While buying a HUD Home can save you a lot of money, there are some things to watch out for. In this article we'll cover the basics of buying a HUD foreclosure home and some tips on getting the lowest price possible.

HUD Homes

HUD Homes are 1 to 4 unit residential properties acquired by HUD as a result of a foreclosure on an FHA-insured mortgage. The condition of HUD foreclosures can vary substantially. I've been in some homes that reminded me of the final scenes from The Silence of the Lambs. Some homes, however, were in near move-in condition. Some HUD Homes were built just a few years ago, while others are 50+ years old. Finding the home that's right for you will take some work, but your willingness to buy a home that needs some repairs and improvements presents an opportunity to buy a home at a big discount.

It's also important to understand that the availability of HUD housing varies from location to location. In the mid-West, for example, there are many homes to choose from because of the price range (FHA only insures mortgages of a certain dollar amount) and number of foreclosures. In other more expensive areas, you are likely to find far fewer available homes. Fortunately, HUD and its property management contractors offer a convenient way to search for homes online.

HUD Homes Online

On the HUD website you'll see in the left sidebar a link to HUD Homes. This page provides links to all fifty states and the District of Columbia. Because HUD contracts out the management of its properties, these links will take you to the website run by the property management company for the state you select. For this article, we'll take a look at Ohio properties, which are managed by National Home Management Solution (NHMS).

Each property management website offers four categories of information you should know about:

1. HUD Home Buyer Information: They provide information on how to buy a HUD Home and on buying your first home. Links to this information typically point back to the HUD website.

2. HUD Home Search: They provide a means to search for homes by city, county and zip code.

While the format of the search results varies from one management company to the next, this screen shot from HUD Homes in Ohio is typical and gives you an idea of the information that is available (click image to enlarge).

From the listing, you can then look at detailed information about each home (click image to enlarge):

From the detail listing you can read an inspection report of the home and details about the home as provided by the management company.

3. HUD Housing Bid Results: Bid results and bid statistics (discussed below) are two critical data points for predicting the minimum bid price HUD will accept for a given home.

It's critical to recognize that the list price for a HUD Home is almost never the price you'll pay. For my investments, I've bought homes for anywhere between 60% and 87% of the list price. Knowing what HUD's minimum acceptable bid is takes a lot of trial and error. I probably bid on 15 HUD Homes to get one. But over time, you learn how low you can bid to get a home.

Bid results show you the amount of winning bids. From this you can compare the list price of the home with the winning bid price.

4. Bid Statistics: Unlike bid results, bid statistics shows you all bids on a property (both the winning bid if any, and all losing bids). Coupled with bid results, bid statistics represents extremely valuable information to study when evaluating a HUD Home.

Owner Occupied HUD Homes

As a buyer who will live in the HUD Home, you get several advantages over investors. First, you get to bid on the home first. When HUD housing is first put up for bid, only bidders who will live in the home can bid on it. In the listing of homes, you'll see the designation "Owner Occupant," which indicates that the home is open for bids only by those who will occupy the property. After about two weeks, if no acceptable bid is made, investors can bid on the property.

Second, HUD provides a number of incentives for owner occupied buyers. These incentives can change, but typically include assistance with closing costs (currently $2,500), ability to borrow more than the cost of the home to fund needed repairs and improvements, and low down payment financing.

Using a realtor

Only licensed real estate agents can submit a bid for a HUD Home. My strong advice is to find a realtor that has a lot of experience buying HUD Homes. There is definitely an art and science to bidding on these foreclosures, and I've seen homeowners bid way too much for a HUD Home due to inexperience. A realtor with experience investing and improving HUD foreclosures would be ideal.

Final Thoughts

I've bought five HUD Homes as real estate investments and the fifth one was just this week. It is a 3 bedroom one bath home for which I paid about $40,000. The list price was $65,000. We estimate that improvements will cost $15,000, and we can either rent the property for about $745 per month or sell it for about $85,000. Either way, it should turn out to be a great investment.

Buying a HUD Home for yourself can be equally rewarding. If you've bought a HUD Home before, share your experience with us. And if you have any questions, just leave a comment or send me an email.

The problems experienced with both stock or property investments are more often due to the investor rather than the asset class.

This got me to wondering, is flipping a house investing or speculating? I think the answer depends on at least three factors that usually are present in almost all speculative endeavors:

Rising Prices: Gains from speculation almost always depend on anticipated, significant changes in price, without any change in the value of the asset. Remember, price is what you pay, value is what you get. Day trading is a perfect example, as traders jump in and out of stocks in the hope of taking advantage of short-term changes of price, even though the underlying value of the asset is unchanged.

Quick Profits: Speculators are looking for quick profits. Thus, the anticipated changes in prices occur (or at least a speculator hopes they occur) over the short-term, ranging from a few hours (day trading) to weeks or maybe a few months (flipping houses). You won't ever hear of a speculative endeavor taking 20 years.

Leverage: Speculators often borrow most of the price of the asset. During times of rising prices, the use of leverage can significantly increase returns. During times of declining prices, leverage could be disastrous, as the current rash of foreclosures in a declining housing market demonstrates.

So back to our original question--Is house flipping investing or speculating? I think the answer depends on the circumstances, as these two examples demonstrate:

Example #1: An individual draws down their home equity line to purchase a condo that will be completed in five months. The plan is to sell the condo when it is complete. The rising prices in the condo market make this a sure thing.

Example #2: An individual purchases a foreclosed property that needs substantial work. Some of the purchase price is borrowed, but a substantial down payment is made, and the individual pays for the rehab costs in cash. The plan is to improve the property (and thus the value of the asset) and sell at a reasonable profit.

Example # 1 is speculation. Example # 2 is investing. It's worth noting that a lot of money can be made speculating, and money can be lost investing. But in the end, speculation will catch up with the speculator in unpleasant ways. For the real estate investor, patience, consistency and perseverance will eventually pay off by building wealth for the log run.

Here is what others had to say on this topic:

• Active Rain: Real Estate Speculation vs. Investing--Does Cash Flow Matter?

Interestingly, EquityScout notes that in many areas this rule of thumb as fallen out of favor because rents have not kept up with the rising cost of residential real estate. That's certainly true where I live, which is why I buy real estate in the mid-west. We closed on a 4-bedroom single family home last month. The home was a HUD foreclosure. Total cost was $127,000, and we rented it for $1,350 per month, or about 1.05% of costs, which makes for a great real estate investment. Let us know whether your able to find rental properties that generate rent at or near 1% of total costs, and if so, what's your secret?

Will the property generate monthly gross rent equal to at least 1 percent of the total cost of the property?

The total cost of the property includes four things: (1) purchase price of the property; (2) fix-up costs; (3) financing costs; and (4) carrying costs from the time of purchase until the first tenant moves in. Of course, this requires making a reasonable estimate of what the rent will be and the cost to fix-up the properties. With enough experience and research, I've found that these estimates can be made with good accuracy. On estimated rent, for example, I usually estimate within a range of $100 and calculate the 1 percent using the mid-range of this estimate. Because my investment properties are all in the same area, I've got a very good idea of how much rental income a given property will generate.

A note of caution. In many areas of the U.S., finding a property that meets the 1 percent rule is next to impossible. I invest in the mid-west, and given the high rate of foreclosures, have been able to find properties that generate rents at or near 1 percent of total cost. I am able to finance nearly 100% of the total cost on a 30-year fixed rate mortgage that enables me to generate positive cash flow immediately, even after factoring in an allowance for repairs and vacancy.

I'd be interested in hearing if anybody else uses this or another guide to evaluate potential real estate investments. But I've found the 1% solution to be a great way to make money.