Foreclosure 101: mechanics of a trustee sale

Why Trustee Sales?

Most buy at Trustee Sales to make or save money. When compared to resale properties, Trustee Sales are generally discounted between 10% and 20% and sometimes the discounts are even greater. The first post in this series featured a property being flipped for a 25% gain, a significant profit for taking risks and trapping cash for a few months. However, flipping for profit is not the only reason to consider this market.make_a_deal

My disdain for flippers is apparent, but my ire is not spread evenly. Flippers who buy at auction provide necessary liquidity in a market isolated from lender financing, and flippers who renovate properties (even with pergraniteel) add tangible value; however, the flippers who annoy me are the ones who trade stucco boxes without making improvements or adding value as they merely drive up prices for families.

The problem is “how can families take advantage of this situation and save the flipper profit?” Families who have enough cash to purchase a property without financing at a Trustee Sale are missing a major opportunity to either (1) save money, or (2) buy from inventory unavailable to financed buyers. It isn’t always about the discount as simply having “first dibs” is big advantage, the fact that it is discounted to resale is a bonus.

So why don’t more buyers purchase at Trustee Sales?

Trustee Sale Risks and Limitations

The purchase of real estate at a Trustee Sale is inherently more speculative, complicated, and risky than purchase by conventional means. The above-average risk is due to such considerations as potential title problems, the possibility of unknown liens, unpaid property taxes, delayed holding periods, unknown property condition prior to purchase, potential acts of vandalism, unforeseen governmental intervention, etc. Overcoming these obstacles requires a major investment of time and brainpower making Trustee Sales suitable for buyers who can invest the time and effort and who will not be economically devastated should they lose their entire investment. The major risks and limitations are as follows:

Cash Only: Trustee Sales allow cash bids only — Buyers will need to bring cashier’s checks for the full amount of the purchase to the sale.

Selection: A property fitting a Buyer’s property parameters and price range may not be scheduled for a Trustee Sale in a reasonable time.

No Inspection: Buyer will not be able to view the inside of the property prior to the sale unless the property is actively listed in the Multiple Listing Service, or in the unusual case where the current owner allows access. The property is acquired “as is” which may include undetectable physical damage.

No Insurance: Buyers can’t purchase title insurance at the sale and protect against unrecorded mechanic’s liens or judgment liens against the owner. This is rare, but it does happen, and the buyer is liable for these claims against the property.

No Remorse: The Sale is final – there is no recourse for buyers with remorse.

Unannounced Postponements and Late Cancellations: Most Trustee Sales are postponed at least once, and many are postponed numerous times, sometimes for a period of several weeks or months. If the Sale is postponed, the postponement may not be announced until buyer attends the scheduled sale, unused cashier’s checks in hand. Some owners are able to sell or refinance their properties at the last minute, cancelling the Trustee Sale altogether.

High Opening Bids: Most or all properties fitting Buyer’s criteria may be over encumbered, and the published opening bids are often higher than the property’s market value. The foreclosing lender has the option of starting the bidding at less than market value, and they may not decide whether or not to do so until the auctioneer begins to call the Sale.

Competition: There will often be competing bidders at the Sale, and some will bid above the property’s market value.

When you think about it, the reason for the price discount is due to the combined effect of the factors listed above; prices need to be under resale to compensate buyers for the risks and unknowns. The more risks and unknowns, the greater the discount.

Trustee Sale Research

Most buyers when considering a Trustee Sale immediately run into a deficit of information. These properties are most often not on the MLS, and without MLS access to find basic information, to pull comps to estimate value or to locate old pictures, buyers have no way to conduct basic property research. This information barrier dissuades all but the most determined.

At a minimum, buyers need to determine the following:

  • Detailed description of Property
  • Property tax information (tax rate, Mello Roos status, etc.)
  • Basic Home Owners Association information, if any
  • Recent market comparable sales
  • Recent comparable foreclosure sales, if any
  • Updated Trustee Sale Status (confirmation of current Sale date, published bid, etc.)

In addition to the basics, most buyers will also want to know:

  • Title -all persons currently vested on title, or previously vested at any time as of or since the acquisition of the Property.
  • Liens – all Trust Deeds and all other liens currently encumbering Property, and an analysis of their effect or standing, if any, at or following the Sale
  • Property Tax Status – total property taxes owed against the property, if any, including current taxes, delinquent taxes, and penalties
  • Final Analysis – an estimate of the total amount that will still be owed on the Property, if any, following purchase at the Sale.

Since it is not possible to get Title Insurance at closing, a buyer is advised to obtain a title report on the property and the owner because judgment liens survive foreclosure. This does not protect the buyer from unrecorded mechanics liens.

The research list is long, and it may take several days, many phone calls, and out-of-pocket costs for title reports and other data. Given the difficulties of doing proper research and ignorance to what research is required, many buyers either take unnecessary risks by failing to do the proper research, or they give up on the idea and go back to shopping in the easier resale market.

Preparing for Trustee Sale

To prepare for a Trustee Sale, a buyer has three important tasks: (1) determine vesting, (2) establish a maximum bid amount, and (3) obtain Cashier’s checks in the amount of the maximum bid. We covered vesting in Foreclosure 101: Vesting Title. The buyer must give this information to the Trustee if a sale is successful.

Trustees like Cashier’s Checks, mostly because the buyer cannot stop payment after the sale. A buyer could attend the sale with a single Cashier’s check and wait for the Trustee to refund the difference. However, with a little effort, it is relatively easy to obtain a number of checks in various increments to cover bid amounts less than the maximum.

The best method for obtaining checks is to decide on your minimum increment and obtain checks starting with the initial increment and doubling in value with each successive check. For instance, a buyer would get Cashier’s checks for $1,000, $2,000, $4,000, $8,000, and so on until the negotiating range is covered, and then one remainder check brings the balance up to the total. The bidder on a $600,000 property who wanted to start bidding at $500,000 would obtain checks for $1,000, $2,000, $4,000, $8,000, $16,000, $32,000, $64,000, and $473,000. Some combination of those checks will cover every $1,000 increment between $473,000 and $600,000 allowing the bidder to leave the Trustee with only the amount of the winning bid.

The Cashier’s checks should be made out to the buyer, not the Trustee. If there is a sale, the buyer merely endorses the checks and gives them to the Trustee. If there is no sale, the buyer can either hold the checks for the next auction or redeposit them. There is no way for the money to be lost or stolen as the buyer is the only one who can cash the checks.

What happens at auction?

At the appointed time and place, a Trustee will call a public auction. The Trustee announces the property and asks the assembled if any wish to bid on the property. One at a time, the Trustee will meet privately with each bidder who must show the Trustee their Cashier’s checks to verify the amount held. The Trustee will not permit any bidder from exceeding the total of the Cashier’s checks on their person — nobody is “good for it.”

Once each bidder has shown the Trustee their money, the Trustee will call out the opening bid from the first mortgage holder. This is a pregnant moment because the advertised opening bids often do not match the actual opening bids, and even after all the preparation, a lender may come in and vastly overpay for the property because their loss mitigation procedures demand it. Lenders who underestimated the amount owed sometimes increase their advertised opening bid, but often, lenders drop their opening bid to avoid obtaining more REO.

Most buyers give up after attending a few postponed auctions. It takes half a day or more away from work or other responsibilities to attend a sale, and most busy people do not have the time. It is possible to go to only one auction and get a dream property at a 25% discount, but the more common scenario is for people to go to half a dozen auctions and obtain nothing.

In today’s market, dropped bids are the opportunities that bring third-parties to auctions. Assuming the first lien holder’s opening bid is less than the maximum price a third-party buyer is willing to pay, the auction begins. In an open outcry system, bidders verbally announce their bids and the Trustee acknowledges the highest bidder. There is no minimum increment to increase a bid, which leads to the rather tedious process of two bidders outbidding one another with small increments until one of them reaches their walkaway point. In fact, one of the major frustrations for many Trustee Buyers is the fact that they often get outbid by a single dollar, such is the nature of auctions.

If a buyer is the highest bidder, the Trustee takes the buyer’s vesting information and Cashier’s checks. In return, the Trustee gives the buyer a receipt at the sale. The buyer does not obtain the Trustee’s Deed at the auction.

Getting the Trustee’s Deed

The Trustee usually mails the Trustee’s Deed to the buyer within days of the sale; however, there is no legal timeframe the Trustee must adhere to. In contrast, the owner has 15 days to record the Trustee’s Deed in order to be considered the owner as of 8:00 AM the day of the Trustee Sale, otherwise ownership begins the day of recordation. The day of legal ownership is important because if a lien appears after the Trustee Sale but before recordation, the buyer can be liable, or at a minimum, have to deal with getting an invalid lien off the title of his new property. It is a rare occurrence, but the problem is best avoided by timely recordation.

Taking Equitable Title (possession)

Taking possession of a vacant house only requires the buyer to show up with a locksmith. If the house is not vacant, taking possession is more complex. The simplest solution is for the buyer to approach the occupants and offer them money to leave: cash for keys. Many holdover tenants, including the previous owners, are happy to get some money to cover the costs of moving out. Obviously, getting occupants to leave voluntarily is better for all concerned.

In situations where the holdover tenants are not cooperative, the new owner will need to employ the services of an eviction attorney to remove the occupants, and there are situations where renters do not have to leave due to local ordinances that protect renters. The rental contract itself is extinguished at the foreclosure sale, so renters cannot stay for the duration of their lease, and the new owner is not required to repay any security deposits. The exception to this is where the lease pre-dates the foreclosing lien – in this case the buyer takes title subject to the terms of the lease.

Is it worth it?

Buying at Trustee Sale is time consuming with (1) property research, (2) attending auctions and (3) following up to take possession, and the sale is fraught with risk, but for those who make the effort, saving what can amount to a year’s salary or more is very tempting, particularly when the resale market is likely to show further weakness. Buying at auction today puts an owner in a property well below rental parity, and likely below the resale bottom.