Foreclosures can be a gold mine for commercial real estate investors, as they often come at a discounted price due to the urgency of the sale. But what is a foreclosed commercial property and how can you find one?
Look no further than this guide. We’ve put together everything you need to know to understand how foreclosures work. You’ll also learn how to identify the best opportunities and navigate the buying process more effectively.
What is a Foreclosed Commercial Property?
A foreclosed commercial property is a real estate asset, such as an office building, apartment complex, industrial building, or shopping mall, that the lender has reclaimed due to the owner's inability to meet their mortgage obligations.
This can happen due to financial, physical, or personal strain on the owner.
Key reasons for foreclosing a property include:
- Defaulting on mortgage payments
- Failure to maintain the debt coverage ratio (the net operating income divided by the debt service)
- Not paying property taxes
The lender typically initiates a legal process to sell the property and uses the money from the sale to pay off the loan. However, the specific process followed can vary by jurisdiction and the terms of the loan agreement.
Types of Foreclosures
There are two types of foreclosures, each with its own process, timeline, and legal implications. It's important to understand these differences if you're considering investing in foreclosed properties.
A judicial foreclosure is a court-supervised process initiated by the lender.
The lender files a lawsuit against the borrower, and if the borrower cannot pay the mortgage, the court orders the sale of the property.
The property is then sold at a public auction, and the highest bidder becomes the new owner.
In a non-judicial foreclosure, the lender does not need to go through the court system to foreclose on the property.
This process is faster than a judicial foreclosure and is determined by the terms set in the mortgage agreement. The lender typically issues a Notice of Default and then a Notice of Sale, and the property is sold at a public auction.
Why Might You Consider Buying a Foreclosed Commercial Property?
For a buyer, there are distinct benefits at each stage of the foreclosure process.
Buying a property in foreclosure gives you bargaining power on the price.
The seller will be more driven to accomplish a quick sale which means they’ll be more willing to make repairs and/or give price concessions during foreclosure.
If you find a property before it becomes foreclosed (called pre-foreclosure) both the seller and the lender might be eager to prevent a foreclosure and therefore be willing to reduce the asking price.
There are great potential deals to be made on foreclosed and pre-foreclosed commercial properties.
Knowledge of the Property’s Condition
The seller must provide a thorough history of the property's condition. The buyer will therefore have a detailed knowledge of the title and condition of the property. Within the typical due diligence contingency period, the buyer may conduct normal title searches and do the required inspections.
Flexibility regarding financing is another advantage. The seller might agree to work out alternative mortgage financing such as a mortgage assumption or a lease-purchase agreement. The buyer could also still use conventional mortgage financing.
How to Find a Foreclosed Commercial Property
Finding foreclosed commercial real estate is trickier than finding foreclosed residential properties. However, it’s easier than you think, if you know where to look and what to look for.
Here are a few places you might find foreclosed CRE:
Your first stop should be county records. A foreclosure process begins with a public record at the county courthouse.
To find out exactly where to search, check your state's legislation on the foreclosure notification procedure.
There should also be a notice of sale for an approaching auction. To find out how much is owed on the property, you can check the county's mortgage records.
Local News Outlets
Local news outlets can be a valuable source of information. Both the initial foreclosure filings and auction announcements are frequently printed in the local paper. Through social media or word-of-mouth, you might also learn of a property owner having financial difficulties.
The Multiple Listing Service (MLS) will have lists of pre-foreclosures and real estate owned (REO) properties.
A real estate broker can usually see the amount owed on a property on the MLS, even though a property owner who is missing payments isn't officially in foreclosure yet.
Online real estate marketplaces can help you find pre-foreclosures and REO properties. Pre-foreclosure properties will be referred to by a variety of terms.
Properties that are classified as short sales can be pre-approved by the bank, subject to bank approval, or requiring third-party inspection.
Given that the seller's bank has already approved the sale, the first two options may be safer wagers.
Additionally, some properties indicated as being in pre-foreclosure aren't up for sale. The listing price is merely an estimate based on local sales data that was included on the website since a public notice was kept on file.
Some of the top loan servicing companies also list REOs on their websites. Bank of America and Wells Fargo, for instance, have searchable lists of the properties they have in their books.
The federal government has various outlets to list commercial properties that have been seized or repossessed. This includes properties that have been repossessed due to failed loans, tax defaults, or criminal forfeiture.
The US Department of Housing and Urban Development (HUD), Freddie Mac, and Fannie Mae primarily deal with residential properties, but occasionally, they may handle mixed-use properties that include both residential and commercial elements.
The IRS and US Marshals, along with other government agencies, have auction sites for properties they've seized and forfeited, which can include commercial properties.
How to Buy a Foreclosed Property
Investing in foreclosures is an excellent way to purchase properties at significant discounts. However, it’s essential to always conduct thorough due diligence.
This includes researching the property, understanding the local real estate market, and considering potential renovation or maintenance costs. This can help minimize risk and maximize the potential for a successful investment.
Here are some ways to buy a foreclosure property, along with strategies to approach each:
At public auctions, properties are sold to the highest bidder by the Trustee or the county court, with the proceeds going to the lender.
The lender (or their representative) initiates the bidding with an opening bid, which is often the remaining balance of the loan, plus any interest, penalties, and costs associated with the foreclosure process.
Other bidders can then place higher bids. Buyers often need to pay in cash, or with a cashier's check, and may not have an opportunity to inspect the property before the auction.
To increase your chances of success at an auction, make sure you do some research and prepare a solid bidding strategy. Foreclosure auctions can be complex and risky, and buyers should ensure they fully understand the process and the property they're bidding on.
Bank-Owned or REO (Real Estate Owned)
If a property does not sell at a foreclosure auction, it becomes a bank-owned or REO property.
The lender, now the owner of the property, will try to sell it, usually through a real estate broker. This can be a good opportunity for buyers, as banks are often willing to negotiate on price, closing costs, and financing terms to sell the property quickly.
This is the least risky option when it comes to buying foreclosed commercial property. Do your research and make a compelling offer to persuade the bank to sell the property to you.
In some states, the owner or another lien holder may redeem a property after the auction. There's usually minimal competition in these situations because the process can be complex and uncertain.
For example, a buyer who purchases a property at a foreclosure auction may face the risk that the property will be redeemed, effectively nullifying the sale.
For savvy CRE investors, this could be a golden chance to snag an inexpensive property.
However, it’s important to consult with an expert to understand the laws in the specific area before pursuing an opportunity like this.
A property is considered 'under water' when it cannot be sold for enough money to cover the debt. The property owner can only sell the property if the lender agrees to accept less money than is owed.
While a short sale is not a type of foreclosure it is a related concept. The goal of a short sale is to prevent foreclosure, which can be costly and time-consuming for the lender and damaging to the borrower's credit.
This option requires some work but can lead to lucrative opportunities because less investors are willing to put in the legwork.
Can you Buy a Commercial Property Before It Becomes Foreclosed?
Yes, you can! This is called purchasing a pre-foreclosure property. While it can be a bit more challenging due to the circumstances of the property owner, it can save you a considerable amount of money when purchasing property.
The pre-foreclosure process begins after the property owner has missed several loan payments and the lender requests that the loan be brought current.
A notice of demand and election (NED) is then sent to the owner and to the county where the property is located, announcing the lender's intention to foreclose.
It is usually a lot harder to find commercial properties in pre-foreclosure than it is to find residential pre-foreclosures. However, you may still find a few bank-owned properties and commercial real estate in pre-foreclosure status on listing platforms such as LoopNet, Tranzon, and LandWatch.
After conducting your initial research and locating a prospective property, the next step is to contact the property owner directly.
This stage requires sensitivity and professionalism as you will be dealing with someone likely under financial stress. A location insights platform like AlphaMap can help you gather information about the owner and their situation.
During negotiating try your best to recognize that reaching an agreement together will be advantageous to both of you: you are helping the owner to prevent them losing the property for nothing. They are helping you purchase a property at a great price.
Once an agreement is reached with the owner and you've secured financing, put the agreement in writing and sign a formal contract.
This contract should include an addendum stating that the transaction is legitimate and not taking place between friends, with no ulterior motives other than to prevent the existing owner from going into foreclosure.
The final stage in the process is the signing of a commercial real estate purchase and sale agreement.
Final Thoughts on Buying Foreclosed Commercial Property
Purchasing foreclosed commercial properties may seem daunting, but for ambitious entrepreneurs, it can be a fantastic opportunity.
The rewards can be significant due to the discounted price of the property and increased negotiating power, leading to potential for a quicker return on investment.
With the right knowledge, due diligence, and a bit of patience, you can uncover exceptional investment opportunities in the world of foreclosures. You might just find the perfect property (at a steal of a price) to add to your budding CRE portfolio.