Steve Byrne is founder of EquiSource and has been in commercial real estate investment, management, and finance for nearly 40 years.
Whether you’re a professional real estate investor or just getting your start in real estate investing, distressed properties offer a profitable opportunity in today’s market.
Seasoned investors might recall that 45% of all home sales at the end of 2008 involved distressed properties. Although distressed sales have declined over the years, many expect this market to make a comeback in 2021. One such expert is Charles Koch, who leads Koch Industries Inc. According to the Wall Street Journal, Koch Real Estate Investments, the company’s Dallas-based arm, has already started scooping up large-scale distressed listings often ignored by private equity firms.
As someone who has been in commercial real estate investing for years, I believe any investor can find opportunities in the distressed property market. You just need to understand how it works.
What is ‘distressed property’?
Distressed property refers to homes either under foreclosure, pre-foreclosure or control of the lender/bank. A property becomes “distressed” when the owner falls behind on their mortgage payments and/or property tax bills. Real estate might also become “distressed” during liquidation as part of a bankruptcy or divorce.
Distressed property usually falls into three categories:
• Foreclosure or pre-foreclosure: The homeowner falls behind on monthly mortgage payments, and the lender repossesses the property. Lenders often sell the property at auction as-is to the highest bidder.
• Real estate-owned property: If the lender cannot sell the foreclosed home at auction, the bank seizes control of the property and sells at a reduced rate on the market.
• Short sales: If a homeowner owes more on the mortgage than what the home is worth, the mortgage becomes “underwater.” The lender might agree to a short sale at a reduced rate so the bank can recoup some of the cost.
Should you buy a distressed property?
Distressed real estate can be attractive because it allows both investors and general buyers to purchase property often far below market rate.
As you can imagine, this strategy can be quite lucrative in areas with high home prices; you can buy a distressed home at a reduced rate and sell at a much higher price. In my experience, banks will even sometimes offer lower mortgage payments and interest payments on distressed listings, as they’re often happy just to have someone take the property off their hands.
On the downside, a distressed property can sell quickly, so expect plenty of competition. At the moment, home inventory is low, and properties usually don’t stay on the market long. However, I believe that could change over the next few months.
Also, note that since distressed properties sell as-is, you’re on the hook for any and all repairs, upkeep and improvements if you want to profit. For example, buying a distressed home at auction could mean you’re responsible for evicting occupants as well as covering tax liens and other related costs.
How do you find distressed property listings?
You have several options for buying distressed properties. Some involve more investment and risk than others.
• A multiple listing service: An MLS works on a state-by-state basis yet serves as a comprehensive research tool for monitoring the status of various properties. Anything listed for more than 90 days usually implies the seller is highly motivated to move the property.
• Tax records: These are public information and can guide your search toward homeowners facing pre-foreclosure, such as those delinquent on property taxes.
• Auctions: Banks and lenders often sell distressed properties at auctions to investors anywhere in the country at low prices. Make sure to ask if inspections are allowed, and inquire about the home’s foreclosure status.
• Real estate-owned property and bank listings: This is your best chance to buy distressed listings and sell at a higher price. In my experience, bank or real estate-owned property often sells for a much lower rate yet usually allows inspections and won’t put you on the hook for tax liens or evicting occupants.
• Probate courts: Deaths, divorces and bankruptcies all might involve liquidating property assets at probate court.
• Investigative work: You can search online or on foot for properties in your target area that are either listed for sale “by owner” or simply appear neglected.
How can investors profit from buying distressed properties?
Following a few protocols can help you avoid disaster and sell a distressed home you’ve purchased for a much higher price. I recommend:
• Researching the location of a prospective distressed home: A home might look like an incredible deal and even involve minimal repair work, but if it’s in an area surrounded by other distressed homes, don’t expect to sell it at a higher price.
• Choosing your locations first: Keep your eyes peeled for distressed properties next.
• Always getting an inspection on distressed real estate: Unless you’re the Koch brothers, you probably can’t afford to play the long game on distressed properties. Always hire someone to inspect the home on your behalf, and don’t only rely on what the seller’s inspector says. Otherwise, I’ve found that sometimes, these inspectors might only include cosmetic issues and neglect to mention things like structural damage.
• Understanding the foreclosure process: Where a home is at in the foreclosure process makes a huge difference in whether you can turn a profit on a distressed property. Buying before the foreclosure is complete and the occupants are out could mean you’re responsible for all kinds of costs.
The Bottom Line For Real Estate Investors
I’ve found most real estate investors either love or hate distressed property, and their opinion depends largely on their experience or what they’ve heard from peers.
The truth is, buying distressed properties isn’t so black and white. Do your research, keep an eye on the market and you, too, might find a great deal on distressed properties to sell at a much higher price.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.