The two primary risks associated with a foreclosure acquisition are title and physical risks.
When buying at a foreclosure sale, there is no warranty on title–express or implied–by the court, lender plaintiff, plaintiff attorney(s) or clerk of the court. The bidder at auction buys the title “as-is” and assumes the risk of title defects.
The title defects can be varied and highly problematic. The property can be subject to superior mortgage liens, mechanics liens, municipal and county liens, federal or state forfeiture proceedings, probate proceedings, family law proceedings, federal and state tax liens, outstanding water bills, open permits, open code compliance violations and citations, adverse possession, HOA/condo maintenance fees and special assessments, outstanding judgments, county property tax deed applications, unnamed junior liens, and so on so forth.
A foreclosure investor purchasing at a foreclosure auction can lose his or her entire investment if the property purchased is subject to a superior lien and that lien is foreclosed against the investor. In such instances, the investor is caught between two terrible prospects, pay the superior lien or lose the property. Many times, the first of the two options is not even available to the investor.
Since a foreclosure proceeding is judicial, the owner of the property or occupants are subject to an involuntary forced sale. Therefore, they are not happy. This may result in them intentionally damaging the property. Also, since a foreclosure investor will almost never have access to the interior of the property or even most of the exterior, there may be major structural and infrastructural problems that the investor cannot anticipate. This results in the challenge of budgeting for unknown repairs prior to the purchase and getting the repairs done properly and efficiently after the property is purchased.
Defective sale process. There may be a basis for the defendant disputing the sale. In such instances, the defendant will have to timely raise the issue by motion and argue the motion in court. The creditor-plaintiff may or may not contest the motion. This process may take months and can result in the third-party investors money being tied up in court for that entire time without interest. If the sale is cancelled, then the clerk of court refunds the money paid by the third-party investor in its entirety. The sick to the investor is the opportunity cost of tying up money with no benefit and losing the opportunity to invest in a fruitful prospect.
Market Risks. There are always economic risks associated with a real estate acquisition. The risk being that there will be a downturn in the market. In the case of a foreclosure investors, the risk is all the more palpable because cash is completely tied up without any leverage.
One way to dilute such a risk is to pool with other investors in a joint venture. This way not all your eggs are in one foreclosure basket. Another way is to get a hard equity/hard money refinance of the property. This can be useful to raise capital for repairs. The lender assumes some of the risk. Loan to value ratios tend to be in 60/40 to 70/30 range and interest rates can be relatively high. However, in many cases, the investor benefits from sharing the risk and improving the property without tying up additional capital.