Real estate investing is a high-risk opportunity. There is no way to guarantee a profit at the end of a project, especially when dealing with investments at a fair market value. Distressed properties, however, provide the opportunity to secure profits in the front end because their value is significantly diminished, allowing for large gains. Unfortunately, when dealing with distressed properties, like foreclosures, there is the potential for hidden problems. When securing these properties through auction, the issues become inherited.
Despite the risks, many real estate investors still see foreclosure auctions as a significant opportunity, but the availability of financing options also limits that. While investors typically rely on traditional and private funding to bankroll projects, allowing for sustained liquidity, increased leverage, and managing concurrent projects, auctions restrict most financing options, especially those most beneficial to the frequent investor.
Auctions of Foreclosed Properties Do Not Permit Hard Money Loans
A common misunderstanding is that a hard money lender, like HML Solutions, can approve a purchase loan. However, that belief goes against the fundamental and operational principles of hard money lenders. The money we lend is specifically tied to the real estate purchased. It is impossible to provide a loan against the possibility of a client being the winning bid at an auction. To secure a loan against a house purchased at auction, the real estate needs to go through the escrow process.
To limit any potential risks, a private lender will also require title insurance. Title insurance provides the lender insight into the property, allowing them to understand any obligations or financial risks belonging to the property, like liens. Any problems that could jeopardize the lender’s position become caveats to possible loan approval.
Since escrow and title insurance are not available at a foreclosure auction, hard money loans aren’t either. Auctions require all cash.
The Definition of All-Cash Bids
When an auction stipulates “cash offers only,” that does not imply bidders must come to the auction house or site with suitcases full of cash. Instead, an all-cash auction requires bidders come with cashier’s checks.
A cashier’s check is a bank-backed and funded check, meaning the bidder legitimately has the funds they are bidding with. Before an auction, all bidders are required to show the signed and authenticated cashier’s checks to the auctioneer.
Strategies for Using Hard Money Loans on Foreclosure Auction Properties
It is impossible for a hard money lender to directly fund an auction property. However, there are some options – three specifically – for securing funding after a successful bid.
- Cash out refinance after the auction: Unfortunately, there is no direct way to use hard money loans for auction purchases. However, if an investor has the cash for the bid and purchase, they can use cash out refinancing after the acquisition of the real estate. You can use a hard money loan once the property is yours to re-establish your savings, increasing overall liquidity.
- Cash out refinance on existing property: If you already own another piece of real estate, it is possible to obtain a hard money or bridge loan to acquire the funds to purchase an auction property. The loan is not against the foreclosure but the existing ownership property. A private lender, like us, will assess the existing property, and if approved, transfer loan funds into your account. You can then use those funds to bid on and acquire a new property.
- REOs listed on auction websites: Finally, there is the possibility that an investor can purchase a bank owned or real estate owned property directly through an auction website. While you will not often find such opportunities, some do exist that allow for the direct purchase of a property that failed to sell at auction. In specific situations, a seller might consider a buyer with other financing options. Hard money loans are often accepted in these rare situations.
The reason a hard money loan might be favored in these situations is the speed of the transaction. Conventional loans typically come with significant caveats that can slow the approval process and hinder ownership transitions. However, to know if a hard money loan is acceptable for direct purchases through an auction website, you might need to contact a representative directly.
Advantages of Purchasing Through an Auction
Have you ever heard the saying, “you make money when you purchase a property, not when you sell it?” While the sentiment is lost on many amateur real estate investors, more seasoned professionals will understand that a real estate project hold promised value early in the process, but only if you can buy below market value.
Purchasing real estate – residential or commercial – is always a risk, but that risk increases the closer to market value the purchase price is. Think about it: if you buy a house for $190,000 in an area where property values hover around $200,000, your potential profit is limited to $10,000, and that is barring any significant problems with the property. However, if you find a foreclosed property and secure a winning bid at $100,000 in the same area, your potential gains shoot up to $100,000, allowing room for unforeseen problems.
It is the unforeseen problems and the cash-only offers that make auctions such a lucrative opportunity. See, few investors are willing to bid or purchase a property blind, meaning without prior knowledge of history, liens, damage, etc. Even fewer investors have the funds to make all-cash offers and take on the increased risks. Because of these two factors, capable investors can often purchase properties significantly below market value, almost guarantee a backend profit.
Drawbacks To Purchasing Real Estate at a Foreclosure Auction
Buying real estate at auction comes with unavoidable risks. Some of those issues are seen as drawbacks to the process:
- No inspection
- “As is” purchase
- No title insurance
- Hidden problems (Existing tenants)
Most real estate auctions do not allow on-site or interior inspections. A bidder can drive by the property on their own, looking at the exterior and attempting to assess the structural integrity of the property, but that only provides a limited insight. For example, while the exterior might look tip-top, the inside could be missing essential and expensive elements, like cabinetry, appliances, flooring, etc.
The main problem with purchasing at auction is that once the sale is done, it is final. You inherit the good and the bad. You do not get to request repairs or ask for opt out clauses. The purchase means you have to deal with the problems, and hope they don’t result in a financial loss.
Auction purchases are a gamble. The lack of title insurance means you have no insight into liens, unpaid child support, back taxes, etc. Worst yet, as the winning bid, you are responsible for any debts that transfer with the property.
Beyond debts, you are responsible for dealing with any remaining tenants, squatters, or previous owners if they are still residing in the residence. With any luck, they will leave peacefully with the need for law enforcement.
Risks Versus Reward
Is a foreclosure auction the best place to purchase real estate? There is no denying an auction provides the best chance to increase profit potential through below market acquisition. However, the risks involved do limit the applicant or bidder pool to only those who can afford potential financial losses.
That being said, any investment presents its risks. As an investor, you need to weigh the pros and cons to determine whether the gains outweigh the cons.
Securing Funds To Encourage Quick Turnaround
One of the most intimidating aspects of auction purchases is the all-cash requirement. Many investors do not have capital available for a cash bid and then construction costs. Thankfully, hard money loans provide a quick solution to cash-strapped investors.
While you cannot use a hard money loan to purchase an auction property, you can use a cash out refinance to quickly re-establish liquidity. With funds available, you can make any improvements or changes to the property and get it back on the market as a rental or sale to repay the loan and secure your profit.
Advantages of Hard Money Loans Over Conventional Loans for Real Estate Projects
Real estate projects require fast turnovers. Unfortunately, speed is not synonymous with most conventional lenders. There are three reasons most real estate investors work with hard money lenders over traditional options:
- Approval odds
Here at HML Solutions, we pride ourselves on being able to customize solutions for each of our clients. We do not expect every project to fit into a neat little box or adhere to predesigned repayment schedules. We view every loan and client as individual, taking into account project specifics. We do not approve or deny loans merely based on the creditworthiness of the applicant because we place more importance on the property value in question. Because hard money lenders do not adhere to the same stringent regulations as conventional banks, applicants can see rapid approvals, with many receiving funds within a week of approval.
Are you interested in learning more about how a hard money loan could help you with an auction purchase? Contact an HML Solutions specialist for more information.