Flipping Phoenix Houses

Bidders surround the auctioneer (in blue jacket) at the Maricopa County Courthouse steps

Foreclosure. What does it mean exactly? According to Google dictionary, foreclosure is:

The process of taking possession of a mortgaged property as a result of the mortgagor’s failure to keep up mortgage payments.

Well stated. Foreclosure is a process, something that happens to a property, not what the property becomes. It really bugs me when I hear someone say, “I want to start buying foreclosures.” Really, you want to buy a process? I’d much rather buy a house. There are three phases in the foreclosure process:

1. Pre-foreclosure – the period of time between when the lender officially informs the homeowner they are in foreclosure and the actual auction date for the property. In Arizona, for example, homeowners have 90 days from the day they receive their foreclosure notice (notice of trustee’s sale) to either bring their loan current or pay it off. If this doesn’t happen the lender may foreclose on the 91^st day.
2. Foreclosure Auction – If the homeowner fails to bring their loan current, or pay it off, the lender will foreclose. In many states, these auctions take place at the courthouse steps. If the opening bid of the property is low enough the home will sell to the highest third-party bidder. These bidders are usually private investors looking to fix and flip or buy and hold. However, more and more people are buying their primary residences at the auction.
3. Real Estate Owned (REO), Bank or Lender Owned – A home in foreclosure will end up in the hands of the bank if no third-party bids. This happens a lot because lenders usually set the opening by adding the past due payments, late penalties and interest to the original principal mortgage balance of the loan. Because property values have dropped significantly after the crash, most homeowners owe more than their homes are worth.

You probably noticed that short sales aren’t included in the three phases of foreclosure. There are two reasons for that:

1. A homeowner doesn’t have to be in foreclosure to do a short sale.
2. If a homeowner is in foreclosure and is doing a short sale then it’s considered a pre-foreclosure because the bank hasn’t foreclosed on the property yet.

Now that you’ve read this post you’ll avoid ticking me off and sound a lot smarter around your friends. You can make intelligent comments like, “I plan to invest in pre-foreclosure properties.” Or, “Because I have significant cash reserves I plan to purchase homes at foreclosure auctions.”

Caribbean Lane - Short Sale = $52 per square foot

Prior to the real estate market crash in 2008, determining the after-repair value of a home was much easier. That’s because a majority of homes on the retail market were what housing experts call normal sales. In other words, these houses were not in foreclosure or owned by a bank.

With the tidal wave of foreclosures that hit nearly every city in the United States, retail markets were overrun by short sale and bank-owned (REO) listings. Nowadays, distressed sellers can make up more than 70% of the housing stock in America’s hardest hit cities.

This is why, in the post-boom era, there’s an extra step required to accurately determining the estimated after repair value for the house you intend to flip. There are three sub-markets to consider:

1. Normal sales (houses not in foreclosure or bank-owned)
2. Short sales (homeowner owes more than the house is worth, therefore the bank must approve the sale)
3. REO or bank-owned (home has been foreclosed on and is now owned by the lender)

In Phoenix, for example, normal sales average $100 a square foot, while short sale and REO properties sell for $72-$75 per square foot. Why the discrepancy? There are two reasons:

1. Timing – A normal home seller can respond quickly to a purchase offer from an interested buyer, usually within 24-48 hours, and close quickly (15-30 days). Ironically, short sales are anything but short. Even though banks have drastically increased their staffs and improved systems since the crash it can still take 3-6 months to get a short sale approved. Buying a bank-owned house is no picnic either. While the process takes less time than a short sale because the lender actually owns the house, there are still lots of hoops for the buyer to jump through. Banks, and their Realtors, aren’t that responsive either. It’s not uncommon for 6-8 weeks to go by before the deal closes.
2. Upgrades and Repairs – Normal home sellers typically make upgrades and improvements to their homes as time goes by. They are also willing to address issues that might come up during the buyer’s home inspection. On the other hand, short sale and REO properties are almost always “as-is” sales. The buyer can do an inspection but the seller won’t fix anything. The buyer must pay the repair costs.

Caribbean Lane - Normal Sale = $77 per square foot

The “terms of sale” (normal sale, short sale, or bank-owned) have a huge effect on the estimated after-repair value of a property. Statistics show homebuyers are willing to pay more if they don’t have to deal with a bank. How much more? In Phoenix, about 10-20%. For example, I purchased the property pictured to the right on Caribbean Lane in Surprise, Arizona as a short sale for $52 a square foot and resold it one month later for $77 a square foot.

So, in the post-boom era, in addition to looking for recent, comparable sales in the same area, you’ll also want to find normal sales to determine the estimated after-repair value of your property.

Last week, I posted a video about an REO in Ahwatukee my Realtor, Bill Watson, found on the Arizona Regional Multiple Listing Service.

Purchased December 20^th, 2011, it went on the market January 17^th.  I wasn’t in much of a rush to get the rehab done in my normal 7-day window because sales are typically slow to start at the beginning of the year.  I didn’t want this listing to die on the vine while homebuyers recovered from New Year’s Eve hangovers.

Listed for $375,000, the buyer offered $374,000 and didn’t ask for any closing costs or concessions.  After the buyer’s inspection was complete only minor repairs were requested.  There was no problem with the appraisal (it came back at $380,000).  After repair costs of $21,277 my net profit was $30,197 (I say 40K in the video but the deal hadn’t closed yet so I didn’t have all the repair costs tallied up).

Since this deal closed I’ve yet to find another REO deal anywhere with a similar spread.

I’ll give the banks credit – they’re fixing up their properties with new carpet, paint and appliances.  That makes them more desirable to retail homebuyers.  At trustee’s sales homes are being sold for 85-90% of retail value.  I’ve been shut out down there since last November.

On the other hand, I’ve closed two short sale deals in the last month and have another 30+ offers on others throughout the greater Phoenix metro area.  As banks face political pressure to work with homeowners on short sales I believe the short sale may be the acquisition method of choice for fix and flip investors in Phoenix.

Ahwatukee.  This little section of Phoenix actually has its own Wikipedia page.  Nestled up against the South Mountain range, Ahwatukee is popular with families, white-collar types and professional athletes.  Larry Fitzgerald, star receiver for the Arizona Cardinals, lives there.

So you’d think that it would be difficult to find a great deal on a house in this little slice of desert Heaven right?

Not if you have a great Realtor that knows how to search the MLS for diamonds in the rough.  My friend and real estate agent Bill Watson found 1211 E. Desert Broom on the Arizona Regional Multiple Listing Service in early November.  Listed for $305,000, we wrote an offer for $290,000.  The seller accepted a better offer, but came back to us after the deal fell through.

We ended up buying it for $295,000 and closed mid-December; the best-case scenario for this flip is a retail sales price of $375,000.  Here’s a video we shot at the house before the start of rehab: