Are distressed homes worth it? (© Image Source/SuperStock)

Homebuyers are finding that the battered real-estate market offers just as many opportunities for headaches as for bargains.

Seth Grotzke and his wife, Crystal, both 25, recently bought a bank-owned two-bedroom, two-bathroom town house in Edina, Minn., for $110,000 — when similar homes in the same development were selling for as much as $131,000. But exactly one day before the scheduled July closing, the Grotzkes learned there was a second, unpaid mortgage. Because of the foul-up, the couple was forced to live in Grotzke's boss's basement for more than a month. They finally closed on Aug. 31.

"We knew there would be title issues, but none that would last for that long," says Grotzke, an assistant pastor. He adds that buying a foreclosed property is a way for God to "teach you patience."

Lots of homebuyers are learning about patience these days. In August, nearly a third of overall housing sales were distress sales, according to the National Association of Realtors. That was up from 18% in March 2008, when the association began tracking such sales. The figure includes both foreclosures and so-called short sales, in which the lender agrees to accept less than the full balance of a mortgage in order to unload the property.

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In some parts of the country, such as Bakersfield, Calif., Las Vegas and Lakeland, Fla., distressed properties constitute half or more of all sales. So far this year, there have been nearly 411,000 sales of U.S. properties in some stage of foreclosure, according to RealtyTrac, which publishes a national database of homes in default, auctions and bank-owned homes.

Those numbers aren't making it any easier to buy distressed property. Bidding wars are erupting for the lowest-priced foreclosures. Experienced investors with cash are elbowing aside first-time buyers who need mortgages. And banks generally sell property "as is," without the defect disclosures that are required of other owners. Short-sale buyers, for their part, often face delays of weeks or months as they wait to hear back from lenders — and from the institutional investors who bought securities based on the mortgages.

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Bing: Search & decide

Vandalized properties
Distressed-property buyers also often have to cope with the fallout from the ruined lives of previous owners, such as vandalized properties and liens from second mortgages, taxes, unpaid water bills, homeowner-association dues and court judgments. For all that, final sale prices often aren't significantly lower than average in some areas, because the foreclosure glut has also driven down prices for sellers who aren't in default.

Buyers have to be thoroughly prepared by securing financing in advance and making sure they have a strong stomach, experts say. They should seek out agents with extensive experience and training in distressed property, because the transactions are often complicated and time-consuming. Pushing and prodding bank officials, loan servicers and others is a big part of the job.

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Colin and Alisabeth Shearn of Cherry Hills Village, Colo., a Denver suburb, managed to snag a seven-bedroom Mediterranean-style house in a short sale for $1.27 million -- more than $900,000 below its original listing price in 2007. By the time they bid on the house last February, it had gone unsold for nearly two years and the price had been reduced to $1.5 million from $2.2 million. The couple closed on the purchase at the end of May, and moved in with their two preschool-age children.

"It was nerve-racking," says Colin Shearn, 41, a university research scientist. There was a long delay hearing back from the seller's bank, and the last-minute discovery of a lien from an unpaid water bill — the water was about to be shut off.

But in the end, Shearn says he and his wife, 42, a co-owner of a software company, were happy. "We really lucked out to find this house."

Short sales like the Shearns' are particularly complicated. Lenders require detailed information about both buyers' and sellers' finances, and sellers generally have to prove hardship. The entire package of documents is scrutinized not just by lenders but by the mortgage investors. Second- and third-lien holders frequently hold up transactions, demanding a larger share of the settlement. The average transaction takes four to six months or more, agents say.

Read:  6 rules for buying foreclosures online

Lenders say they are stepping up their efforts to handle short sales. JP Morgan Chase has doubled the number of employees handling such sales, while Bank of America recently began allowing real-estate agents to submit short-sale documents online, reducing the chances that a sale will be stalled. At Wells Fargo, efforts to speed up short sales helped produce a 145% increase in these transactions in August, compared with the same month a year earlier, the bank says. Meanwhile, the NAR and other groups have recently launched short-sale and foreclosure certification programs for agents.

House Rules
Thinking of buying a distressed property? It's very different from a standard real-estate transaction. Here are some pointers:

  • Distressed-property listings can be obtained from local real-estate agents, classified ads and Web sites such as RealtyTrac.com,Foreclosure.com,Trulia.com and Zillow.com, as well as bank Web sites.
  • Work with experienced real-estate agents and brokers with special training in foreclosures and short sales.
  • Get pre-approved by a lender, or certify that you have sufficient cash available, before bidding on properties. Auction buyers must be prepared to put down a cash deposit of 5% to 10% cash and pay the balance within 30 days in many states  — and in some states, on the same day.
  • Get a thorough inspection by a qualified professional inspector or home-inspection engineer prior to auction or sale.
  • Arrange for a thorough title search and title insurance.
  • Be prepared for a long wait to hear back from the bank on a short sale, but be prepared to move quickly on a foreclosure; banks often set strict timetables on foreclosures.
  • First-time buyers with minimal cash and little time or aptitude for repairs probably should avoid foreclosures, and inexperienced purchasers should avoid auctions.

Sources: RealtyTrac.com; Distressed Property Institute; Department of Housing and Urban Development;WSJ research

New guidelines
The Treasury Department is expected to issue streamlined guidelines to lenders on short sales soon. Housing-industry leaders say complicated procedures are hindering them from clearing the large inventory of distressed property, which is necessary to return the housing market to normal. Now, only about 20% or so of short sales are successful, according to real-estate brokerage Re/Max International.

Buying a foreclosure is usually speedier than a short sale because lenders already possess the property. But there are other drawbacks. State laws vary considerably with respect to legal procedures surrounding foreclosures. Many states require judicial proceedings for foreclosing on a home that can take more than 12 months, during which time the home may be vacant or occupied by tenants or squatters. Appliances, pipes and even electrical wiring may be ripped out of the home.

What's your home worth?

Buyers of bank-owned properties are usually stuck with whatever hidden problems they discover, including construction defects, and they seldom get additional price concessions. For these reasons, it's especially important for distressed-property buyers to have a thorough inspection by a qualified home inspector or inspection engineer, as well as a thorough title search and title insurance.

Despite the hurdles, competition for foreclosures under $300,000 is keen, sources say. "The bargain hunters have come out from everywhere, and they are getting into bidding wars," says Re/Max Chairman Dave Liniger.

Buyers must be prepared and ready to move on a dime. If they're paying cash, they have to certify they have the money available. Those who need financing should obtain pre-approval from a lender before even looking at properties.

Successful foreclosure buyers often bid significantly above the asking price. Chuck Brueske, 46, a hospital biomedical technician, says he paid $111,000 in August to win a bank-owned town house built in 1981 in Maple Grove, Minn., listed at $99,600.

Brueske says his good credit history helped him win over two other bidders.

"It was unusual that in a down, depressed market that I had to bid more than the asking price, but as it turned out the other bids were higher than mine," he says. "It took me a while to swallow that."

Some homebuyers give up after discovering there are bargain properties without all the obstacles. Jerrold Horning, 34, an electronics technician for the U.S. government in El Cajon, Calif., says he and his wife bought a house in the conventional market after seeing the condition many houses were in.

"Some of the foreclosures I looked at were horribly trashed. You would have to put another $100,000 in just to make it livable," he says. Of buying a distressed property for a primary home, he says, "I don't think it's worth the hassles."