Jean Folger | 11-14-2013
Buying a house usually goes something like this: figure out what you can afford, find a lender, hire a real estate agent, make a list of your must-haves, view properties, view more properties, make an offer, secure your mortgage, close on your new home. Although time consuming and at times frustrating, viewing properties first-hand is considered by most buyers to be a fundamental part of the home buying process, and many would never dream of purchasing a home without first inspecting the neighborhood, home and yard.
There are buyers, however, who are willing to purchase homes without seeing them first. For various reasons, these buyers and investors are willing to skip this part of the process, relying instead on multiple listing service (MLS) descriptions, Internet photos and virtual tours. With the number of distressed homes on the market, some real estate investors purchase homes sight unseen in an attempt to score great deals.
Buyers might also snatch up homes while they have the chance in markets that have a limited supply of properties. Because of competition – from buyers to aspiring first-time investors and institutional firms that buy up entire blocks of property – there is an increase in the frequency of sight-unseen real estate purchases in certain markets across the nation. While you can get lucky and spin a nice profit when it’s time to sell, there are significant risks that need to be acknowledged before engaging in this type of real estate investing.
Distressed properties are generally damaged or in poor condition, and are under foreclosure or advertised for sale by a bank or lender. Most banks try to unload these properties as quickly as possible, because they are expensive to hold: between property taxes, maintenance and legal fees, it can cost banks $1,000 per day to maintain each property in its inventory.
Because a quick sale makes financial sense for the bank, these properties are often offered at a significant discount, and it’s not unusual for some homes to sell for pennies on the dollar. This creates an excellent opportunity for both buyers and investors to get properties at below market prices.
Markets with limited supply can compel buyers and investors to purchase houses sight unseen. Instead of finding great deals, however, here buyers can expect to pay market value or higher just to secure a property in a desirable area. In tight markets, such as Boston and New York City, it is common for sellers to receive multiple, competitive bids, which can significantly drive up the price. Many of these offers come from buyers who have never stepped foot on the property but who know they want to buy in that particular market.
Pre-construction properties also provide opportunities for buyers and investors. A pre-construction property is on the market even though it has not yet been built. This type of property can be beneficial to both sellers and buyers: sellers (most commonly the builders) get money they need to continue construction while proving the viability of the project to lenders and other potential purchasers, and buyers are able to purchase at a lower pre-construction rate with the ability to sell afterwards at market value (or above, depending on the project).
Investors looking for great deals or prime properties may be up against tough competition from flippers, wholesalers and institutional buyers. Flippers are real estate investors who aim, much like stock market investors, to buy low and sell high. Typically, flippers purchase properties at a discount, make repairs and renovations, and sell within a short time-period for a profit. A property’s After Repair Value (ARV), an estimate of its fair market value after repairs and renovations, is used to determine if a property has profit potential.
Flippers calculate potential profits by taking the ARV and subtracting the purchase price, repair and renovation costs, and carrying costs (expenses incurred for holding onto the property, including mortgage payments, property taxes, insurance and utilities). Because flippers depend on these calculations to determine if they can make a profit, some will not purchase sight unseen. Others, however, focus on foreclosed properties that can be bought at a steep discount but that are sold at auction with no opportunity to view before signing the papers.
Similar to flippers, real estate wholesalers attempt to profit from properties in a short period of time. Unlike flippers, however, wholesalers don’t purchase and rehab properties. Instead, they generally put properties under contract with contingencies (so they are able to terminate the contract if needed) and then assign or sell the properties to other investors for a profit. A wholesaler can be considered a “middleman” who rounds up properties for established investors.
After putting the property under contract, a wholesaler markets the property to find a willing buyer and, in many cases, the wholesaler has a buyer lined up even before putting a property under contract. The spread between what the wholesaler pays for the property and the price he or she sells it for is the wholesaler’s profit. Because wholesaling doesn’t involve time-consuming repairs and renovations, many wholesalers look for smaller, more frequent profits than flippers.
Institutional investors purchase large inventories of properties, sometimes entire blocks of distressed properties. Institutional investors, backed by deep pockets, can purchase dozens or hundreds of homes, driving down inventories and consequently driving up prices in a market (and increasing the likelihood of selling at a profit). Institutional investors can have such massive buying power that they can make it quite difficult, if not impossible, for smaller investors and individual homebuyers to find good deals within a target market.
In addition to flippers, wholesalers and institutional investors - a smaller group of buyers will purchase homes sight unseen out of necessity. This most often involves an individual who, for business or personal reasons, is relocating to a new area but does not have the time to shop for a new house. Typically, these buyers work with real estate agents who send them detailed descriptions, photos and videos (or virtual tours) of properties that meet the buyers’ criteria. Because the agent essentially becomes the buyer’s eyes and ears, it is vital that buyers specify their exact needs, not only in terms of what features the home should have, but also requirements for schools, commutes, public transportation and nearby amenities.
Homebuyers and investors may purchase homes sight unseen, but the practice is not without risks. One of the biggest risks is that there will be something wrong with the property that doesn’t show up in photos. Furniture and camera angles can easily hide many defects, including water damage, infestation, mold and structural damage. While many properties are in disrepair because the owners did not have the time, expertise or money to properly maintain the home, some properties are intentionally damaged by previous owners. Often, this is a misguided attempt to “get back at the bank” by making it more difficult to sell the property. Other times, people rip out whatever they can – appliances, fixtures, copper wiring, even landscaping – for the money.
Regardless of motivation, destruction after foreclosure can involve relatively inexpensive fixes such as holes in the drywall, or extensive and costly repairs. In a particularly ugly incident from 2011, a home in an upscale gated-community in California needed about $250,000 in repairs after its previous owners lost the home to foreclosure. Chemicals and cement had been poured down the property’s drains and water was left running for what may have been months – leading to extensive mold throughout the home and a floor that caved in under the weight of water-soaked items. In addition, the property’s appliances, cabinets, sinks and toilets had been removed.
Another reason buying sight unseen can be risky is that photos and virtual tours don’t allow you to see undesirable features of the home, such as nearby high-tension wires, traffic, neighborhood noise levels and unusual odors (from things such as mold or the 100 cats that used to live in the house). A walkthrough is the only way to be sure that you’ll like the house, the yard, the neighbors and the area.
Flippers, wholesalers and institutional investors have the added risk of not being able to sell the property in a timely manner because of the need for extensive repairs. For investors, the longer the house is held, the more money is lost in terms of carrying costs. The premise of real estate investing is often to buy and sell quickly, and when this doesn’t happen – for whatever reason – the investor can end up taking a loss, especially when unexpected and expensive repairs are needed.
Ways to protect yourself
A contingency clause is one of the best protections when purchasing a home sight unseen. A contingency defines a condition or action that must be met in order for a real estate contract to become binding. One of the most important contingencies when purchasing a home without seeing it first is an inspection contingency, which gives the buyers the right to get the home inspected within a specified time period, such as 5-7 days. This protects the buyer who can cancel the contract or negotiate repairs based on the findings of a professional home inspector. An inspector examines the home’s interior and exterior, and evaluates the condition of the electrical, finish, plumbing, structural and ventilation elements.
Depending on how the contingency is worded, the buyer can:
- Approve the inspection report and move forward with the deal
- Disapprove the report and back out of the deal
- Request additional time for further inspections
- Request repairs or concessions
Buyers can also ask for a walkthrough contingency. This type of contingency allows you to do a final (or first) walkthrough of the property before signing the papers at closing. Keep in mind, as with all contingencies, seller do not have to agree to any contingency, and they often expect a higher purchase price to compensate for the added risks to the seller (i.e. the risk that the buyer will back out of the contract).
Buyers and investors can both add a layer of protection to buying sight unseen with the aid of an experienced real estate professional. It is important that the agent be on your side of the deal (working on your behalf as a buyer’s agent) and not working on behalf of the seller. The agent should have a fiduciary responsibility to you to make sure you get the best deal. Many buyers and investors vet several agents before finding one who understands their needs and who they feel they can trust.
The Bottom Line
Some people purchase homes sight unseen out of necessity, while others do it for the profit potential of a real estate investment. In any case, buying a home without first seeing it involves risks: the property could have defects or damage that may result in extensive and expensive repairs. Also, the home might be in an undesirable location (e.g. next to a busy road) or have other detrimental features. Whether you are buying sight unseen out of necessity or as an investment, you can limit your risks by working closely with a trusted and experienced real estate agent, and by including certain contingency clauses in the offer to purchase real estate.Back to News | View Related Link
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