by Jay Castillo
I’ve met a lot of people who ask me how I can make money from investing in foreclosures. I then give a lengthy explanation on the various ways I can earn money to every person who asks. For the benefit of everyone who wants to know, especially in these times with all the news about the global recession, I’ll list down all possible ways one can make money through foreclosures, based on what I have learned in the past 2 years. Please feel free to add more by leaving your comments.
1. Buy and Hold
This is the strategy of a person who buys a foreclosed property and holds on to it until its market value appreciates. In a nutshell. one can make money from the buy and hold strategy through the following:
- Selling the property for a profit. This assumes of course that the market value has indeed increased. Most of the time, however, it would take several years for a property to appreciate in value, and the cost of maintaining it, taxes, etc. are often not considered, hence, the owner has no idea if he will make any money when he sells his property.
- Refinancing the loan to convert the owner’s equity into cash*. Equity is the difference between the current appraised value and the loan principal balance. When the appraised value increases, the equity increases as well. To cash out the equity, one can get a new appraisal from another bank that reflects the increased market value of a property and then a new and bigger loan is secured based on this new appraisal. The original loan will then be paid for using the proceeds of the new loan and then the owner pockets the excess cash.
*On a side note, I almost did something similar when a townhouse I acquired through an auction was given a very high appraisal by one bank compared to my winning bid, and I could have pocketed the difference which was about Php400K. Unfortunately, I had to back out of that deal because of some issues with the mother title. The possible headaches were not worth the Php400k.
Actually, there are two common ways the buy and hold strategy is done here in the Philippines.
- Buy and hold( and pray), which basically means aside from praying that the property will go up in value, the buyer does nothing with the property and it becomes idle
- Buy and hold and have the property rented out
Here in the Philippines, it’s common to see people using the buy and hold (and pray) strategy for land. In my opinion, this is not a very smart move because there’s usually no positive cashflow from land while there will surely be expenses like real property taxes, property mainenance, etc, and of course let’s not forget the risk of having squatters taking over the land and the owners would later have to spend money just to eject them.
Furthermore, I often hear a lot of stories where people are unable to sell a piece of land they have been holding for a long time when they have an immediate need for cash, so they are forced to sell at a loss. There are some instances too when people sell the land they have been holding for a long time and jack-up the prices so they can have a huge profit, and because of this, no one is interested in buying the land.
Others apply the buy and hold strategy by buying a property, and then have it rented out, while hoping that the property’s value will appreciate, without considering the cashflow it generates. More often than not, these properties are negatively-geared or have negative cashflow. Again, this is not a smart investment strategy in my opinion as they tend to be like a money pit. I won’t be surprised if some of these properties end up being foreclosed again.
One should only apply the buy and hold strategy if a property can generate positive cashflow as a rental property as described below.
2. Rentals (with positive cashflow!)
Buy a property, apply minor cosmetic changes like a fresh coat of paint and have it ready for occupancy, then rent it out. At the very least, when buying a foreclosed property, the numbers should work in such a way that if you turn it into a rental property, it can generate positive cashflow.
You basically make money through the rent your tenants pay you on a monthly basis and this should more than cover all expenses like amortization, taxes, insurance, etc. This should produce a nice steady positive cashflow every month. I personally don’t take a second look at a property if it won’t be profitable if I rent it out as this is my last exit strategy. Check this out if you want to learn how to calculate the ROI of rental properties.
3. Rent-to-own
With rent-to-own (which is more appropriately called a lease with an option to purchase), you give tenants the right to purchase the property for a certain amount, which is often called a downpayment. Tenants who become buyers still pay on a monthly basis but instead of paying rent, they are actually paying for the property through monthly installments.
Instead of the usual 2 months advance and 1 month deposit, tenant-buyers pay a down payment which is usually higher than 3 months rent. The seller has the option to charge monthly installments that are higher than the usual monthly rent in this scheme. Because of this strategy, the monthly positive cashflow and ROIcan be substantially higher than if it was just a simple rental property.
This method is showcased in Dr. Larry Gamboa’s book, Think Rich Pinoy!. If you haven’t read this book yet, I highly suggest you do.
4. Flipping
Flipping is done when one buys a property and sells it quickly for a profit. The best flipping method is when you buy a foreclosed property today, but already sold it yesterday. How, you ask? Sometimes one may already have an agreement with a buyer that he will buy a property before you have actually bought it.
5. Rehabbing
When you buy a foreclosed property that may need some repairs, fix it up, and then sell it at full market value, you call that Rehabbing, or buy-renovate-sell. If done correctly, this can result in huge profits. This is quite risky though, as cost over-runs during repairs or renovations are quite common.
If you’ve watched the show “Property Ladder“, you’d know what I mean. Anyway, since foreclosed properties are often priced below market value by as much as 40% or more, there’s a lot of room for hefty profit margins.
6. Wholesaling
Wholesaling is buying a property way below market value and then selling it for a price slightly higher, often to other real estate investors engaged in rehabbing. Profits are not as big as profits from rehabbing because obviously the buyers would need to buy at a price with room for them to make money as well.
Some say this strategy is a great way to make quick cash and is far less risky and beginning investors should seriously consider using this strategy when getting started. You just have to be good at spotting diamonds in the rough, so to speak.
7. Tax Foreclosures
For tax foreclosures, one makes money when his winning bid for an auctioned property earns interest. The City Treasurer or his deputy shall return to the winning bidder the entire purchase price paid by him plus the interest of 2% per month computed from the date of sale to the date of redemption.
The earned interest can be substantial (Hey, 2% per month is 24% per annum and that’s pretty hard to beat) and is truly passive income. However, one will have to wait until the delinquent owner redeems his property, and this could take up to a year. If the year lapses, you end up owning the property and then you can earn money by using any of the techniques I discussed above.
By the way, the most recent tax foreclosure auction I attended was in Marikina City and you may want to check it out. Other cities in the Metro like San Juan still have no scheduled auctions as of this writing.
8. Commissions
If a foreclosed property is sold through a negotiated sale and the buyer formally notifies the bank that you are the one that referred the property to him, you can earn a commission, which is normally 5% for accredited licensed brokers.
For public auctions, I believe the commission rate is only 1%. I have been a licensed broker for more than a year now but have yet to earn from this because I only learned about this recently, during the Unionbank auction I attended. I noticed that the registration form for the auction had a space for “Referred by” and I asked about this afterwards.
Also, I haven’t been accredited by any bank at the moment, mainly because my Broker’s ID from DTI is yet to be released due to a technical glitch in their ID system. So far I have managed to get accredited with CBRE as they don’t require the Broker’s ID from DTI.
Once I do get my Broker’s ID and get accreditation from other banks, I will definitely pursue this. This might also give me leverage and get bank foreclosed property listings before they are released to the public, which I’ll post in this blog for sure. We’ll see!
9. Pre-foreclosures
This is when a property owner is facing foreclosure and an investor would help stop the foreclosure by buying the property, which is often the last recourse to avoid the foreclosure as the proceeds of the sale shall be used to have the mortgage fully paid. The seller often sells the property at a very low selling price, usually for what he owes plus a little cash, just to get the property sold as fast as possible. In these situations, an investor should never take advantage of the seller’s misfortune and should offer a win-win solution for everyone.
Conclusion
These are just some of the ways of earning money through foreclosures and do take note that these strategies can be combined with one another. Actually, all of these techniques or strategies apply to real estate investing in general, not just to foreclosures. However, these can be applied more easily to foreclosures because they are often sold way below market value, require very little down payment (usually only 10%), and banks offer long payment terms.
You guessed it, all of these strategies shall be discussed in greater detail in future posts.
How about you, do you know of other ways of making money by investing in foreclosures? Have you started making money?
When I first learned about all of these stuff, I thought to myself that I wish someone had told me about these earlier!
Let me know what you think by leaving your comments. Thanks!
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