By Amy Hoak
MarketWatch
Saturday, March 3, 2007

The number of homes in or nearing foreclosure is growing, and some investors are taking advantage of the bargains being created. But even with a steady stream of distressed properties coming on the market, jumping into foreclosure investing is dangerous, especially if you are not familiar with the process or are new to real estate investing.

"Some people are using the phrase 'tsunami'; there's going to be a tsunami of foreclosures," said Dave Jenks, co-author of "The Millionaire Real Estate Investor." "The people who are pros at dealing with foreclosures and have the infrastructure of information and wherewithal . . . will take full advantage of this."

Consider these recent statistics: 1.05 percent of mortgages were in the foreclosure process in the third quarter of 2006, according to the Mortgage Bankers Association. The foreclosure rate increased from 0.99 percent in the second quarter; it was 0.97 percent in the third quarter of 2005.

RealtyTrac reported recently that the number of homes entering the foreclosure process increased 19 percent from December to January. Compared with January 2006, the number of homes in the process is up 25 percent. In 2006, a total of 1.2 million homes entered the foreclosure process, 42 percent more than in 2005.

While there are opportunities to purchase homes at reduced prices in many markets, they're "cautious opportunities," said John Anderson, owner of Twin Oaks Realty in Crystal, Minn.

Above all, you can't assume that just because a home is heading for foreclosure means that it is automatically a good deal, Anderson said.

Remember, even for pros, foreclosure investing involves some risk, as does any purchase of "real estate as an investment, as opposed to a home" in which to live, said Rick Sharga, vice president of marketing at RealtyTrac.

The transaction has to make sense financially, figuring in the costs of getting the property back into marketable condition, the value it's going to have at resale and the length of time it's going to take to find a buyer -- if you do, in fact, plan on reselling immediately instead of holding it to rent out or live in. It's also important to know if there are liens on the property.

Adding to the complexity of the investment are the various state and county foreclosure laws and regulations throughout the country.

"This is hard work," said Daryl White, a foreclosure investor in Valencia, Calif., near Los Angeles. "Forget about 'If I can do it, you can do it' " lines from television infomercials, he added.

White uses a spreadsheet to figure the costs associated with investing in a particular property.

When his analysis is complete, he can decide what to pay for the property. The goal, he said, is to buy at 30 percent below the after-repaired market value. Half of the discount allows him to cover such expenses as holding costs and repairs, while the other half earns him a profit. The formula is taught through Foreclosures.com, a foreclosure listing service.

In the "changing market" White is in, he has to factor in that houses are taking three to five months to sell, which adds to his holding costs, he said. But even in a cooling market, a home that is priced right will sell, said Alexis McGee, president of Foreclosures.com. It's important, she said, to pay careful attention to prices of comparable houses that are selling in a particular neighborhood, to get an idea of what return an investment can bring.

Many successful real estate investors also recommend against depending on a strong market for a good return, Jenks said. "Most of the really good investors will tell you, never rely on appreciation to make a deal work."

There are a couple of key reasons for the increase in foreclosures, said Sharga, whose Web site also lists homes in foreclosure.

First, a slower housing market has stretched out the time it takes for a home to sell, making it tougher for families who must sell to strike a deal in time to avoid the foreclosure process, he said. Also at play is the rise in interest rates on adjustable-rate mortgages, at times squeezing "people who have overextended themselves in the first place."

White said he often battles a negative image because people "don't see the white knight part of it," when, in fact, the sale of a pre-foreclosure home could help homeowners keep negative marks off their credit histories and get at any remaining equity.

Anderson said his first thought is to try to find a way to keep the homeowner in the house. If a sale must take place, he recommends that the seller have fair representation before proceeding -- to ensure the owner gets a fair deal.