Residential foreclosures are a very tricky area to invest and require a depth of understanding of the process, regulatory issues and foreclosure procedures, which can vary significantly state by state. First, there is a significant cost to foreclosure, as you need specialized legal counsel to pursue each case and you need to budget for that. The procedures in some states can be more cut and dry and in others more drawn out. The time periods to conclude a foreclosure can vary from 90 days, on the short end, to as long as two years in states like New York due to procedural differences and court calendar delays. In addition, for residential foreclosures, if the lender did not follow all of the regulatory requirements imposed by law in the making, servicing and foreclosure of the loan, exercising foreclosure remedies can take much longer and be fraught with all sorts of dangers for these regulatory breaches. You would not be in a position, as a successor to the lender, to defend that. There have been many regulatory problems with certain banks and other lenders not following the strict regulations that apply to residential mortgages to protect homeowners from predatory or aggressive lenders against homeowners.
How can foreign investors mitigate risks in a foreclosure market?
As a foreign institutional investor, I am thinking about diversifying our portfolio in the U.S. by adding some residential foreclosures. Some opportunities that have been offered to us by a third-party agency look very attractive on paper, but we are concerned about potential risks. What are the pros and cons for foreign institutional investors to invest in foreclosures? How can we mitigate our risks?
The risks in a foreclosure market are the same whether the investor resides in the U.S. or is a foreign investor. We have many clients who invested in the foreclosure market since 2010 and have slowly got out of that market due to rising home prices since 2012, when the profit margin dropped tremendously. One of the biggest potential risks I can think of would be the qualification of the "third-party agency." This is because foreign investors are not familiar with the U.S. market and probably don't know how and where to qualify these third parties. It is recommended to have someone who specializes in these foreclosure markets locally review these foreclosed properties and make sure the comparable sales provided by these third parties are valid, as well as see if the turnover costs and profit margin can meet the minimum IRR. We have heard too many horror stories from foreign investors who purchase properties through these "third-party professionals" who provided false comparisons and not realistic projected returns. These investors ended up losing most (if not all) of their investments.
The only way to mitigate against risk is to do your diligence. Learn about the neighborhood and pricing. Check the quality of the house. Are you relying on an agent to do this? Is the party responsible? Is the party qualified? Don't you want someone on your team to check personally?
If the asset is under foreclosure and auction, basically, you have to buy and then work the numbers. Therefore, in my opinion, to mitigate risk on foreclosed assets is not going to be easy.