Smart Ways To Profit From Foreclosures

With 700,000 bank-owned homes on the market, and another one million in some state of foreclosure, according to RealtyTrac, an Irvine, Calif., provider of foreclosure listings, you might be tempted to add a distressed property to your portfolio.

Beware. Buying a home in foreclosure is not for the meek. Those with an appetite for risk, however, will find the tumultuous market stocked with plenty of investment opportunities.

These may include the sale of brand new luxury homes in an upscale Nashville community for half their marked value or a bank giving away a foreclosed property in a poor Detroit neighborhood for back maintenance.

In Depth: Smart Ways To Profit From Foreclosures

But this complex arena is teeming with professionals. Private equity juggernaut Blackstone Group (nyse: BX - news - people ) alone this year raised an $11 billion war chest to chase distressed properties, and large homebuilders looking to recapitalize, like Centex (nyse: CTX - news - people ) and Lennar (nyse: LEN - news - people ), unloaded over $1.5 billion in homes to vulture funds between December 2007 and April 2008, for between 30 and 40 cents on the dollar.

Whether you're looking to flip a home, buy into a neighborhood you couldn't otherwise afford or planning to rent the home, you, like these big companies, must have heaps of cash on hand.

There are properties that can be turned within a few months, but the overall market is still slow. Even if you have a renter lined up or have enough money for a 10% to 20% down payment, you should be ready to weather a depressed market for another two or three years.

Go to the county assessor's office and study recent sales for price-per-square foot and time spent on market to determine what sort of price you can expect at resale. Be conservative. If you are renting, calculate a capitalization rate, and subtract 10% or more of the annual yield for maintenance and depreciation. Make sure that your endeavor is still profitable if you incur two to three years of carrying costs and depreciation.

It's also crucial to remember that bad loans that plagued speculators and unprepared borrowers don't simply disappear when distressed owners sell their properties. Unless the property goes through foreclosure auction and becomes bank-owned, outstanding liens and fees are simply transferred to the new owner. If you plan to buy out of pre-foreclosure, make sure the property has a clean title; otherwise you'll just be trading places with the distressed homeowner.

In such situations, outstanding fees, second liens and the like aren't automatically washed away. It isn't always the case that pre-foreclosure homes lack clear title, but once a home goes into the auction on the courthouse steps and is bought back by the bank, it is clear of all the bad loans that got the original owner into trouble. Making sure a home has clean title is a critical first step to a sound investment.

Click here to see how one buyer is turning foreclosed properties into cash.

It's also important to note that you make money on a foreclosure the moment you buy the home. You can make a good return if you're selling in a sinking market, for example, by unloading a home at 70 cents on the dollar, if you bought it for 50 cents on the dollar. In heavily hit foreclosure areas, banks are juggling so many properties that offers on distressed homes, out-of-business homebuilders' developments and excess inventory are being entertained at under-listing prices.

What's housing like in your neighborhood? Weigh in. Post your thoughts in the Readers Comment section below.

Just don't get attached. As in any market, falling in love with a home--and overpaying--is a surefire way to lose money in a highly risky one.

When you've located an appealing property, order a new appraisal and study foreclosure patterns in the neighborhood. You'll also want to explore creative financing options to defer costs.

However you do the math, the most important thing to keep in mind is that the investment has to be worthwhile--even if you can't sell the home at your desired price for two or three years and the current housing market deteriorates a further 10% to 20%.

If that's a model you can live with, it might be time for a subscription to a foreclosure listing service.

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The secret of Bill Gates' success

By Charles Miller
BBC Money Programme

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From schoolboy to software titan, Bill Gates on how it all started

As Bill Gates prepares to end his full-time work at Microsoft, he tells the BBC in an interview that it wasn't just what Microsoft did, but what his rivals didn't do that let Microsoft get ahead.

"Most of our competitors were very poorly run," he tells Fiona Bruce, for The Money Programme.

"They did not understand how to bring in people with business experience and people with engineering experience and put them together. They did not understand how to go around the world."

Sir Alan Sugar, one of Britain's computer pioneers with his Amstrad range, testifies to Microsoft's global mobility even as a comparatively small company in the 1980s.

Amstrad, in Brentwood, Essex, was visited by a Microsoft salesman - or "mid-Atlantic smoothie" as Sir Alan describes him - who came to sell Microsoft's MS-DOS operating system.

Bill Gates explains how internet fever changed Microsoft in the 1990s

Sir Alan declined, telling the salesman he was quite happy with the rival DR-DOS system from Digital Research for his new computer, explaining that "we're a consumer electronics manufacturer here, we're not a bunch of geeks, we don't give a sh**".

But the Microsoft man wouldn't take no for an answer, and "was constantly coming back each day" to the Amstrad offices, Sir Alan says, until a deal was done.

Long game

Sir Alan believes he got the better of it, buying MS-DOS for a pittance, a figure he's legally unable to disclose to this day according to the contract he signed with Microsoft.

From Mr Gates' point of view, it was all part of the long game.

Getting MS-DOS out there was more important than the price of any particular deal.

Debates about Microsoft's tactics to win dominance of the software industry have been stuck in entrenched positions for years.

On the one side are Microsoft's competitors, along with some government regulators and courts, arguing that the company has benefited from strong-arm, even illegal practices.

On the other, Mr Gates and his colleagues insist their only purpose in life is to make "great software" and that if customers don't like it, they wouldn't choose it.

The interview with Mr Gates adds a new dimension to the debate.

Steve Wozniak co-founder of Apple Computer on how it all began

"Most of our competitors were one-product wonders," he says.

"They would do their one product, but never get their engineering sorted out.

"They did not think about software in this broad way. They did not think about tools or efficiency. They would therefore do one product, but would not renew it to get it to the next generation."

Self-serving claims?

Doug Klunder, a former Microsoft staffer, and the lead programmer for Microsoft's Excel spreadsheet agrees.

"People forget that what really launched Microsoft was [the programming language] Basic," he says.

"And then they made the transition to DOS, and then to applications and then to Windows, and managed to do all of those successfully."

Klunder says it was Mr Gates' ability to understand the business as well as the technical side that gave Microsoft the edge.

On the other side of the argument is Mitch Kapor, founder of the Lotus Corporation.

Lotus was at one time bigger than Microsoft, thanks to the success of its 1-2-3 spreadsheet software.

Mr Kapor pulls no punches in his criticisms of Microsoft.

"Claims by Microsoft that people were buying the software because it was good are pretty self-serving," he says.

"I'd like to smoke what he was smoking."

Intermediary

Mr Kapor claims that Microsoft "took advantage" of its position in controlling the operating system to make life hard for independent software developers like Lotus.

Microsoft's challenges in the age of the internet

When these criticisms are put to Mr Gates, he says he finds it "ironic" that he could be accused of such a thing when Microsoft had "evangelised" its software to other companies, begging them "please write software for our platform".

And when the criticism is attributed to Mr Kapor, Mr Gates says that he had personally visited Lotus "so many times" to plead with the company to adapt 1-2-3 to work on Windows.

In a sense, it is possible for both sides of the argument to be right.

On the one hand, Microsoft did hold the fate of other software companies in its hands.

When it decided to develop Windows, smaller companies had to fall in line with Microsoft's plans, or risk disaster.

But it is also true that because of the success of Microsoft software, its operating system became the intermediary between one industry, of application developers, and another, the computer manufacturers.

Slow response?

Heidi Roizen is a software entrepreneur who became a friend of Mr Gates.

She says of Microsoft that "because they were the operating system, everyone else in the industry had to deal with them".

Stepping into Bill Gates' shoes, by Microsoft's Ray Ozzie

Microsoft's clout was, by this argument, unavoidable.

Mr Gates himself attributes the success of Microsoft's own applications in 1995 - providing a second great profit centre alongside the operating systems business - to the tardiness of other companies in shipping products ready for Windows.

"We tried to get everyone who did productivity software to come along and support Windows," he says.

"But they were quite slow, so our own Windows applications, Word, Excel, were doing incredibly well."

'Conservative approach'

Others will say it wasn't as simple as that.

But there is a final essential element in the Microsoft formula, which is indisputable: its use of massive cash mountains to insulate itself against the vagaries of the market or the failure of a particular product.

Mr Gates describes this as his "conservative balance sheet approach".

In the early days, Mr Gates explains, he needed money in the bank to provide security for the families of his first dozen employees, most of whom had shown enough faith in him to move to Albuquerque, New Mexico, the location of Microsoft's first office.

But as the company expanded he wanted "great financial strength so we would have the flexibility to do software in the new way, or whatever we wanted to do".

Mr Gates is proud to claim "we are very conservative", and points out that "even today, if you look at the Microsoft balance sheet, you will see that we keep quite a bit of cash on hand".

Well, yes, more than $25bn should be enough for a good few rainy days.

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The Smaller the Better, Automakers Are Finding

DETROIT — The demand for fuel-efficient small cars and hybrids is so fierce that automakers cannot produce them fast enough.

Limited supply of some of the hottest models is taking its toll on an industry that has already suffered a 14 percent drop in unit sales in the United States this year.

Analysts say that June sales are coming in at the lowest monthly rate in at least 15 years, partly because manufacturers have been unable to satisfy the surging demand for compact cars and hybrid models.

Sales for the month so far are equal to an annualized selling rate of 12.5 million vehicles, according to the market research firm J. D. Power & Associates.

“It’s abysmally low, the lowest we have seen in a long time,” said Tom Libby, J. D. Power’s chief industry analyst. “And the inventories of small cars are hurting sales, no doubt about it.”

With gasoline prices topping $4 a gallon, consumers are overwhelming dealerships with demand for the littlest vehicles in the showroom.

Mr. Libby said that the tiny Honda Fit is on a dealer’s lot an average of 11 days before it is sold, half the time of traditional quick sellers like the Cadillac CTS and Mercedes-Benz C300 luxury sedans.

“These are amazingly low numbers for a car of this type,” he said. “If gas prices stay where they are, I think we’ll see this for quite a while.”

Hybrids are even more difficult to buy. Four of the 10 fastest-selling vehicles are hybrids, led by the Toyota Prius, which sells within four days of arriving at the dealer, according to J. D. Power. The average time to sale for the industry in June, by comparison, is 57 days.

But while inventories are low, manufacturers cannot move quickly enough to increase production of popular small cars like the Toyota Corolla, Honda Civic and Ford Focus.

Ford Motor Company, for example is running its Wayne, Mich., assembly plant on overtime and Saturdays in an effort to meet demand for the Focus.

General Motors had planned to add a third shift in September to its small-car plant in Ohio, but recently moved the start date up to August.

A Toyota spokesman said the Japanese automaker was limited by production to selling 175,000 Priuses in the United States this year, no matter how hot the demand.

Honda Motor will open a new plant in Indiana late this year that will increase its output of Civics by 200,000 a year. The automaker has already increased production of the car at factories in Ohio and Canada.

“Even though we’ve got more vehicles in the pipeline than ever before, we didn’t expect to sell 53,000 Civics in May,” said a Honda spokesman, Edward K. Miller.

Dealers say that sales have been constrained based on availability. “Most of the Civics and hybrids are coming in already sold,” said John Rooney, the new-car sales manager at Pearson Honda in Richmond, Va. “Generally, right now people are waiting a couple of weeks or a couple of months for these vehicles.”

Honda has doubled its allocation of Fit subcompacts for the American market to about 80,000 vehicles a year, Mr. Miller said.

Still, consumers are finding the supply tight. Bob DiGiacomo, a schoolteacher in Fogelsville, Pa., put down a deposit on a Fit four weeks before the model he wanted became available. To get it, he drove 90 minutes to a dealership in Philadelphia.

“Gas mileage was a big factor for us buying the Fit,” he said. “The money I’ll save on gas in a year will pay for insurance on the car.”

Auto executives have been startled by the rapid shift this year by consumers from bigger vehicles like pickups and S.U.V.’s into small cars and lightweight crossovers.

Small cars now account for more one in five vehicles sold, and the numbers are rising. Less than a decade ago, the percentage was one in eight.

While some automakers — Honda, for example — have flexible plants that can shift productions from minivans or crossovers to cars, the factories of Detroit automakers are limited to specific models.

So while Ford has shut down its big S.U.V. plant in Wayne, Mich., for nine weeks because those vehicles are not selling, its nearby Focus plant is running extra hours.

“This seismic shift in the marketplace has definitely taken us and everybody else by surprise,” said George Pipas, Ford’s market analyst.

Mr. Pipas said that Ford currently has a 20-day supply of Focuses nationwide, well below the 60-day supply that is considered the industry norm.

The automaker, based in Dearborn, Mich., is drafting a major overhaul of its manufacturing plans in North America to address the shift to smaller cars.

But for now, it has a red-hot product in the Focus, and not enough production to meet demand.

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