Some investors are eager to purchase single-family homes in foreclosure, hoping to take advantage of low prices and then turn a profit by renting the properties to tenants. But many of these buyers are not experienced landlords, and even experienced landlords often fail to consider crucial factors that will make the purchase of a foreclosed home a success or failure as a rental property.
Wise buyers will consider such things as the neighborhood in which the home is located, how the home has been maintained, and whether any existing tenants who rented from the prior owner will remain after the purchase. Here's a rundown of the things you should consider before you buy a foreclosed property with the intention of renting it out.
A sad fact of sub-prime life is that in many areas of the country, whole neighborhoods are awash in foreclosures. Typically, these areas were hastily built by developers eager to take advantage of the seemingly endless appreciation of real estate, and they all came crashing down when the purchasers (and in some cases, the developers) became unable to meet their mortgages or construction loan payments. For hard numbers on the incidence of foreclosure in your area, use RealtyTrac to check the concentration of foreclosures by Zip code.
Purchasing a foreclosed home may not be the home-buying experience you might imagine. Instead of dealing with motivated individual sellers, anxious to showcase their home by staging it and working closely with their broker, most buyers will encounter an institution -- a bank's asset management department, where it's hard to reach and converse with an individual, let alone the same individual each time. Don't expect quick turnaround and individual attention by people who have the authority to make decisions. Instead, you may find yourself dealing with a department that knows banking but not home selling and stops answering the phone at 5 p.m. sharp.
However, if you are lucky enough to buy a home in preforeclosure (preforeclosure is the period after the homeowner has received a notice of default but still has months before the auction takes place), often you can negotiate a deal with the homeowner instead of the bank. (To learn more about the pros and cons of buying a home in preforeclosure and other stages of the foreclosure process, read Nolo's article Foreclosure Homes: Your Way Into the Real Estate Market?)
A key factor in the success of your rental is the neighborhood. In general, a rental in an area dotted with foreclosures is likely to command less rent when foreclosed properties remain unsold and, more importantly, unoccupied. These forlorn properties are likely to be unmaintained and are targets for vandalism and even squatters. Few tenants will want to join the ranks in such a neighborhood, and those that do may expect the rent to reflect these negative attributes. When making a bid on such a property, factor in the realistic rent the house can command.
A neighborhood of foreclosed homes bodes ill even if they have been purchased and are in relatively good shape. All of these homes aren't going to be occupied by the owners -- many will be rented out, just as yours will be. That makes for a concentration of rentals -- in short, a glut on the market, which will drive prices down. The same property in a different part of town might fetch a higher rent simply because there is less competition.
A foreclosed property in good condition located in a neighborhood with few other foreclosures will most likely fetch higher rent. Of course, such a property may command a higher selling price as well.
Buyers should next turn their attention to the house itself and its history. If they're lucky, they can find out who lived there, and whether the occupants were renters or owners (some 40% of foreclosed properties were bought as investments, making it likely that you're dealing with a home that has already been a rental).
To learn about the house, start with the neighbors if you can't locate the prior owner. Did the owners take great pride in their home and leave it in good shape? Or was the home occupied by unmonitored and malicious tenants (unsupervised by an owner already demoralized by the property's imminent loss)? Or was the home occupied by resident owners who spitefully trashed the home before moving out?
Even if the property was a rental that escaped the wrath of its last occupants, think about the extent of wear and tear suffered by this property. Often, rental properties suffer more deterioration than owner-occupied homes. Take this into consideration when setting your purchase bid.
The more you learn about the home, the more realistic your purchase offer can be. If you can spiff up the home with a coat of paint and some landscaping and reasonably offer it at market rates, your post-purchase expenses will be small (and you can afford a higher bid). But if you have to replace copper pipes, sheetrock, flooring, and appliances, you're looking at major expenses before you can even place a For Rent sign on the front lawn. The "bargain" you thought you had may turn into a very expensive investment. (To learn more about the ins and outs of buying a foreclosed home, read Nolo's article Buying a Foreclosed Homes: Your Way Into the Real Estate Market?)
Finally, there is always the possibility that the house you are considering will come with resident tenants who had been renting from the prior owners. Until recently, most tenants lost their leases when a rental property was foreclosed on, which gave the new owners the option to keep the tenants (under a new lease) or evict them. But that changed on May 20, 2009, when President Obama signed the "Helping Families Save their Homes Act of 2009." This legislation specifies that all leases will survive a foreclosure, except when new owners intend to personally occupy the premises (in that case the current tenant's lease may be terminated with 90 days' notice). Month-to-month tenants may be terminated with 90 days' notice (which is longer or as long as any notice period required by the states).
According to the new law, if you are buying a home that you intend to use as a rental, it was foreclosed on or after May 19, 2009, and it comes with a lease-holding tenant, you must honor the lease. You can terminate month-to-month tenants with 90 days' notice, but keep in mind that if the home is subject to local rent control that requires landlords to have a "just cause," or good reason, to terminate a tenant, you cannot give the tenant a notice to vacate the property. You'll be stuck with these tenants as long as you use the property for rental purposes, or until you fit within one of the rent control ordinance's allowable reasons for termination.
If you are inheriting month-to-month tenants in a non-rent controlled city, should you allow them to stay? Evaluate these tenants as you would any set of prospects. If they have been paying rent on time (admittedly, it might be hard to get the facts unless you can talk to the prior owner), and have been taking reasonable care of the property, you might decide to keep them and negotiate your own, new rental agreement or lease (after giving the tenants 90 days' notice).
But if you sense trouble, particularly if the property comes with tenants who have an appreciable time left on a lease, think twice about purchasing this property in the first place. You don't want to be saddled with tenants whom you would never have rented to in the first place. And if you purchase the property, counting on evicting the residents, understand that if these tenants refuse to leave, you'll need to begin an expensive and drawn-out eviction. (To learn more about the eviction process, see Nolo's article How Evictions Work: Rules for Landlords and Property Managers.) This is hardly the way to begin your new rental business.
For more information on dealing with tenants, including evicting them, get Every Landlord's Legal Guide, by Janet Portman, Ralph Warner, and Marcia Stewart (Nolo).