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Distressed properties are homes or commercial buildings under financial duress that tend to sell under market value. This may be the result of a foreclosure or loan default, or the need for serious renovations.
Distressed properties tend to be seriously attractive to investors. They offer the potential for significant discounts on purchase price, opportunity for value-adding renovations, and allow investors entry into competitive markets at less-than market value.
Properties can become distressed for a number of different reasons, ranging from economic issues to personal to legal. Each factor can push a property into distress, but most commonly distressed properties result from a combination of several of these factors at once. For instance, a property may become distressed when:
Distressed properties can involve a number of different players, including:
The distressed property market includes a number of types of distressed real estate. Read on to learn the most common.
Foreclosed properties are among the most common categories of distressed properties. It’s triggered when a borrower misses mortgage payments. As a first response, a lender will send a letter that outlines the missed payments and their consequences.
If the missed payments aren’t remedied according to the lender’s demands, they’ll send a Notice of Default. This is a formal letter stating the borrower is in default on their loan and at risk of foreclosure. It also outlines how they can bring their loan current. This may include a loan modification, forbearance (temporary loan suspension), or a short sale to recoup the losses.
If the loan isn’t brought current, foreclosure begins. The lender records a notice of sale with the county recorder that details the date, time, and location of the property auction. At auction, the property is sold to the highest bidder. The proceeds of the sale are used to first pay back the lender, then other outstanding debts. If any proceeds remain, they’re returned to the homeowner.
When a homeowner can’t keep up with their mortgage payments, they often have the opportunity to bring their loan current using a short sale. In a short sale, a lender allows a homeowner to sell their home for less than their outstanding loan balance. Depending on the state, the lender may have to accept the proceeds as full loan payment, or they may be able to obtain a deficiency judgement, meaning the homeowner is responsible for paying back the difference.
Short sales can be beneficial for both the homeowner and the buyer. Homeowners avoid foreclosure and buyers get a deeper discount on the property.
If a home fails to sell via foreclosure auction, the bank can repossess it and list it as a Real Estate Owned (REO) property. The bank can then list it for sale through a more traditional MLS real estate process,with marketing photos, pre-listing inspections, and set prices. In many cases, these properties are listed under market price in as-is condition.
In some cases, homeowners can choose to voluntarily transfer their title to their lender to avoid a formal foreclosure. This can be an effective way to speed up the lender recovery process, but it does require a clear title.
In the event of a bankruptcy or the sale of a deceased person’s estate, buyers can often get discounts on properties. Again, these properties are typically sold in an as-is condition. These types of purchases may also require extra layers of negotiations, legal approvals, and longer timelines.
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Interested in the distressed property market? Read on to learn how to find distressed property sales.
Find distressed properties by looking at lis pendens, sheriff’s sales, or pre-foreclosure filings in your local county clerk’s office or in online databases. These may also be listed in local newspapers. In some cases, subscription services are available to help buyers find distressed properties.
Sometimes, you can also find distressed properties based on visible cues. Neglected properties with boarded windows, overgrown yards, and unsecured doors may be a sign of a vacant, foreclosed on property. Drive through target neighborhoods and keep your eyes peeled. Then, do research on that property to determine whether it’s in distress.
A deeply discounted listing or a sudden price cut may indicate that a property is in distress. Compare potential properties to comps in the area to identify outliers or homes that deviate significantly from the local average.
Purchasing a distressed property is different from a standard home purchase. Read on to learn our step-by-step guide to acquiring this property type.
Distressed properties can sell much more quickly than traditional properties. Not only are lenders extremely motivated to sell, but they’re sold in an auction format.
Before attending a property auction, look at registration requirements, bidder deposits, and property preview windows. It can be a good idea to build a list of several properties you’re interested in and set bidding limits for yourself.
If the property you’re interested in needs renovations, it’s essential to thoroughly analyze the associated cost. Look at common repairs like structural, roofing, electrical, plumbing, and cosmetic work. As a starting point for a budget, look at local contractor rates and add a buffer of between 10% and 20%.
Because distressed properties originate from legal and financial issues, it’s vital to do proper research before purchasing a property. Do a title search and look for unpaid taxes, judgements, and HOA or mechanic’s liens. Some of these are capable of surviving foreclosure and will fall on the shoulders of anyone who purchases the property.
There are a number of different options for financing your distressed real estate purchase.
Traditional mortgages are always an option when buying distressed real estate. These loan types typically have strict eligibility requirements and long application processes.
A traditional mortgage lender will look at your employment, income, credit score, and other financial factors to determine your eligibility and loan amount. Overall, the traditional mortgage loan process can take several months.
If you need greater qualification flexibility, faster funding, or shorter loan terms, explore hard money loans. These loans are secured by real estate and rarely consider your income or credit score. Hard money loans offer up to 65% loan-to-value ratios and require clear exit strategies, like a sale or refinancing into a more traditional loan.
There are a number of loan programs in place that may apply to people who purchase and rehabilitate distressed properties. They allow homeowners to finance both the cost of purchasing a distressed property and the cost of renovating in a single loan. FHA 203(k) and Fannie Mae HomeStyle are both common examples of this loan program.
Finally, it’s time to negotiate and close the deal on your distressed property. Consider negotiating on points like necessary repairs, seller credits, and flexible closing dates. It’s also important to cover escrow, contingencies, inspections, and the final walk through before closing.
Don’t make these common mistakes when investing in a distressed property.
Because distressed properties have often gone through a period of neglect, it’s important to budget for hidden issues like mold, structural damage, and outdated wiring. These costs can dramatically inflate your renovation budget.
It’s also vital to stay on top of any legal and title issues with the property. Skipping lien checks or probate clearances can derail your ownership down the line and end up costing a pretty penny.
Just because the property is distressed doesn’t mean it’s guaranteed to be a great deal. Make sure you analyze recent comps and vacancy rates to avoid paying premiums in slow markets.
Finally, a professional inspection is always in order. Doing the inspection yourself may cause you to miss critical mechanical or structural faults with your property.
A short sale is an alternative to foreclosure to help homeowners settle debts with their lenders. In a short sale, a lender agrees to let a homeowner list their home for less than their outstanding loan balance.
In some cases, the lender may forgive any outstanding loan balance after the short sale. In others, they may pursue a deficiency judgment that requires the homeowner to pay the outstanding balance.
A foreclosure, on the other hand, occurs when a homeowner goes into default on their loan and is unable to settle the outstanding debt. In these cases, the lender takes possession of the home and places it for sale in an auction. Using the proceeds of the sale, the lender pays off the homeowner’s loan debt, then pays off any other outstanding debt. If any money remains, those funds are returned to the homeowner.
Yes, traditional mortgages are an option when purchasing distressed real estate.
In order to determine your budget for renovations, start by listing out the renovations you know you’ll need to do. Then, research contractor rates in the area to determine a rough cost estimate. Finally, add between 10% and 20% to your budget to account for unforeseen repairs and renovations.
There may be tax benefits when purchasing a distressed property, like tax-free growth when investing through a self-directed IRA. These topics can be extremely complex, so it’s advised to talk with a tax professional to ensure you understand the specifics.
Distressed real estate can be an excellent opportunity to purchase real estate at less-than market value, whether to renovate and sell or live in yourself. If you plan on doing so, it’s vital to do your due diligence by performing proper research, setting realistic budgets, and consulting professionals. With careful, informed investment decisions, investing in distressed real estate can be a great opportunity to build wealth.