This month's topic is high-risk behavior. Insurance guys use that term for jumping out of airplanes, racing motorcycles, or teasing the bulls in Pamplona. For the financial set, buying junk bonds and playing commodity futures are the equivalent adrenalin rushes. There's another hot fad that a lot of people seem to be getting into these days, but not all of them realize it's high-risk: Buying foreclosures.
Michigan is seeing a record number of mortgages going into foreclosure. Ten years ago, I could go months without seeing a "distressed" property sale. In the last year or so, I have inspected at least one per week.
Home inspectors (and knowledgeable buyers) know that owning any real estate involves a certain amount of risk. Hiring a good inspector reduces the risk by a huge margin, but can never eliminate all of it. What is it about foreclosed homes that creates so many nasty surprises?
Most homes that are sold this way are vacant, with the utilities off. Agents and buyers sometimes try to get the gas, power and water turned back on for inspection purposes, but often this isn't possible. The last occupants probably left owing large bills to the utility companies, and those companies aren't going to restore service until they get paid. Let's look at the effects of leaving a home several months without utility services.
Things will freeze that weren't designed to freeze. Even if the plumbing has been "winterized", there is still a chance that supply pipes, drainage pipes or fixtures have been split open by ice. With no water pressure for testing, the inspector can't always find this damage. Even if all the visible pipe is carefully examined, the pipes inside the walls and floors are uninspectable. The new owners won't know exactly how bad the problem is until they have taken posession and gotten service restored.
With no power in the house, sump pumps quit running. This often leaves water on the basement floor, which leads to a whole list of consequences. For instance, the buyer won't be able to tell if the water is from the immediate sump failure, or from a long-standing (and more expensive) basement leak.
Oddly enough, this water on the basement floor may not freeze. The soil at that level is near 52 degrees all the time, and the floor slab will conduct this heat to the standing water. Some of the water will then evaporate into the air of the basement, raising the relative humidity to near 100%. The upstairs atir temp may still be way below freezing. As you've heard me say before, water vapor always moves to the coldest surface, so in winter the humidity condenses on the ceiling of the basement, which is the underside of the main floor. What do we have now? A perfect growth medium for mold. When a couple of sunny days warm up the house a bit, the mold growth will take off wildly. This kind of mold clean-up is usually beyond the capabilities of the home handyman, and needs the men-in-space-suits approach. Very expensive.
When a house is in use, its indoor climate is fairly steady. In a vacant unheated house, humidity and temperature will fluctuate across a wider scale, causing building materials to grow and shrink much more than normal. Plaster will crack, woodwork will warp, paint will peel, doors and windows will jam. The house may undergo 20 years of "normal" age-related deterioration in a few months.
Beyond the hazards of weather, there are the human elements to consider. Sellers in normal transactions have an incentive to leave the house in decent condition. After all, they may be facing the buyer across a closing table. Besides, they are probably moving to a better house, a better job, a better place, and are in a pretty positive mood. Now think about how folks feel when moving out of a house that they've lost to foreclosure. Depressed. Angry. Vengeful. Certainly not feeling any empathy for future owners. "The *#!@bank may be getting the house, but I installed that dishwasher myself, and I'm not leaving it for them!" So, out comes the dishwasher, or the water heater, or even the furnace. And all the light fixtures, and maybe even the bathroom sinks. Any collateral damage that's done during removal is "not my problem any more!" Yes, they're called "distressed properties" for good reasons.
So who are the buyers? Traditionally, such homes were bought by professional investors. These are folks who have owned dozens or hundreds of properties. They have the experience to understand the risks, the network to get repairs done cheaply, and the financial padding to take a loss if they get burned. Importantly, they have the emotional detachment to walk away if it starts looking like a bad deal. When presented with uncertainty, like that water on the basement floor for instance, a wise investor assumes the worst and builds it into his offer. If the offer is rejected, it's not a disaster; for an investor, there's always another deal around the corner.
Lately, though, we're seeing young, first-time buyers making offers on distressed homes. They are stretching their wallets just to get the house, have very little cash left for repairs, and no cushion for nasty surprises down the road. The emotional commitment ("Oh, I love that house, let's get it!") is in full force even before the inspection. Folks in that state are likely to assume the best of any uncertainties, and can be devastated, financially and emotionally, if things turn sour later on. Is this another foreclosure waiting to happen?
There's another group of folks who are using their 401k funds to get into distressed real estate investing. I'm no investment counselor, but I do know houses. If you're comfortable with this risk level for your retirement funds, I won't try to talk you out of it. But I will leave you with this advice:
Once the house is fixed up and back on an active market, or rented to solid tenants, it's a blue-chip item. But up till then, it's more like a crap game. So...
Gamble what you can afford to lose.
Minimize your risk by using a really good inspector.
Know when to walk away. Know when to run.
Good Luck, and Think Spring !
Matt
This newsletter is a 2-way street. If you have any questions or concerns, please use this e-mail link to let us know.
Presented by Sherlock Homes Inspection, Ltd. Copyright 2006 Matthew J. Bezanson
http://www.inspectmichigan.com