What to Consider Before Investing in Distressed Properties

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Foreclosures and misfortune create what are known as “distressed properties.” When a buyer can’t keep up with the payments, their lender may resort to foreclosure. Alternatively, the borrower may try to sell their home before their bank moves to foreclose, salvaging some of their equity and their credit rating. Either way, a property that becomes available because of this kind of financial distress may be an attractive investment. Be sure to look into these important factors to consider before investing in distressed properties.

Hidden Costs

Distressed properties can look cheap. Banks don’t like to hold on to properties that don’t produce revenue, and homeowners anticipating financial problems are willing to take less than the market value of their home to raise some cash and relieve themselves of debt obligations. Investing less upfront increases the opportunity for a substantial profit upon resale.

However, financial distress can cause debtors to do unwise things, such as taking out one loan to pay off another. Before taking on a distressed property, do a thorough search to determine not only how many mortgages of what type and amount might be tied to it, but also whether there are liens or legal judgments against the property. Mortgage and lienholders must receive full payment to clear title. There could be unresolved homestead or other residual rights held by former residents that haven’t been brought to closure. The property may end up being much more costly than it seems.

Profitability

On the surface, it may seem profitable to purchase a distressed property. A foreclosed home in reasonably good condition can continue to appreciate, and with some renovation and upgrades, the value increases still further. Should the real estate market take a turn for the worse, investors can rent the property and generate a steady income until conditions for sale become more favorable. However, if the home contains numerous code violations or hazardous materials, any profit from purchasing and “flipping” the home could vanish in costly repairs. This is true even if the seller or the bank has offered favorable financing because they want to unload the property as quickly as possible.

Low prices attract interest from multiple investors, and that interest generates competition, which can drive the price back up, negating some of the benefits of buying the distressed property in the first place.

Homeowners who have fallen on hard times and can’t make the mortgage won’t be able to afford renovations or even basic upkeep, such as repairing or replacing appliances or fixing the plumbing and electrical systems. Even if a property is in fairly good shape, profits depend on consistent and timely maintenance. Deferred or delayed maintenance will cost more in the long run.

Location and Financing

Finally, distressed properties are often in poor locations, not only because of the neighborhood but possible because of environmental issues. Finding a distressed property in a good location can take some digging in public records, on bank websites, and with good old-fashioned driving around. Lenders don’t want to be burned twice, so financing might require substantial additional evidence that the property can be made livable and profitable, and that means more paperwork.

Work with professional property managers who will know the factors to consider before investing in distressed property. Property managers may know of inventory for investors to consider, along with the possible pitfalls involved in buying a foreclosed home.

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