A friend and business associate who is looking into real estate investing (for rentals) asked me question about homes up for auction and what I thought of them (i.e. homes with a starting bid of $50K yet an appraised value of $250K). I thought I might share my email response with the world (keep in mind real estate is local; these comments are about the DFW area/market):
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I believe that homes up for auction can be a high-risk/high-reward proposition (especially high-risk for the novice real estate investor). [I was asked about doing the inspection before bidding] Inspection rules (i.e. when they are allowed) are dependant on the auction house, so we would have to check with each one (not just on when you can inspect them, but on who pays for utility connection & service). I'm not a big fan of auctions because (in most novice investor's cases) you have to outlay money for an inspection with no guarantee of getting the home. If the inspection results show the home is horrible, like a traditional purchase, you probably don't want it and have already wasted your time and money (as is often the case with auction & floreclosed homes). If the inspection results are moderately clean, the home will probably sell at auction for much higher than you had hoped... only there is no guarantee that you'll get it (in which case, again, you wasted time and money on the inspection). Most of the hard-core investor-buyers are doing inspections themselves on these homes (costing them nothing but their time). However, I've seen it cost them plenty more as things were missed (depends how good at inspecting they are [and if they do a more formal inspetion later]). The biggest difference is when you buy a home through traditional means (i.e. not at auction), you lock the property up for very small amount (usually <$100) with a contract before you spend anything on an inspection (and the Seller turns on/pays for the utilities).
That brings up one of the things I wanted to discuss in-person, but now's as good a time as any: How much work are you two are looking for?
If the answer is "lots" (i.e. we're going to live, eat & sleep there while making most of the repairs ourselves; hiring out only the "biggies" like foundation repair & roofing) then there can be significant "Sweat equity" found in homes in need of lots of repairs (as is often the case with auction homes). However, if you plan to hire the work out, then there is generally not much (if any) equity left after the bills are paid. Of course, hard-core investor-buyers put together crews that can do the work for less (because they are going to be doing work on multiple properties for the investor). This can quickly become a full-time job though...
If you're just looking for homes in need of "a little" work (i.e. paint, carpet, a little sheet-rock, etc.) you should know that these homes tend to sell for much more. The free-market tends to adjust for condition pretty well (i.e. better conition = better price) [in a market that is flooded with more homes than DFW, you may find better prices]. Again, if you do the work yourself, you might have a little extra equity. If you hire it out, I've seen it cost more than what little extra equity was supposedly in a "deal" of a home.
In closing, I'll say that I think an auction is a fine place to find deals if you're very risk tolerant (i.e. it can be a fine place to lose your shirt; so as long as you can afford to buy more shirts and try again [you'll probably be ok]...). I prefer the more traditional method of finding a fair deal on a home that is in good condition and in an area that will rent well and provide income for years to come. The idea is to pay it off and cash-flow. I think too many people fall into the trap of looking for a "deal" only to find that the price-tag to repair it, and the time it sits vacant, cost them far more than if they just bought something that was in good shape to start (unless you're talking about fixing & flipping houses, a whole other topic). Remember, our market is not that bad here. So, there aren't tons of wonderful homes selling dirt cheap like the media might have you believe. Maybe in CA, NV or FL (where home prices were severely over-inflated before), but no so much in TX (where our prices have been stable). Typically, if a home is cheap [here in DFW], there's a reason for it... and unless our market becomes much worse, the reason is almost always the home's location or condition. Hope that helps.
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Ryan Cave, The "Caveman"
Truth, Honor & Personal Integrity
214-789-9366
www.CaveRealty.com