A distressed property is a property that’s on the brink of foreclosure—or one that’s already owned by the bank. Managing distressed property can be difficult, as they’re often in need of repairs and their long-term profitability can be hard to predict. However, with the right strategies, you can either sell a distressed property for a reasonable profit, or improve the property enough to make it livable—and either collect rent or live in it yourself.
Identifying Distressed Property
Usually, distressed property falls into one of three main categories:
- Bank foreclosed properties. When a property owner is no longer able to make mortgage payments, or fulfill the terms of their mortgage, the bank may foreclose on the property. At this point, the bank auctions it off to the highest bidder.
- Real estate owned (REO) properties. REO properties are owned by lenders after a foreclosure auction fails. The bank is responsible for tax liens and evictions, and may sell the property at a later date.
- Short sale properties. In some cases, a homeowner may partake in a short sale, selling the property for less than what they actually owe on the mortgage. The bank may agree to this in hopes that their funds may be at least partially repaid.
Why Distressed Property Is Risky
Distressed property can be highly profitable. You’ll be able to capitalize on low prices in auctions and short sales, and potentially sell the property for a much higher price later on. However, there are some risks to this strategy.
For starters, distressed properties are often in a state of disrepairs. Their owners, unable to pay their mortgages, have likely failed to take good care of the property. In some cases, they may intentionally damage the property out of spite. In either case, you may be forced to deal with major structural problems and superficial flaws that can make turning a profit nearly impossible.
On top of that, there’s no guarantee that you’ll be able to sell the property for more than you paid for it—especially when you include the costs of repair and improvements.
Buying the Right Distressed Property
Much of your success will depend on your ability to buy the right distressed property.
- Understand foreclosure laws. First, work to understand the foreclosure laws in your area. Depending on where you live, you may have to wait for complex judicial processes to complete before a property is available for sale.
- Search in multiple places. Look for distressed properties in multiple outlets. Peruse online listings, attend options, and network with other real estate investors to get wind of more offers that aren’t listed.
- Consider the neighborhood carefully. Buying a distressed property in a good neighborhood is much better than buying a distressed property in a distressed neighborhood. There isn’t much you can do about the surrounding properties.
- Conduct a thorough home inspection. Before committing to a purchase, conduct a thorough home inspection with someone you trust. You need to know exactly what the state of this property is.
- Calculate your costs conservatively. Estimate the costs you’ll bear to get this property in shape, and estimate them conservatively. Too many people underestimate the true cost of fixing up a property.
How to Manage a Distressed Property
However you acquire a distressed property, there are three main options you’ll need to consider for how to proceed:
- Conducting repairs yourself. First, you may want to take the repairs on yourself. Doing your own repairs can save you money and give you more control over the process. However, it can also be risky—especially if you don’t know what you’re doing. On top of that, you may have a hard time estimating costs, which can jeopardize the profitability of your entire strategy if you aren’t careful.
- Hiring someone to make repairs. You could also hire a contractor or a team to handle the repairs and improvements on your behalf. This option is more expensive and less time consuming than doing the repairs on your own, but it’s also more reliable—and can lead you to a higher sale price. However, there’s no guarantee that you’ll make a profit this way.
- Selling the property outright. If you want to simplify things as much as possible, you may consider selling the distressed property outright. Selling the property quickly means you won’t have to spend any time or money making repairs, though you may be faced with a slightly lower sale price. Depending on your priorities, this could be the best option.
Distressed property can be a profitable real estate investment strategy, but it isn’t the right approach for every investor. If you proceed with managing distressed property, do so carefully, and make sure you have a solid plan in place.