What to consider when buying a foreclosure for a rental property
The lure of a good deal can make some pounce before they think, and foreclosures are no exception.
Let’s say you’re scanning the internet for some hiking boots. As you know, your search history follows you, and a pair of hiking boots pop up in an ad for 50% lower than others. You pounce. You get them in the mail, and they look like a floppy, sad version of what you actually wanted.
That’s what acting too fast on a foreclosure is like. You see a good deal, buy, and find that it wasn’t worth the money.
Related: Save 40%-70% on your next rental property with a pre-foreclosure
Four considerations when buying a foreclosure
Before you buy a foreclosed home as your next rental property investment, consider these four things.
1. Can you view before you buy?
When you find a good deal, it might be tempting to buy sight unseen because of the fear of missing out (FOMO) nagging at your brain. Don’t let FOMO win. Always make time to see your potential investment before you buy, even if you need to travel to see it. No one wants a surprise money pit.
By seeing the property ahead of time, look for the following:
- The neighborhood. This can tell you what kind of tenants you will likely have.
- The house. This gives you an idea of what work needs to be done.
- Area rents. You’ll need to know what rent you are likely to get to determine whether the deal will be worth doing.
2. How long was it empty?
When homes are unused for a long time, the decay gets worse, not better.
Rodents and bugs infest the house. Plumbing dries up from being unused. Bigger problems could have happened and never noticed like a roof leak, plumbing burst, mold, or vandalism/theft.
If you are purchasing a foreclosure that had been abandoned for some time, it’s even more important to get a thorough inspection before buying. You always want to get an inspection, but when it has been empty for a long period of time, ensure that the inspection dives deep.
Related: Risks of leaving a property vacant
3. Should you find skilled labor before you buy?
With nearly all foreclosures, there will be repairs that need to be completed. You should have a team of tradespeople in place before you buy, and have them review the property with you.
By having trusted tradespeople lined up, you have a better idea of what you are getting into or on whether to pass on the property. Ask them to go to the inspection, and then begin pricing repairs before you purchase. Ask their opinion on whether this is a good investment. A reliable team can help you budget properly, quickly repair the property, and turn a profit faster.
4. Are there any rules I should know?
Foreclosures have different rules than a typical property-buying situation.
Some government programs will not allow a buyer to rent out a property for up to five years. Understand the program you are buying your foreclosure from, and ensure that you are allowed to rent it once you own it.
If there are current tenants, legally, you need to honor their lease in some states. The Helping Families Save Their Homes Act of 2009 requires that all new owners of a foreclosure honor leases of previous tenants if they plan on renting the property.
However, if the new owner plans on living in the property, they are allowed to give the tenants 90 days’ notice. This law expired in 2014, and now tenant’s rights vary by state. In Illinois, tenants still need 90 days’ notice; however, in Wisconsin, they can be evicted immediately.
Related: Are tenants required to move out during a foreclosure?
Use the same best practices as with any property
The same considerations for any rental property are still valid with a foreclosure.
Before buying, consider the cap rate. What is your predicted rent? Subtract expenses, including expenses to get the property ready to rent, from the annual rental income. Divide that number by the value of the property. A cap rate of 5%-10% shows that the property is a good investment.
The bottom line
Before making the decision to buy a foreclosure as a rental property, know what you are getting into. Landlords need to find tenants, make fixes, collect rent, and have great relationships with your tenants. You’re running a business, so weigh the pros and cons before diving into renting a foreclosure.
Don’t buy the discount hiking boots without doing the research first.