What Are Distressed Properties and Why Do They Matter?

If you are active in real estate investing there are a few niches you can fall into based on your interest and skills. One of the most popular and profitable areas for investors is buying and flipping distressed properties.

What Are Distressed Properties and Why Do They Matter?

If you are active in real estate investing there are a few niches you can fall into based on your interest and skills. One of the most popular and profitable areas for investors is buying and flipping distressed properties.

If you are looking to make some money in real estate your goal is always to buy low and to sell high. The best way to buy low is to find homes that are not in the best physical or financial shape and may have owners who are looking to offload them quickly and cheaply. This is why distressed property is always a hot commodity on the real estate market.

So what makes a property distressed and why are these kinds of properties so popular in real estate investing?

What Are Distressed Properties?

A property can be considered distressed for a number of reasons based on its financial or physical condition.

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Financially Distressed Properties

A financially distressed property is one in which the owner has fallen behind on property tax or mortgage payments and may be in foreclosure or in pre-foreclosure. These kinds of homes are generally sold quickly to recoup some of the money lost to missed payments. Financially distressed properties generally fall into three different categories based on how they are owned or sold.

  • Still owned by the homeowner but facing foreclosure or pre-foreclosure and may be looking to sell quickly to cover debts.
  • Bank owned when a lender cannot sell the property at auction and the bank takes control and attempts to sell the property quickly for below the market value.
  • A short sale situation when the homeowner owes more than the home is worth and is considered underwater. In this instance the lender might consider a short sale to recover some of the cost.

If a home is financially distressed it has likely also fallen into some kind of disrepair and whoever owns it sees more value in getting rid of it quickly than holding on to it and trying to get a higher price.

Physically Distressed Properties

If you are thinking of the classic definition of ‘distressed’ you are probably picturing an old and dilapidated home with unkempt landscaping, chipped paint and maybe some broken windows. These kinds of homes would be considered physically distressed. Many physically distressed properties are also financially distressed as well.

A physically distressed home is a property that has fallen into obvious disrepair. These properties are often vacant with owners that have ignored or abandoned them. A physically distressed property shows that the owner either cannot afford to keep up with the property, inherited it and does not want to maintain it, or simply does not want to manage it.

Owners of physically distressed properties are generally motivated to sell but frequently have not actually put their homes on the market. In these cases investors can get a great deal if they find these distressed properties through driving for dollars and reach out personally to make a bid.

Why Do Investors Buy Distressed Property?

If you are looking to buy low and sell high there isn’t much lower you can go than a distressed property. Distressed properties usually sell for less than market value because there is financial strain that is making a fast sale more important than a big sale for the homeowner or bank.

If a homeowner is underwater or facing foreclosure, selling off the property fast is often more advantageous for them. They could wait months to fix it up and hope to get more money but they usually don’t have the time or resources. The same is true for a bank looking to offload a property and recoup some of the debt owed on it. For the owner, these properties are not worth investing more time and money in.

If a property is physically distressed it is also often sold for below market value because the owner cannot afford the upkeep and is looking to get rid of the property, or the owner no longer wants to own the property and is willing to part with it faster than usual. If a property needs considerable work to become habitable and has already been sitting vacant for some time an owner is usually very motivated to get rid of it rather than fix it up and sell it.

Distressed properties can be huge opportunities for real estate investors. If you are experienced in flipping houses these kinds of properties are ideal and can yield higher profits since they are sold for well below their value.

It Can Be Risky

Buying and flipping distressed properties may seem like a great way to make money, but like all real estate endeavors there are risks involved.

Distressed properties are almost always sold “as is,” which means you inherit the property with all of its issues. If you are not careful when selecting a property you could find yourself with a home that is extremely expensive to repair and make habitable. The goal when flipping a home is to invest some time and money to make it worth more on the market and make some profit off the sale. If the property you buy has major issues it could quickly become a money pit and could actually cost you money in the end.

A distressed property is always a risky investment.

To avoid the risks, investors should be well versed in flipping houses and know the costs associated with certain repairs to get a good idea of whether or not a distressed home will be worth the flip. Investors should also be experienced and knowledgeable of the local real estate market to judge whether or not they could sell for a profit.

Getting involved with a distressed home flip as a beginner or amateur can go poorly very quickly. So how do you mitigate the risk?

  • Make sure you get a detailed inspection before you sign for any property. This is the only way you can get a full view of all of the flaws you will inherit and be responsible for correcting.
  • Do your due diligence beforehand and know the area and neighborhood and the value of nearby properties.
  • Consult an expert to make sure you understand the sale process whether it is foreclosure, auction or short sale.

The Breakdown

Pros

  • You can almost always get a lower price.
  • Potential for profit is much higher because of the low sale price.
  • Great opportunity for someone experienced in flipping houses.
  • Potential for a quick sale depending on the situation.

Cons

  • Properties are sold ‘as-is’ so you may find yourself with costly repairs you were not anticipating.
  • The sale can be held up depending on the legal situation of the property.
  • In a hot market the sale price can shoot up if there are many interested parties, making the profit margin much smaller.
  • Not a great area for beginners.

Where Investors Find Distressed Properties

If you were trying to find properties that are financially distressed where would you look? There are a number of places real estate investors turn to when generating leads

Driving For Dollars

If you want to find distressed properties in certain neighborhoods or towns that have not yet hit the market you might just want to take a drive! Driving for dollars is a classic way for investors to find off-market opportunities. Driving for dollars simply entails driving around a desired neighborhood and looking for homes that show obvious signs of physical distress. Once you locate these homes you then reach out to the owner to talk about a sale. This is a great way to find properties that may not be on the market or do not have any kind of financial issues that make them easy to find through municipal databases.

MLS and Real Estate Software

One of the fastest ways investors find properties is through MLS searches and utilizing real estate investing software like Invelo, that also offers MLS search. Using a tool like Invelo allows you to pour through millions of property listings in seconds by sorting through them with dozens of filters and parameters. Invelo can help you build a solid list of leads to investigate and market to to try and find the perfect deal to grow your business.

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Distressed Property and Foreclosure Websites

You can search through distressed and foreclosed properties specifically on websites dedicated to these kinds of properties. Check out resources like Foreclosure.com, Equator.com, and HomePath.com for some of the latest foreclosure listings. Properties that are listing on public websites like these may have multiple interested parties so make sure you know your limit when you negotiate.

Tax and Court Records

If you are looking for a property that is in financial distress there is probably some kind of public record available. Take a trip to your local tax assessor’s office (or website in many municipalities) and look for properties that are behind on their tax payments. If you look through local court records you can also find notices issued to homeowners who are looking at foreclosure or are facing other financial problems related to their property.

Auctions

If a bank is trying to offload a distressed property they often put them up for auction. Check out websites like Auction.com to see the latest properties that have been put up for auction. You may be able to get a great price on a property but you may not have the chance to do a full investigation before you buy.

Lawyers and Real Estate Agents

If you want to know what is going on in real estate in a certain location talk to the people who know what is going on! Networking with lawyers and real estate agents is a great way to get insider information on what properties are heading into foreclosure or may be hitting the market soon.

Final Thoughts

Investing in a distressed property is not a quick buy and sell – it requires careful consideration and hours of work. If you are aware of the potential risks and have educated yourself as much as possible the work may just be worth it in the end! If you are an experienced investor with an understanding of repairs and renovations flipping distressed property may just be the niche for you.