Academic journal article Journal of Critical Incidents

To Bid or Not to Bid? Is It Time to Purchase an Investment Home, Maybe a Foreclosure?

Academic journal article Journal of Critical Incidents

To Bid or Not to Bid? Is It Time to Purchase an Investment Home, Maybe a Foreclosure?

Article excerpt

Was it time? Was it time to buy a foreclosure rental property? Jim already owned one rental property in a college community but investing in a foreclosure property was something new for Jim. The prospect of purchasing a foreclosure property was appealing. Real estate prices were down across the country. An increasing number of foreclosed properties were for sale in the local market. Could Jim pick one up for a great price? And what about risks? The market could continue to decline, and what looked like a value might not be. Any home Jim bought would not be his primary residence. Instead he and his wife would rent the property. The rental market could change and the estimated cash flows might not materialize. Foreclosure presented another obstacle as well; it was a bidding process that required cash funds. Jim had the cash available and his decision ultimately came down to getting the "right" price for a property. Determining the right price for the property involved assessing the appropriate cash flows, estimating a cost of capital and assessing the risks associated with his cash flow estimates.

Jim lived in a small university town in Idaho. He owned his primary residence in an area of town known as upper university. The area was up a gentle hill from the main campus of a regional university. All of the houses in this area were within a ten minute walk from campus. The other area close to campus was called lower university and Jim owned a rental here. It too was within a ten minute walk from campus. Jim was a professor on campus and liked having his rental close to his primary residence. It made it easier to keep an eye on the property. It also saved time when he had to stop by to make a repair. Jim's rental property had stable, longer term tenants. Jim had been looking around for another rental but appropriate homes for sales were scarce in the university areas. Jim was very interested when he noticed a foreclosure for sale about a block from his current rental property.

The U.S. Housing Market

Jim had a great experience so far with his rental but he knew markets and the economy can change. Investing in a second rental was a big step. Jim had moved to Idaho from Las Vegas the year before, in the summer of 2007. Jim's house in Las Vegas sold, but at a price lower than he wanted. Jim quickly realized his sale in the Las Vegas market was actually well-timed because the real estate bubble had already been starting to burst. The housing market seemed stronger in Idaho, and Jim bought his first rental when he moved. Now that he was thinking about buying another rental, Jim realized there were some changes in the U.S. housing market in the summer of 2008 he needed to consider.

Jim kept abreast of the news and heard a radio show describe how in the summer of 2008 the national real estate market was beginning to collapse. There was a run on Bear Stearns and the Federal Reserve had lowered interest rates to combat a subprime lending crisis. The news story described how this crisis occurred after several years of relaxed bank lending practices. Investors were interested in high interest, low risk bonds, and historically mortgage backed securities issued in the United States were just that. With high demand for mortgaged backed securities, mortgage companies began making riskier loans to create more securities. In an effort to increase loans, mortgage companies made loans without verifying income. They were called no income verification loans and were popular. In a no income verification loan the borrower needed only to state his or her income. For due diligence, the banks had an "expert" state that it was possible for someone in the profession of the borrower to make the income the borrower claimed. In addition, many loans were made with nothing, or little down.

The decline in housing prices in some parts of the country started back in 2006. By 2008 the consensus was that the U.S. real estate bubble had popped. …

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