My business partner and I just completed a successful BRRRR of a property we bought at a tax foreclosure, and it was not without some challenges! Watch the video below for my thoughts on it right after we left the bank with the refinance check. Read the short summary below to get more insight on the deal.
So, we bought a 3-unit rental property at a tax foreclosure in June 2018 using private financing to finance both the purchase and the rehab costs. We remodeled the building top to bottom and the total cost of the purchase and rehab came to $185,000 (this included the interest-only payments we made to our lenders between the time we bought it and six months later when we got it fully rented). We ended up collecting approximately $43,000 after rehab and then refinanced it with a commercial lender and pulled $178,000 and change out of the deal. The refi proceeds plus the rent collected (after expenses) totaled more than the $185,000 invested. This is the Buy Rehab Rent Refinance Repeat (“BRRRR”) strategy at its finest!
Not only did we get a cash flowing property, but we did not have to use any of our own money to acquire it. This ended up being a successful deal in the end, but we made several mistakes and definitely learned some lessons that I would like to share with you.
Lesson One: Do Not Pay Contractors Any Amount Up-Front.
Don’t pay contractors any money up-front, even if you have worked with them on prior deals. It just invites problems. You should pay contractors based on progress of their work on the project. Period. If the contractor will not accept that kind of arrangement, then look for another contractor. We did not follow this rule in this case and it ended up costing us an extra $10k-$15k in rehab costs.
Lesson Two: Tax Foreclosure Auctions May Not Allow You the Opportunity to View the Property Before Purchase.
Buying a foreclosure deal at a tax auction is risky. Sometimes you may not even have the opportunity to go inside and see the condition of the property before you buy. Even if you do see it, you certainly won’t be able to do a full inspection. Because most foreclosures usually sit vacant for years before actually being sold, the chances that the property will be in really rough shape are high. Only do this if you are able to handle a big rehab, the purchase price is low enough to give you a big cushion, and that if things go wrong and it ends up costing more than you expected you can afford to take the hit.
Lesson Three: Expect High Transaction Costs When Buying at a Tax Auction.
If you are going to buy a property at a tax auction, expect to pay significant closing/transaction costs. In this case, the bid price that the municipality accepted for the 3-unit building was $57,000. But, the various costs added up to another $13,000 for a total all-in cost of $70,000 at closing.
Lesson Four: Factor the Likely Delay in Obtaining Title Insurance into Your Exit Strategy.
This is the biggest lesson of all: you may have trouble getting title insurance on a property you buy at a tax auction. Why? Because the municipality will usually transfer title to you through a quitclaim deed. This is the lowest form of deed you can get. It comes with no warranties of any kind and essentially means that the seller is transferring to you whatever right the seller had in the property (it could be full right to ownership or no right at all).
Title insurance companies are very reluctant to provide title insurance on tax foreclosures because they are notorious for being successfully challenged after the fact by the original owner. If the municipality failed to follow all of the technical laws and procedures involved in a foreclosure action, the original owner may get a judge to vacate the foreclosure and return title to him or her. Each state has different rules on this, but an owner may have up to two years or more after the foreclosure to challenged it in court. If a title company insured title, which ends up getting transferred back to the original owner, the title company will have to pay the subsequent buyer.
For this reason, title companies prefer to wait two years before they will insure title. What this means for you is that if you can’t get title insurance, you can’t sell and you can’t refinance, which means you have to hold on to the property. This would not be a good situation if your intent was to flip the property. So, you better make sure you check the rules in your jurisdiction and talk to some title companies before you buy the property about whether this is going to be a problem.
This deal ended up working out pretty well for us when all was said and done. But, it could have gone very differently. We spent more than we wanted on transaction and rehab costs and we were almost prevented from refinancing the property prior to the two-year ownership mark. The fact that we were able to pull all of the lender money out and not use any of our own funds on the deal is a testament to my business partner’s experience with construction and my ability to find a title company that was willing to work with us on this deal. Although the contractor I mentioned cost us an extra $10,000-$15,000, we were still able to keep the overall costs within the 80% of the value of the property due to my business partner’s ability to find reasonably priced contractors to finish the work and to manage them until the project was complete.
My advice to new investors is to stay away from tax foreclosures and start with less risky projects. Once you have some experience under your belt, you can expand and try your hand a tax foreclosure. But, be sure you perform your due diligence on the costs, title insurance prospects, and the contractors who will be doing the work.
Happy investing guys!