Dipping your toes into buying foreclosures

Looking to profit from other people's pain by investing in foreclosures? It's the American Way, right? Well, not so fast, at least according to a story in the L.A. Times:

With 700,000 bank-owned homes on the market, and another one million in some state of foreclosure, according to RealtyTrac, an Irvine, Calif., provider of foreclosure listings, you might be tempted to add a distressed property to your portfolio.

Beware. Buying a home in foreclosure is not for the meek. Those with an appetite for risk, however, will find the tumultuous market stocked with plenty of investment opportunities...

Whether you're looking to flip a home, buy into a neighborhood you couldn't otherwise afford or planning to rent the home, you, like these big companies, must have heaps of cash on hand.

There are properties that can be turned within a few months, but the overall market is still slow. Even if you have a renter lined up or have enough money for a 10% to 20% down payment, you should be ready to weather a depressed market for another two or three years.

Go to the county assessor's office and study recent sales for price-per-square foot and time spent on market to determine what sort of price you can expect at resale. Be conservative. If you are renting, calculate a capitalization rate, and subtract 10% or more of the annual yield for maintenance and depreciation. Make sure that your endeavor is still profitable if you incur two to three years of carrying costs and depreciation.

It's also crucial to remember that bad loans that plagued speculators and unprepared borrowers don't simply disappear when distressed owners sell their properties. Unless the property goes through foreclosure auction and becomes bank-owned, outstanding liens and fees are simply transferred to the new owner. If you plan to buy out of pre-foreclosure, make sure the property has a clean title; otherwise you'll just be trading places with the distressed homeowner...

However you do the math, the most important thing to keep in mind is that the investment has to be worthwhile--even if you can't sell the home at your desired price for two or three years and the current housing market deteriorates a further 10% to 20%.