Tag Archives: distressed

Why are Banks Setting the Opening Auction Bid Below The Principal Balance?

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I attended a foreclosure auction in Bellevue, WA last week to discover if the rumor was true that banks are opening their bids below the amount owed.  I received confirmation from three professional investors that yes, the banks have been doing that, it’s no secret, and there seems to be no discernable pattern.  It’s not one particular bank or lender, it’s not particular types of property or in any specific area. It appears to be random.

In addition to the 92 active trustee sales scheduled for that day in Bellevue (auctions were also going on in other King County locations,) there were 81 postponements.  Only a few of the trustee sales attracted bidders, and the rest were deeded back to the bank.  Out of the 92 active sales, 25 had opening bids below the amount owed to the bank.

Why would a bank or lender set their opening bid below the amount owed?

Banks and lenders have duties to their shareholders and investors to maximize profits and miminize losses (well, at least they use to.) If opening bids are set LOWER than what’s owed, perhaps the banks have already tallied their losses, realized that if they had to take back the house, get it cleaned out and cleaned up for resale, pay a real estate agent their commission to sell it, pay for title, escrow, excise tax, utilities, and any other carrying costs,  they might as well sell it at a discount at auction.  But maybe there are other reasons.  I wondered if the banks were trying to keep more REO inventory off the market in an attempt to prop up home values for their existing REO inventory.  Maybe appraisers can ignore trustee sale prices in their reports.  Not knowing the answer, I emailed three appraisers for help and here’s what I learned:  Appraisers need to mention trustee sales in the neighborhood if these trustee sales make up a significant percentage of available comps because they are legitimate sales even though title is transferred using a trustee deed instead of a warranty deed.  If an appraiser choses to ignore these, he/she will run the risk of having the appraisal run through an “enhanced review” process in order to catch trustee sale market activity.  If a trustee sale is a significant comparable sale, it can be used. The requirement to use closely comparable trustee sales as comps can also vary based on the requirement of the lender and investor.  It may not be absolutely required but it may be in the appraisers best interest to mention trustee sales. Thanks to Jonathan Miller, Shane Leady and Richard Hagar for teaching me something new today.

That still doesn’t explain the phenomenon of banks undercutting their own principal balances at the auction.  My theory is that banks are relying on third party information such as a mini appraisal or Broker Price Opinion (BPO) prior to auction.  If the BPO suggests that the outstanding principal balance is so high and out of range as to likely attract no bidders at auction, then the banks have nothing to lose by setting the opening bid closer to or significantly lower than the principal balance owed.  If no one bids at auction, they’re still only out the money they would have been out anyways and on the upside, if the low opening bid attracts investors, then perhaps the bidding will rise closer to the payoff.  If not, they have an immediate loss that could be significantly LESS than losses that would add up over time, having to carry the REO on its books for months of marketing time in addition to the other costs mentioned above.

If banks are undercutting their own payoffs, then why isn’t this phenomenon more widely publicized?  Okay, so we know that bidding on a home at a trustee sale is too frightening for most first time homebuyers but still, if more people know about this, then maybe there would be more folks showing up at the trustee sales and bidding those homes UP, thereby reducing the banks losses.  There certainly is NO shortage of tall, well-groomed, good looking, muscular investor gurus in shorts showing off tanned legs, even though it was only 63 degrees outside hanging out at foreclosure auctions with all kinds of downpayment solutions to offer newby real estate investors:  “We have zero down financing available for the right investor!” and “We have private hard money financing available for your purchase and you can refinance out of that loan in 30 days….My mortgage broker is right here, let me introduce you to her.”

Maybe the banks aren’t publicizing their low bids because they don’t want to bring buyer attention away from purchasing their REOs or short sales, knowing that investors are the ones who typically show up at the auction anyways.  The banks also have a vested interest in keeping traditional buyers focused on MLS listings. 

If I owned stock in a bank or lender that was undercutting their own payoff at auction, I’d want to be darn sure that this practice was saving the bank money and not hiding something else such as higher losses to be pushed on into the next earnings report…or the next stress test.


Foreclosure Auction Video Part 1
April 24, 2009
Bellevue, WA
Here is the rest of the auction.
Special thanks to Phil Leng for introducing me to all the investor bidders.

A lesson in the dangers of distressed property purchases…

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A friend of mine contacted me the other day about a property investment opportunity that her brother-in-law (BIL) was placing in front of her and her husband. The property in question is located in the city and state where the BIL lives – and it’s far from the Seattle area at roughly halfway across the country. The house reportedly, and confirmed in the report I read, has a major mold issue that has attacked even the underlayment of the floors. (if you want to see some gross mold photos, check out this site) The buyer’s agent and BIL (who agent represents) are attempting to state that the water damage was caused by the former owner having a drug problem and not cleaning up after himself or perhaps because of a water leak in the bathrooms and from a leaking dishwasher. Hmmmmm…..

The house is supposedly being offered off-market at a lowball price of $400k for this tony neighborhood where $550k-800k is the common price points for various sized homes. Even the listing agent is nervous about selling the house with the mold issue but the owner is now deceased and the family can’t afford the home or to fix the home. This tells me that there is likely no insurance money to fix the problem especially if the insurance company deemed it to be failure of the owner to maintain the property. BTW – did most of you know that this is a common disclaimer in most insurance policies? If an insurer can point to an owner’s failure to maintain (ie. ignoring a leak) they can deny coverage. Also, as I’m learning, this particular state has had a rash of insurance companies choosing to deny the option of mold coverage in their policies at all… period because of prior mold problems that required huge insurance payouts.

Now, the price point initially sounds good but my personal concerns surround the mold issue, the fact that it has not been specifically identified in the mold specialist/inspection results, and the amount of work that actually needs to be done to get this house back in to the condition that this neighborhood typically expects. We are getting conflicting reports about the source of the mold and no one has sent my friend photos of the subject property to review. Also, there is the stigma associated with trying to sell a house that has HAD mold – and note I say “HAD” mold because frequently the average consumer can’t get past… well, the past. Agents are required to disclose known material defects, and so are homeowners (at least in WA State), so you’d have to tell a prospective buyer about the issue, even if it was fixed.

The BIL is a contractor and thinks he can replace the floors for about $20k and the only other item he thinks he needs to fix is a broken bathtub. Again, hmmmmmm……. Somehow I don’t think that this will be all that needs to be done.

His (BIL) expectation is that someone else will come in with the money to buy the property and he’ll do the labor and then they’ll split profits. I’m telling my friend/client that there is a lot more that needs to be sorted out and specified in a contract between the parties of the financial investor and the contractor (BIL). Thankfully, she agrees. On top of this issue there are questions of whether or not the house can be purchased with financing (likely not), what type of financing (preferably a renovation loan) is available, can it get insured, will it require oversight (it seems so based on the mold report) and by which entities (city, inspector, insurance, bank? most likely all of the above) and what it will cost to have re-testing done (what if it doesn’t pass?).

After even more phone calls today to the agent I have now learned that the listing agent is actually his secretary who has just gotten her license 2 months ago and that this is her first deal – ever. On top of this news, I also ferret out that the house is in foreclosure so we’re in a short sale position IF the $400k is even accepted. Wait, let’s recount the issues in a quick rundown….

1. mold problems that may or may not have had the water issue fixed.

2. foreclosure with short sale with proposed sale price at 80% of owed amount.

3. estate sale with unknown additional liens, taxes, etc. owed or owing. If the guy was truly a cocaine addict as desribed to us then there could be a lot more outstanding. Also unknown is who is actually selling the house: the widow, the attorney, the lender? Since it’s not yet foreclosed it’s likely the widow or attorney.

4. listing agent that works for the guy trying to be the buyer’s agent (MAJOR conflict of interest and not initially disclosed)

5. 1st time listing agent that has no other sales or negotiating experience working with a guy who has little, if no, experience in short sales.

6. unknown actual costs of repairs

7. no current photos available for review by prospective buyer (yet)

8. unknown lending environment for a distressed and damaged property

9. unknown insurance liability and potential to be an uninsurable property

I know what I think about this deal (a potential disaster) but I’d be curious to hear from others. What are your opinions? Would you go for it, and why? If you wouldn’t touch it, I’d love to hear your comments too.

Update on 'Fix and Flip'

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Last Thursday night at the monthly REIA meeting, Than Merrill from A&E’s Flip this House presented an informative glance into his working business model. Than does more than 120 flips a year at an average of $27,000 each.  Although he just started 3 years ago, Than is making millions using a system that he partially nabbed from other fix and flip coaches and partially created himself.  Than acknowledged up front that he would have something to sell, otherwise he says there would be no point in his flying out here from Conneticut to talk to a real estate investment club.  And sell he did.  What my husband and I heard prompted us to attend an all day (9 to later than 6!) on Sunday.  The cost was relatively inexpensive and anything for more education, right?

In case you’re wondering who attends a real estate investing club, I noticed a lot of people with jobs looking for a way to become self employed, and I also found many who had already made that transition using real estate investment as monthly income.  Others are there to build a retirement using real estate investing as a vehicle. Some using sefl-directed vehicles and others doing 1031’s to defer taxes. 

Finding the right investment opportunity is key to good real estate investing. The investments we have been buying are properties that can be subdivided or converted to condos or in some other way create equity through development.  I hate fix and flips because there have been such a small margin in them because we didn’t knowi how to find below market inventory consistently.  We only do the fix and flips if we can increase the value of an adjacent lot or new construction home we sell by increasing the value of the original home. 

However, working with distressed sellers to find below market inventory is a business that is very specialized and can by itself be a full time occupation.  And there are a lot of investment buyers looking to buy discounted properties.  Finding these discounted properties has always eluded me. We have tried the foreclosure route and bought on the court house steps, but too many investors were chasing these properties and they still got bid up, squeezing that profit margin.  Then there are title issues and the fact that you can’t really inspect the properties among other things, like needing cash!

Than has been successful finding these sellers and I wanted to know how. He has multiple sources and mutliple campaigns aimed at finding anyone willing to sell at a discount. His program is a highly developed marketing and operation.  We were impressed, So, we decided to invest in the systems thinking that if he can make them work, so can we (I know, pretty egotistical). The cost of the program is pretty reasonable, the bigger cost being the time to attend a one week boot camp and implement the multiple marketing systems. But we’re looking forward to it and hope soon to have a source of ‘cents on the dollar’ real estate to offer our buyers.  Keep tuned.

BTW, still nothing definitive on the Contractor’s issue, i.e., an owner needing a contractor’s license to perform work on real estate prior to a sale if within one year. We’re all waiting for clarification.