The New Investor’s Guide to Buying Distressed Homes

By
Real Estate Technology with SparkRental

Even in hot markets, investors can score great deals on distressed properties. 

But these properties aren’t just lying around on the MLS for anyone to bid on — you have to go out and find them yourself. That’s the tradeoff: to score a bargain, you have to put in the work to find them. 

Here’s how investors can go about finding distressed properties, and converting them into great deals.

What Is a Distressed Property?

A distressed property is any property owned by someone in financial hardship or with some other urgent need to sell. 

Often, these properties have already been repossessed by the bank or at the verge of foreclosure. If the homeowner can no longer pay property tax bills or mortgage payments then the property, they need to sell fast or lose their property. Therefore, you have to be ready to buy the moment a good deal comes along since the demand is high.

Distressed properties can be:

  • Pre-foreclosure properties
  • Real estate-owned (REO) properties already taken back by the bank
  • Short-sales
  • Properties in tax sale
  • Properties owned by divorcing couples

A few terms worth knowing:

  1. a) A short-sale: In this case, the property is not only sold for less than its market value but also less than what is owed on the mortgage. The lender agrees to this deal to get back a certain percentage of the mortgage loan owed rather than losing everything.
  2. b) Pre-foreclosure: If a homeowner fails to make the monthly mortgage payments, the lender starts the slow process of foreclosure. The homeowner must catch up on payments or pay off the loan entirely, or the property goes to auction. 
  3. c) REO property: Not all foreclosure auctions result in a buyer immediately. The mortgage lender, in this case, will automatically take ownership and handle evictions as well as repairs. The lender also takes responsibility for any pending tax liens.
  4. d) Tax sale: When property owners fail to pay their property tax bill, the local government puts it up at tax sale. Buyers typically bid in silent auctions held annually. 

Tips for Buying Distressed Properties Profitably

If you are not afraid of taking risks then you should consider buying distressed properties. After all, real estate investors who make it big in the industry are the risk takers. Nevertheless, it isn't always a cheap bargain. You may pay below-market prices for the property but it might also mean dealing with unique challenges in the processes. That's why you should be conversant with the process to avoid making mistakes. Here are some guidelines for investors when buying distressed properties

a)  Consider the neighborhood

You shouldn't buy distressed properties in a neighborhood where every house is on the brink of foreclosure. Too many vacant homes or condos are not a good sign either. There is no guarantee that a distressed neighborhood will ever recover. Thus, you may have to get rid of the property at a loss in the future even if you had bought it at a bargain. If it becomes unsellable you will be forced to abandon it altogether. Not only will you have lost money in the process but also your time. Thus, you need to study the neighborhood and understand the market dynamics before buying a distressed property located therein.

b)  Be proactive in finding distressed properties

Don't sit pretty waiting for a call about a distressed property deal unless you have people working for you. You'll have to be proactive in finding these properties and driving around to find them should be a habit. Homes that look abandoned are likely to be distressed. Be on the lookout for piling newspapers on the entrance, overgrown yards, peeling exterior paint, or legal notices posted on the windows or doors. Government agencies like the U.S Marshals, HUD, and the IRS have distressed properties as well due to seizures, foreclosures, and repossession. Additionally, there are online sites that advertise distressed properties and family attorneys can also be a source of information regarding such properties.

You can tax assessors for contact details of the owners of distressed properties you are interested in. Also, some realtors specialize in such properties and you can go to them for help. However, don't forget to be thorough when doing a title search to avoid getting scammed.

c)  Hire a home inspector

A distressed property comes "as-is." That means you will be responsible for all the essential repairs. Most lenders won't approve high mortgage loans for such purchases because the property price is already lower than its market price. A home inspection is essential to highlight the needed repairs before the property can be ready for resale. It would even be better if you get a general contractor involved to get an approximate cost of the repairs before the work begins. This can include a change of kitchen cabinets, bathroom remodels, appliance replacement or repainting. However, you should budget for at least 15-20% more than the figure the general contractor gives you to cover for unexpected expenses.  Also, hire specialty inspectors in case there are fragile issues like mold remediation or pest outbreak.

d)  Get financing in advance

Distressed sellers need to sell fast. That's the tradeoff: the seller accepts a low offer in exchange for a quick, certain settlement. Many investors offer cash for distressed properties, but if you can't afford to do so, you need several options lined up in adance for investment property loans. If you have plenty of home equity, you can potentially tap a HELOC to pay in cash for the property.

e)  Understand the foreclosure laws in your state

The laws regarding foreclosures differ from one state to another. In some states, lenders have to go through an arduous judicial process before the foreclosure is made official. This can even take a year or more. The obstacles are meant to prolong the process to give the previous owner time to put his/her finances in order and pay for the mortgage and tax arrears.

However, there are states where the laws are a bit relaxed and the process can be completed in 60 days. Thus, understand the foreclosure laws in your state before committing to the purchase. If possible, buy distressed properties in states where the process is straightforward and fast. Closing the deal fast gives way for repair work to begin. Since you are in control of the length of time it will take to get the house ready for re-sell, you will get returns on the investment fast. You can even help the previous owner to move before the court-ordered deadline to hasten the process.

f)    Negotiate

You don't have to accept the proposed price even if there are many potential buyers. You always have the leverage to negotiate, especially if the home is in a bad shape. In case the bank or owner refuses to reduce the asking price, you can ask your lender to undertake a property appraisal. If the appraisal indicates that the property value is below the owner's asking price, this can be the leverage you need to persuade the seller to lower the price.

Final Thoughts

Purchasing a distressed property is not always a frustrating ordeal. Also, not all of them will be in extremely poor condition. Some will require basic repairs to restore them to their former glory. However, you need to position yourself in a way that puts you ahead of the competition when it comes to buying distressed property. Hiring a property manager frees up time to form professional networks and identify new business opportunities. Following the guidelines discussed above when buying a distressed property will increase your chances of succeeding as a real estate investor.

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