BUSINESS
04/15/2011 08:04 am ET Updated Jun 10, 2011

Foreclosure Investors Flip Homes, Reap Rewards

Mary Jane McGraw knew her foreclosure ordeal was over when a man showed up on her doorstep and told her that her home in Oak Park, Calif., had been sold. She had a month to leave.

McGraw, 66, hadn't been able to make a mortgage payment for a year but remained in her house regardless, fighting for a modification. Then in March, she said, the man arrived. "He said, 'I represent the investors who have purchased your home,'" said McGraw. According to a deed later sent to McGraw, the house had been bought by a California-based couple.

The strange visit from an investor liaison notwithstanding, McGraw's home represented one of millions of foreclosure properties on the market. Despite the risks of buying into a sagging housing market, a small group of investors eye such real estate with cash in hand. And some want a quick flip.

Foreclosure sales represented 26 percent of all U.S. residential property purchases in 2010, down from 29 percent in 2009, the year housing prices were thought to have hit bottom, according to foreclosure monitor RealtyTrac.

While some buy foreclosed homes so they can rent to tenants, others invest in everything from extensive renovations to cosmetic repairs before re-selling the houses for a profit.

"Investors in today’s market tend to be a little more experienced than the ones in the boom, and in a lot of cases sat out the boom because they thought prices were unsustainably high. It turns out they were right," said Rick Sharga, senior vice president at RealtyTrac. "Now that prices have fallen, they can go out and buy these bargains, and they're not dependent on lenders to make that a possibility, which is good because loans are notoriously hard to come by."

Almost 60 percent of people who bought property as an investment last year paid in cash, said Walt Molony, spokesman for the National Association of Realtors. "We discovered investors are definitely going for lower-priced properties," he added. "The median price of an investment home was $94,000 in 2010, down 10.5 percent from $105,000 in 2009."

Foreclosure homes are almost 30 percent cheaper than the average price of properties not being seized by banks, according to RealtyTrac.

Such steep discounts mean some investors can make a profit while adding little value to the property. "There's a little bit of flipping going on, too," said Sharga. “They'll buy a property at deep, deep discounts; the investors will do some cosmetic work on it and sell it off to another investor at a lesser discount.”

Such depressed prices allowed one subsection of the market to make money from the glut of cheap property without even purchasing any homes. These flippers claimed to simply transfer the property from the foreclosed homeowner to another buyer while increasing the price -- sometimes by tens of thousands of dollars -- in the process. See how it works in this video:

In 2007, McGraw had refinanced the mortgage on her Oak Park property, a 4-bedroom home she bought with a friend for $56,000 in 1976. She had planned to switch to a reverse mortgage in 2009, when she turned 65 and her work-related disability pay ran out.

But McGraw's birthday arrived well into the housing crash. When her work-related disability pay lapsed, she couldn't make her mortgage payments.

She applied for a modification under the Obama administration's pilloried Home Affordable Modification Program. She also waited for the results of a state lawsuit against Wells Fargo for customers who, like her, were given adjustable-rate "pick-a-payment" loans without being told their debt could actually increase.

McGraw was told she didn't qualify for either reprieve, and bank foreclosure proceedings kicked in. She was one of millions who lost their homes in 2010, when banks seized more than 1 million properties. Limited by her fixed income, McGraw plans to move into the recreational vehicle currently parked in her front yard.

"There's no place for me to go for $1400 a month," she said. "So come the end of the month, it's me, the cat and the dog in the RV," she said.

Ralph Norton, the man who appeared on McGraw's doorstep, said he helps investors buy, renovate and sell houses in foreclosure. Norton said the investors he represented planned to spend up to $50,000 renovating McGraw's house before putting it back on the market. "I want a higher price, so it's going to have granite counter tops and new cabinets," Norton said. "It's going to be so nice, the neighbors will be baking me cookies."

Norton said, however, that fluctuating property prices meant the money spent on renovations could be almost wiped out by a drop in the local market. "It's happened to me three times in the last year," he said.

Unlike Norton's clients' plan to sell, most foreclosure investors hold on to the properties as the rental market soars, said Sharga at RealtyTrac. Apartment vacancy rates fell to almost zero in 2010, and rents steadily increased as people started looking for somewhere permanent to live again.

These investors could help the housing market recover, Sharga argued. "If you can enable someone who's interested in buying 20, 30, 40 properties a year to do so, that gets you through this backlog of distressed inventory a whole lot faster than trying to sell these homes one at a time," he said.