Buying foreclosed properties

Buying foreclosed property is a sensible approach to securing real estate, but you should be aware they have their advantages and disadvantages - depending on the market circumstances. The advantages are:
1. Distressed prices - these assets are often being dumped into markets with no buyers
2. Bank indifference - Banks are primarily concerned with recovering their own money, thus there is some willingness to accept low-priced offers from prospective buyers
3. Under-utilised assets - foreclosed assets are often under-appreciated assets because the previous owner was unable to make a profit from it, or didn't have the chance
4. Foreclosed property assets often have a negative perception attached to them, whether its a fear of reprisals from the previous owners or threats by the yakuza (in Japan). This means you can get a low price because buyers are scared off.
5. Illiquid markets - Foreclosures tend to be dispersed across the whole country, which means you can get steep discounts in illiquid local markets because most of the buyers are in the cities. For retirees or holidayers this means they can get particular bargains away from the city.
6. Panic sentiment - The wall of fear gripping the market can create a wave of panic selling, resulting in steep discounts. This is particularly pertinent where their is perceived to be no value for the asset. eg. Vacant, unproductive land. Such assets can become compelling buying at the right price.
7. Limited disclosure - The limits placed on disclosure can drive down prices prompting many buyers to stay away. In Japan bidders are not permitted to enter the property. Most buyers are reluctant to bid on properties they can't look at. In the Philippines the information is very scant, and bank managers are less than service-orientated
8. Generous financial terms - Bidding on foreclosed properties requires a deposit of just 5-20%.
9. Financial literacy - In some markets buyers are less sophisticated than others, so foreclosures in these markets can be more compelling. The same of course is true on the selling side, where poor financial literacy increased the number of foreclosures (sellers). Financial literacy is particularly prevalent in the rural areas.

See http://foreclosured.blogspot.com for further information on specific market opportunities.

Why buying property makes sense

Property does not always make sense. The argument that property never falls in value is a nonsense, even the assertion that it doesn't fall by much, or that you would be paying rent anyway. Property is a market just like any other - except that its considerably less liquid. It can take 2-3 months to transfer property title. So buying property is a matter of timing. The best evidence of falling property markets is Japan in the 1990s and the USA in 2007-8. Between 1990 to 2003 Japanese commercial property prices averaged falls of 7-9% per annum for over a decade. These are huge drops. You can't argue that you should 'hold' investments because your yield was improving, as your capital was being grossly undermined. Many Japanese buyers realised this, and sensibly gave their properties back to the banks rather than pay off loans that were larger than the value of their houses.

The biggest determinants of housing prices are:
1. Rising employment - increasing the number of renters becoming landlords (buyers)
2. Rising immigration - increasing demand
3. Rising incomes - increasing the capacity of buyers to buy more & more expensive properties
4. Rising population - increasing demand
5. Regional migration - shifts between regions even within cities
6. Falling interest rates - increases the confidence of buyers, as well as lowering the cost of interest payments
7. Supply constraints - increasing in the Philippines (albeit slowly)

Of course all these factors are part of the total picture giving buyers a lot of confidence, as well as holding off sellers. But the power to expand wealth from property is far greater when you consider the following:
1. The capacity to leverage your property value by borrowing money from a financial institution
2. The capacity to spend on incremental capital works to lift yields on your total investment
3. The capacity to subdivide the lot into smaller lots

All these elements make property a very good investment, and a very lucrative one if your timing is good. Apart from replacing rent, it can also be a great income earner, whether you rent the asset fully, or just a portion (a bedspacer or granny flat).

Buy properties for land value

People often recommend that you buy properties for land value. What they are suggesting is that you should maximise the land value in any purchase. Regardless of whether you are buying off-the-plan or a 'used' property, you should attempt to break the property value up into:

1. Basic land value
2. Value of improvements

For example I saw a property developer in the Philippines offering house & land packages for P1.5million. They were reluctant to tell me the value of the land, reinterating the point that its a package. Finally he told me that you can buy land in an adjoining lot for P3000/m2. This is a good reference for benchmarking. Given that the package included a 80m2 lot with a 80m2 (floor area) 2 storey house, the implication was:

Having established that vacant land next door is selling for 3000 pesos per sq metre, based on the package price of P1.5mil, we know that the implied value of the house is P15,750/m2. Based on previous independent advice, I know that P12,000 per m2 is a reasonable amount to pay for a basic house, so these lots look overpriced. Of course they are sold this way because most Filipinos lack financial literacy. They think they are getting a good deal because the nominal price of P1.5mil ($US30,000) is low. But they might wonder after they move in - Why is the neighbourhood so noisy? The reason - the neighbouring lots were empty when their house was under construction. Now the neighbours are building their house, its apparent that they are too close to their neighbours. Soon when the whole neighbourhood is filled with kids, dogs, roosters, jeepneys and tricycles, they will realise that they bought into a slum.

Most developers are marketing to suckers who don't know the value of property. Why buy in a fully priced subdivision? Security and facilities are the only reasons, but will you use them? Its crazy that people buy these residential lots and sit on them for decades. Of course if you want to avoid the premiums involved in such packages, you need to consider:

1. Buying a vacant lot and getting an architect/builder to build a house for you

2. Buying a 2nd hand house - privately or foreclosed

3. Establishing a consortium to buy & develop your own subdivision - You need a sought after area because there are many failed subdivisions around

One of these approaches means that you can buy at a reasonable market value. But markets are not static. We should be trying to buy a property for its future capital growth potential. We are looking for a re-rating in the value of the land component - which is why we shop to maximise the land value. In contrast, the house value will depreciate so we want to minimise that capital component. There are several potential capital growth factors we should be looking to find:

1. Trends favourable: Look for areas where the trends support the future demand for your property, particularly where the trend has just changed and is likely to be sustained. e.g. Expansion of the city, development of your area, growing popularity of larger size lots, growing popularity of 2br homes, possibility of a new train station after the area population density increases.

2. Focal point established: Is there some feature in the local area that makes the land more valuable, e.g. A new train line that has reduced traffic, a new shopping mall attracting jobs, an attractive beach

3. Improved accessibility: The impact of a new toll way is considerable because it provides much faster access to the city. An area previously too far away from the city becomes a magnet for weekender accommodation, sparking a lot of property development.

4. Other special attributes: You need to decide what is a positive attribute and what is a negative. The positives are considered to be schools, churches, large lots, big houses, beaches, waterways, access, forests, shopping centres (if you are not too close); whilst the negatives are considered to be industrial areas, prisons, slums, pollution, etc. Of course these attributes are subject to change. e.g. The prison might be closed in time, and the slums might be redeveloped by government or private enterprise.

5. Rezoning: In some countries the distinction between different types of land can be HUGE. The implication is that you can significantly benefit if you are able to hold the land when the zoning is changed. Large projects attract jobs, so they tend to more readily get approved. But there is no reason why you can't profit on their coattails, particularly if you are able to anticipate change. Restrict zoning laws tends to artificially elevate the value of land. If you hold agricultural land on the fringe of a growing city, you will eventually profit from the increase in land value. But the increase in value will not be straight line, so timing is important. Look to buy such fringe land after city property has increased. Get rid of it before, and realise its value before any collapse in the economy.

The implication of these statements is that you should not buy strata title property like apartments, condominiums. I think this is true, though it will depend on personal circumstances. Buying a strata title might be a lifestyle decision. If you tend to buy the property as a owner-occupied premises, it might make sense. You might prefer a small, low-maintenance garden, greater security, or to unlock the land value from your house prior to retirement. These are all valid decisions.