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Turning Foreclosure Properties into Rental Property

With prices for foreclosed homes at rock bottom, buying such properties and flipping them over to rental properties seems like an intuitively good idea. In some markets as home prices fall and rents rise, an owner can pick up a bargain or two or several dozen for that matter, and theoretically make a tidy profit. With displaced owners still needing shelter, it may even be possible to rent the place to the current owner. As the housing crisis deepens, rental profits are looking more attractive. The current administration is searching for ways to transform some of the roughly 250,000 government-owned foreclosed homes into rental properties. Some of those proposals may become public policy and may help investors purchase foreclosed properties to be converted into rentals.

The government is hoping to deal with the glut of foreclosed homes that are dragging down the housing market. The problem is that many of potential individual investor/buyers have little or no experience as landlords. Even experienced property management companies and small scale landlords can fail to consider all the factors that can make a foreclosed home a success or failure as a rental property.

Here's a rundown of the things you should consider before you buy a foreclosed property with the intention of converting it to a rental property.

1. Are there other foreclosures in the same area? Many subdivision developments may have used the same small group of sub-prime lenders. In their haste to get in and out with a profit, many developers rushed buyers through an often “creative” loan process that featured balloon payments or notes tied to economic factors. If a lot of those borrowers then fail to be able to keep up with their mortgages, a neighborhood can suddenly experience a rash of foreclosures. Poorly managed, these foreclosures can result in a neighborhood soon to be full of abandoned run down houses, squatters and vandalism, which will reduce the rentability of any property you might buy there. If you can't rent the property for enough to cover your mortgage, your stuck. The administration is hoping to encourage wealthy investors to purchase all the foreclosed properties in these areas to keep the home values higher in the neighborhood. Whether this will work or not is the subject of a fierce on-going debate. To check out the rate of foreclosures in the area you are considering buying foreclosure property, use Realty Trac. RealtyTrac allows you to check the concentration of foreclosures by Zip code.

2. Is the property already in foreclosure? If you wait till after the foreclosure you will be dealing with the bank. The bank's asset management department will probably handle the sale. You'll talk to whoever you get shuffled to next. They quit answering the phone at 5pm, unlike a real estate agent. There's little motivation to make the process a quick turnaround and the people who can make the decision on a property are often at one or two removes from the people you are talking to.

3. Is the property in pre-foreclosure? Pre-foreclosure properties are still in the hands of the homeowner. He has received a notice of default, but the home has not yet been auctioned. If you can buy a home in pre-foreclosure you may be able to negotiate more effectively with the homeowner. He may be represented by an experienced real estate agent anxious to facilitate the process. It is to the homeowner's advantage to negotiate the sale of the home before the bank places the property on the auction block.

4. What's the home's history? If the owners are still in it, they can give you a better picture of how well the property has been kept up. See if the home was a rental. Forty percent of foreclosed homes were originally bought as investments and used as rentals. Check with the neighbors if the old owners aren't available. Neighbors can probably fill you in on how the home was treated. Visit the home yourself. Have an engineer give it an inspection. Get a good idea of how much wear and tear the place has on it before making your offer.

5. Make and offer that the insures the property will be profitable as a rental .If your pre-rental fix-up costs will be small, you can afford a higher bid. If the neighborhood is desirable with not a lot of foreclosures, you'll be able to get higher rent. If you're working with a real estate agent, do some research with him or her on comparable rents in the area, to get an idea what your income will be. Factor in fix-up costs and figure what on-going maintenance will run you. It's a buyers market during economic hard times, so offer no more than what will give you a worthwhile return on your investment.

6. Evaluate any existing lease agreements. With the large number of rental homes being foreclosed on, you may find a property that already has tenants. As of May 2009, the “Helping Families Save Their Homes Act” specifies that any existing lease will survive a foreclosure. Month-to-month tenants can be terminated with 90 days notice or longer in some states.

7. Find out about local rent control laws that may apply to the property you are considering. You could get be stuck with the existing tenant for as long as you use the property for a rental. If you like the tenant and the rent control price, so much the better. If not, you may want to avoid a situation that could leave you losing money. Just know that if you buy a foreclosure property intending to evict the current renters and they refuse to leave, it can trigger an expensive, lengthy eviction process that simply may not be worth the hassle.

References:

Nolo Legal Encyclopedia: Buying Foreclosed Home as a Rental Property

Pro Publica: Can Turning Foreclosures Into Rental Properties Save the Housing Market?

Wall Street Journal: Development – Seven Questions on Foreclosure to Rental Conversions

Ezra Klein's Wonk Blog: Can a New Plan to Rent Out Foreclosed Properties Actually Work?

Photo courtesy of pnwra via Flickr

 
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