Education

Understanding
Apartment Foreclosures,
Auctions, and Tax Lien Deeds

smartland-understanding-apartment-foreclosures-auctions-and-tax-lien-deeds.mp3 An apartment foreclosure is when a lender takes possession of the property to satisfy the debt. Most lenders try to avoid this option Listen to this article

Introduction

Interest rates are rising, cap rates are compressing, and there is a general fear that property values will take a hit heading into 2023. How well specific properties fare depends on several factors. How much debt was used to acquire the property, the strength of the local rental market, and t ability to execute their business plan strategy.

While most pundits agree that widespread multifamily defaults are unlikely, there will certainly be some below-market investment opportunities.

In this article, we review what investors need to know about buying apartment foreclosures, property auctions, and tax lien deeds.

What is an apartment foreclosure?

Most apartment buildings are acquired with some combination of debt and equity. Debt takes first priority in the capital stack. This means that the lender has to be repaid before anyone else can receive their investment.

A borrower goes into default when they can no longer pay their mortgage. After so many missed payments, their lender may put the property into pre-foreclosure (which is a last-ditch effort to push repayment). If the borrower does not catch up on their payments, the lender may pursue foreclosure.

Most apartment buildings are acquired with some
combination of debt and equity.

An apartment foreclosure when a lender takes possession of the property to satisfy the debt. Most traditional lenders try to avoid this option. Banks are in the business of making loans—not owning and operating real estate.

Debt funds tend to be the major exception. Savvy real estate professionals who can take over the management of an apartment building if need be are often those who also manage Debt funds.

What is a real estate auction?

Foreclosed properties are often those sold at real estate auctions. As noted above, most lenders do not want to own and operate multifamily real estate.

Instead, they will sell the properties at a public auction in order to recover some of all of their losses (i.e., unpaid debt).

Acquiring a property via an auction can be a great way to buy apartment buildings at a discount. Typically, the seller is not looking to get top dollar for the property. Oftentimes the seller will just want to be repaid and get the property off their books.

What to Know about Apartment Foreclosures and Auctions

Here are some general tips for buying foreclosure apartments, especially multifamily buildings sold at auctions:

  • The seller is often the bank, mortgage lender, or U.S. Department of Housing and Urban Development (HUD). Typically, these parties had the first loan on the property that went unpaid and wound up in default. You are not buying from the prior owner or an individual. (HUD sales typically occur when HUD acted as a direct lender to the owner, or more commonly when HUD acted as an insurer through the FHA).
  • Majority of foreclosed apartments are sold “as is”. In other words, buyers have very little negotiating room. They cannot ask for any property improvements or other concessions to be made as a condition of the sale.
  • The interior condition of the property is often unknown. Often, the properties are locked and can only be viewed from the outside. Investors must do their own due diligence on the building without actually stepping inside.

    This is obviously a risk. Without knowing the condition of the units, prospective buyers have no idea how much work will be needed to re-lease the units at the market rate.

  • Not all properties are sold vacant. Sometimes, an apartment building is sold at auction with tenants still in place. They may or may not be on leases. It will be up to the buyer to evict people if need be.
  • Some auctions require cash buyers. Apartments sold at foreclosure auctions often have quick turnaround times. The lender, for example, may require the borrower to close within 30 days.

    For this reason, many auctions insist that people buy with cash. This creates a barrier to entry for all but the most sophisticated and liquid apartment investors.

  • Most auctions have a “reserve” price that must be met. People often think that they can show up at an apartment auction and make low-ball offers on properties. While foreclosed apartment buildings may not sell at market-rate, most will still be sold using a “reserve” price.

    This is a pre-determined floor that must be met before the lender accepts an offer. For example, the reserve price might be $250,000 on a property that would otherwise be worth $600,000.

  • Winning bids must submit an earnest money deposit. Bidders should come prepared with a certified check in hand. This is because those who win the bid will need to put down a deposit, right there on the spot, to lock in the purchase of a foreclosed apartment building.

How to Find Multifamily Foreclosures and Auctions

Foreclosed properties are often referred to as REO properties. This stands for “real estate owned” property. A good way to find foreclosed multifamily units is by searching a bank’s website for their REO properties. Local bank branches might also have lists of REO properties.

There are also websites that feature foreclosures for sale. For example, Auction.com is a popular site that is used for multifamily auctions.

HUD also has a “Multifamily Property Disposition Mailing List” that goes out every Wednesday as new multifamily properties get ready to be sold at auctions.

What is a Tax Lien Deed?

A tax lien is a document filed with the county government. It alerts the public that a homeowner has an unpaid debt. In the case of real estate, this normally refers to property taxes owed and/or unpaid municipal water and sewer bills.

There are other types of tax lien certificates and tax deeds. For example, the federal government can put a tax lien on a property for unpaid federal income taxes. The state can follow suit for unpaid state income taxes.

“Super liens” are used when someone fails to pay the homeowners’ association fees. “Mechanic liens” are when someone owes a contractor money for work performed at the property.

A tax lien is a document filed with the county government that alerts the public that a homeowner has an unpaid debt.

Tax liens have serious consequences. All states have laws that allow the local tax collector to force the sale of a property as a way of recovering unpaid fees. This is usually done at tax deed auctions, in this case, for “tax deed sales”. Depending on the state, the tax collector may also be able to sell the tax lien to a third party through a “tax lien certificate sale,” and then that third party assumes responsibility for the foreclosure process.

Buying Tax Lien Deeds as an Investment Strategy

Some people pursue tax deed investing with the hope of foreclosing on the property directly. Tax liens are often bought and sold through an auction process.

There are often bidding wars, with the person willing to pay the lowest interest rate and/or highest premium of being the winner.

Buying tax liens, and then pursuing foreclosure, can take significant time and resources. However, those who successfully foreclose on a property using this technique can acquire apartment buildings for a fraction of their value. In the meantime, they can collect interest on the outstanding tax lien payment.

Others will instead wait for the home to go to foreclosure.

Things to Know About Buying Tax Liens

Here are 6 important things to know about buying apartment tax liens:

  • Like foreclosed properties, you often cannot tour the property in advance. You are buying the tax lien on the property “as is”. Investors should do as much due diligence on the apartment buildings in advance of bidding on its tax liens.
  • Sometimes, the tax lien is worth more than the property value. This happens less frequently on foreclosed apartment buildings, which tend to have a higher value than the tax lien – but nevertheless, it’s something for investors to be cognizant of.
  • Buying a tax lien does not guarantee you will eventually take ownership of the property. In fact, an estimated 98% of owners will pay property taxes owed prior to the foreclosure process.
  • The rules around buying tax liens vary by state. Anyone who is considering this investment strategy should be sure they understand the local regulations. For example, some states have a two-year redemption period in which the tax collector must hold the deed prior to selling it at a public auction.
  • In addition to tax liens, there may be other liens against the property. After a foreclosure occurs, the new owner pays the tax or other debts owed.
  • Buying tax lien deeds is an active investment strategy. This is very different than passively investing in real estate through a syndication, fund, or otherwise. Those who ultimately take ownership of an apartment building via a tax lien deed will be responsible for all repairs, maintenance, and ongoing property operations.

Why Buy a Foreclosed Apartment Building or Tax Lien Deed

There are certainly risks that come with buying foreclosed apartments and tax lien deeds. However, these properties are also a great way to invest in multifamily property at a lower cost. By some estimates, distressed properties like these often sell for 30-60% below market value.

Moreover, demand for well-located multifamily property remains at all-time highs. The sector continues to outperform other property classes. It is also projected to do well even during a recession. Those who are considering this investment strategy should have strong liquidity to deal with the unknowns associated with buying distressed property.

Conclusion

As the economy became more stabilized, the prevalence of distressed properties decreased.

Apartment foreclosures, auctions, and tax lien sales
were much more common back in 2010-2014 as the
housing market recovered from the Global Financial Crisis.

We are on the precipice of what could be another major market correction. Depending on the severity of the next recession, we may once again see an uptick in foreclosures, auctions, and tax lien sales. Apartment investors looking to purchase real estate at a discount will want to understand these processes so they are ready to move when opportunities become available.


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