Last year was a record year for bankruptcies. Delinquent payments on mortgages, according to the Mortgage Bankers Association of America, reveal a coming wave of foreclosures on the horizon.

There’s opportunity now for investors to step in and benefit from these properties that are about to hit the market. However, despite all the hyperbole, investors can lose money in real estate – a lot of money. If you have some cash itching a hole in your bank account and you’re looking for positive cash flow and possible high returns on investment, be sure to avoid these pitfalls in the foreclosure investor field.

1 - Paying too much for a foreclosure. Many VA and HUD foreclosure buyers have found themselves getting caught up in the excitement of auctioning up on properties and watch, without even knowing it, their supposed cash cow die right in front of them. If you must have a 20 or 25 percent spread to make money on the purchase, then stop bidding when the price gets below that spread amount.

In simple terms, if you’re bidding on a property with a $150,000 value and you intend to sell it for a 20 percent gain, then stop bidding when the price gets above $120,000. In a hot market, even foreclosures will sell at market price, but then the new owner must move in and most likely fix up a dilapidated property that has been neglected by the former owners. (Usually, when an owner is headed toward foreclosure, fixing the leaky roof or basement is the last thing on his mind, leaving it up to the “bank” to fix instead.)

2 - Getting a house without clear title. Since I’m not an attorney, I won’t go deep into this point, but make sure you can get clear title to a property before you put your $10,000 earnest money deposit into the deal. Order a title search by an attorney to find out if you’re going to have any problems taking title to the property. If you can’t get title, you can’t sell the property.

3 - Negative or unprofitable cash flows. The whole idea behind buying a foreclosure is to buy low enough so that rent checks will cover the investor’s mortgage payment, taxes, insurance and fees each month and then leave the investor some profit at the end of the month. Unless the property is in pristine condition and all the systems will last repair -free years, you’re setting yourself up for financial hardship if an air conditioner breaks or the refrigerator has a compressor attack.

The monthly cash flow should include enough to finance any breakdowns or repairs while the tenant lives in the dwelling. Negative cash flows are not deductible expenses.

4 - Not taking care of little problems before they become big problems.

Don’t take the cheap way out on being a landlord. A house starts deteriorating from the day the builder completes its construction. Your new investment property is creating cash flow – take care of it. Keep it painted regularly, clean carpets and floors between tenants, fix broken windows, repair leaks promptly, replaced rotted wood, etc. If you let the property deteriorate until you can’t rent it out any longer, you’ve waited too long to fix these items. In addition, to fix defects early on will save you money if you wait and the bill doubles or even triples.

5 - Failing to educate yourself on tax benefits of owning investment properties. If you’re going to invest in rental property, talk with professionals in the field who know how to maximize your financial benefits form this new form of investment. Accountants, attorneys and real estate practitioners are all worth their fees as they help you avoid pitfalls, increase your gain and keep you out of trouble.

Published: March 8, 2002

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