Phil's Real Estate Blog

You're wise to be thinking about whether any special considerations apply to the purchase and rental of a foreclosed-upon home. First, check the neighborhood to see whether a similar fate has befallen nearby properties. A sad fact of subprime life is that in many areas of the country, whole neighborhoods are awash in foreclosures. Typically, these areas were hastily built by developers eager to take advantage of the seemingly endless appreciation of real estate, and they all came crashing down when the purchasers (and in some cases, the developers) were unable to meet their mortgages or construction loan payments. For hard numbers on the incidence of foreclosure in the area, use the Web site RealtyTrac to check the concentration of foreclosures in a neighborhood. In general, a rental in an area pocked with foreclosures is likely to command less rent when foreclosed properties remain unsold and, more importantly, unoccupied. These forlorn properties are likely to be unmaintained and are targets for vandalism and even squatters. Few tenants will want to join the ranks in such a neighborhood, and those who do will expect the rent to reflect these negative attributes.

A neighborhood of foreclosed homes bodes ill even if they have been purchased and are in relatively good shape. All of these homes aren't going to be occupied by the owners -- many will be rented out, just as yours will be. That makes for a concentration of rentals -- in short, a glut on the market, which will drive prices down. The same property in a different part of town might fetch a higher rent simply because there is less competition.

Next, turn your attention to the house itself and its history. If you're lucky, you can find out who lived there, and whether the occupants were renters or owners (some 40 percent of foreclosed properties were bought as investments, making it likely that you're dealing with a home that has already been a rental).

To learn about the house, start with the neighbors if you can't locate the prior owner. Hopefully, you'll learn that the owners took great pride in their home and left it in good shape. Or, you may hear tales of woe from neighbors who put up with unmonitored and malicious tenants (unsupervised by an owner already demoralized by the property's imminent loss), or maybe even of resident owners who spitefully trashed the home before moving out. Such stories are common, unfortunately. Even if the property was a rental that escaped the wrath of its last occupants, evaluate how much wear and tear the property has suffered; you'll need to take this into consideration when setting your purchase bid.

Clearly, the more you learn about the home, the more realistic your purchase offer can be. If you can spiff up the home with a coat of paint and some landscaping and reasonably offer it at market rates, your post-purchase expenses will be small (and you can afford a higher bid). But if you have to replace copper pipes, sheetrock, flooring and appliances, you're looking at major expenses before you can even place a For Rent sign on the front lawn.

Finally, there is always the possibility that the house you are considering will come with resident tenants who had been renting from the prior owners. Many times, the residents will have left long ago, driven off by the owner's lack of maintenance, or by the foreclosing bank's demand that they vacate (the banks often accelerate the process by offering to pay the tenants to leave, known as "cash for keys"). But sometimes the tenants stick it out and are still there, despite hard-line tactics from the banks (or perhaps thanks to overworked local sheriffs).

In any event, if your home comes with resident tenants, most of the time you will have a choice of whether to keep the tenants. Here's the rule:

• If the tenants have a lease that was signed before the prior owner recorded his mortgage, they will survive the foreclosure; in other words, you have to honor their lease.

• If the tenants have a month-to-month rental agreement or a lease that was signed after the foreclosed-upon mortgage was signed, the foreclosure wiped out their lease or rental agreement, and you can evict them if you choose.

Because most leases are for a year and most mortgages pre-date the current lease, it's likely you'll have the option of asking current tenants to leave or letting them stay. Evaluate these tenants as you would any set of prospects. If they have been paying rent on time (admittedly, it might be hard to get the facts unless you can talk to the prior owner), and have been taking reasonable care of the property, you might decide to keep them and negotiate your own, new lease. But if you sense trouble, you might want to rethink purchasing this property in the first place, let alone buying it and keeping its residents. You don't want to be saddled with tenants whom you would never have rented to in the first place. And if you purchase the property, planning to evict the residents, think twice -- these tenants may refuse to leave, necessitating an expensive and drawn-out eviction, and possibly leaving you with a trashed property. This is hardly the way to begin your new rental business.

Janet Portman is an attorney and managing editor at Nolo. She specializes in landlord/tenant law and is co-author of "Every Landlord's Legal Guide" and "Every Tenant's Legal Guide." She can be reached at janet@inman.com.

Not wanting to be involved in financing "buy and bail" home purchases, the Federal Housing Administration will no longer count rental income when home buyers choose to vacate, rather than sell, their principal residence.

Home buyers seeking to rent out their existing home and buy another with an FHA-backed mortgage must now demonstrate they have sufficient income to pay both mortgages. The FHA won't allow lenders to count rental income for the home being vacated unless borrowers have a 25 percent equity stake or can prove they are relocating for employment and obtain a one-year lease on the home being vacated.

The new rules are intended to prevent the practice known as "buy and bail," where the buyer purchases a more affordable dwelling with the intention to cease making payments on the previous mortgage, FHA said in a letter spelling out the new guidance for lenders.

Because FHA will insure principal residences only, and not income properties, the property being vacated by definition could not have an FHA-insured mortgage. But if the property ended up in foreclosure, it might have an impact on the value of nearby homes with FHA-guaranteed mortgages, the administration said in justifying its actions.

The new rules took effect Sept. 19, and are temporary pending a determination whether a permanent rule change is needed. The rules apply only to a principal residence being vacated in favor of another principal residence, and not to existing rental properties disclosed on the loan application and confirmed by tax returns, FHA said.