deals

The last thing you want to do is become a foreclosure investor who is facing foreclosure yourself.have you facing foreclosure yourself. It is possible, however, to go through the process of gaining that experience prepared. You can be prepared with tools and information that increase your probability of success. I cannot guarantee that you will never get burned in a deal, but I can help you go into those deals with your eyes open.

COPYRIGHT 2009 KIRBY COCHRAN. ALL RIGHTS RESERVED

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2. Real Estate Value Why is real estate valuable? Why is it an investment worth considering? Under normal circumstances, real estate appreciates, meaning it gains value over time. The reason for this is that one piece of property can be like another, but it cannot be identical. If one piece of property could be exactly similar to another, real estate values would be a function of square footage, amenities, age, and some objective measure of construction features and quality. Instead, property in the foothills is more valuable than that in the valleys, property with a view is worth more than property that is boxed in. The essential characteristic that drives real estate values is uniqueness. There is only one of any particular piece of land. In this respect, real estateislikefineart.Thereareonlyso many original Van Goghs and there is only so much land. The concept of uniqueness underlies the other forces at work in the real estate market. Most importantly, it is uniqueness that drives appreciation and appreciation underpins traditional real estate investing. The current real estate climate, however, is rife with distress whereartificialmanipulationshave distorted the relationship between

price and value. These distortions have caused time-tested market factors to become less reliable. 3. The Distressed Real Estate Market Real Estate Professionals call them the three Ds that drive sales: death, divorce and distress. Each of these conditions creates a motivated seller, a reason why sellers have a reason to place another objective over simply getting the highest possible price. Investors take advantage of that motivation by negotiating a lower price than what might otherwise be considered fair value, in other words, the value of the property on the open market where the equilibrium of supply and demand determine price. The motivation behind death and divorce are straightforward. These are singular life-changing events, which clearly induce a circumstance where other concerns take priority over simply getting the most money out of the sale of a property. Distress, however, can be caused by many factors. Distress is sometimes used as a way of describing the physical condition of a property, meaning it is run down, dilapidated, or in bad repair. For our purposes, however, we are looking at a propertys financial

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condition. When we talk about distressed property, we mean property that is involved in foreclosure. Either it is at risk of foreclosure, or it has already been foreclosed. Whatever the circumstances and economics that led the owner todefaultonthefinancingofthe property, foreclosure is the event that primarily indicates that this property is of interest to us. Either foreclosure is imminent, or it has already taken place. Either way, the property ends up in the hands of a motivated seller which creates an opportunity. Foreclosures have been around as long as lending and we can probably expect that a certain number of foreclosures will always exist. The current market, however, is producing historic numbers of foreclosures, which also means we are entering a historic period of opportunity. Theentirescopeandramifications ofthehousingcrisisinthefirstdecade of the new millennium is a topic that Iexpectwillfillvolumesandlikely keep economists and historians busy for decades. Notwithstanding the enormity of the factors contributing to the state of the market, it is important for investors to have at least a basic historical context of how we got here. What follows is a brief and intentionally truncated synopsis of

the critical events leading up to the current state of affairs in real estate. (For a more thorough treatment of thefinancialcrisis,seeAnatomy of a Meltdown, which can be downloaded at np-adv.com/articles/meltdown.pdf.) When the dot com bubble burst at the end of the 90s, investment money fledthestockmarketlookingfor safer havens. As a result, investment banks orchestrated instruments called Collateralized Mortgage Obligations (CMOs) that allowed investment money to be secured by real estate. Historically, real estate in the U.S. had a stable long-term rate of appreciation (about 5.45% since the end of World War II).1 Even though this was less than the historical average rate of return on Wall Street (7.8%), investors were looking for safety after being burned by the tech stock reset. So, these CMOs offered just what they were looking for. The money that hadfledWallStreetinthedotcom crash, now came back into real estate securities like a tidal wave. RatingfirmslikeS&PandMoodys gave CMOs a credit rating, which theoretically took into consideration that sub-prime mortgages (those given to borrowers with bad credit) were riskier than typical conforming mortgages.

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Now, investors could not only invest in an instrument backed by real estate, but if they were looking for a little be