If you’re looking into investing in real estate, then you need to understand the different types of properties you can buy and the pros and cons that come with each. In previous blogs, we’ve discussed numerous types of investment properties – single-family, multi-family, condos, townhouses, fixer-uppers, you name it! (You can head over to our blog to learn more about them). Today, we’re discussing distressed properties and whether or not they’re a good option for a real estate investor. Let’s start with answering the simple question: What is a distressed property?
Let’s not confuse distressed properties with fixer-uppers. A fixer-upper is a property that needs some rehabilitation and improvements to increase its value and sell it for a return on investment. A distressed property, on the other hand, comes in poor condition and suffers from neglect, or it could be at risk of foreclosure due to non-payment of mortgage and/or taxes. Thus, these investment properties typically need more work and money than an average fixer-upper.
So, what are the advantages offered to property investors choosing to buy this type of real estate?
Advantages of Investing in a Distressed Property
#1 Lower Price
The main reason why some property investors buy distressed properties is their low prices. In most cases, sellers (and homeowners about to be foreclosed upon), and banks want to get rid of these properties as quickly as possible. Thus, because they’re in a hurry to complete the sale, they will price the property for less than the market value. Furthermore, when it comes to buying a distressed property, real estate buyers often have the advantage in the sales negotiation process. A real estate investor can take advantage of this bargain – especially when the mortgage and interest rates are low – to renovate the distressed property to increase its market value, and then sell it for a profit.
#2 Potential for High Profits
The potential to make profits with distressed properties are not limited to selling it after the renovation is complete. Just like any commodity, investment properties have a value that increases over time. In the real estate investing business, this is what we call appreciation. Property investors keeping up with the market’s trends will know that property prices are rising. Thus, the value of a distressed property is bound to increase after a few years.
In addition, a savvy real estate investor can turn a distressed property into a rental property! You can achieve a high return on investment from the rental income and cash flow that rental properties generate. This is especially true if the property is located in a great neighborhood where there’s rental demand. Even though distressed properties are negative cash flowing, property investors can turn them into positive cash flow properties when leasing them out.
#3 Better Financing
As mentioned in the first point, banks and lenders are extremely interested in getting distressed properties sold. As a result, they are willing to give property investors looking to buy one better financing. This means that when buying a distressed property for investment, you could end up with lower interest rates, closing costs, and mortgage payments.
These are the main advantages for real estate investors when investing in distressed properties. Nonetheless, there are downsides to buying such investment properties, which you should take into consideration as well.
Disadvantages of Investing in a Distressed Property
Because these investment properties are cheaper, more buyers will jump at the opportunity to get their hands on them. Thus, you’ll have to compete against other property investors and homebuyers. So, even though a bank wants to sell a distressed property quickly, your offer may be rejected due to the high competition. Unless, of course, you have a great team that can find such properties before anyone else.
#2 Bad Condition
The main risk of buying and investing in a distressed property is its condition. Some of these properties may be OK in shape, but you’ll come across others which are in rough conditions and suffer from neglect. Some might need extensive electrical or plumbing repair, have damaged walls, foundation issues, etc. Consequently, renovating and improving these investment properties will likely take a longer time than expected and hit your pocketbook quite fiercely.
#3 Location, Location, Location
We all know that location plays a major role for successful real estate investing regardless of your investment strategy and the type of property you’re investing in. Property investors always aim to find investment properties in the best location with high rental demand, good occupancy rates, and potential real estate appreciation. The location of your property will ultimately determine the price you can charge future renters or buyers.
Unfortunately, most distressed properties are located in low-income neighborhoods which offer none of the above. Regardless of how much work and money required to fix a distressed property, the bad location can negatively impact its value. A rental property in a bad area is still going to generate a low rental income no matter how nice you make it look.
Tips for Investing in a Distressed Property
#1 Invest in the Right Property
Don’t buy an investment property just because it’s cheap! As a real estate investor, you want to ensure that the property you’re buying will, in fact, have the potential to make profits after renovating it. Thus, you need to perform an investment property analysis and estimate the after repair value (ARV) to know exactly how much you can rent or sell it for once the work is completed. An investment property calculator – like the one Mashvisor offers – can help you with analyzing properties.
To start looking for and analyzing the best investment properties in your city and neighborhood of choice, click here.
#2 Work with Professionals
Real estate is a people business, and when thinking of buying a distressed investment property, you have to work with the right people. It’s important that property investors include a real estate agent and a home appraiser in their network. These people are professionals who will be able to give you a good sense of how much it will cost you to bring the distressed property into good condition. Thus, this allows you to plan your finances and set a budget.
#3 Expect the Unexpected
If you buy a distressed property without conducting a home inspection first, expect and plan to spend more than you think you need. Due to their age or how long they’ve been neglected, major hidden costs could be lurking and, once you begin to repair your investment property, you could run into unpredicted issues. For example, you may need to rebuild the roof, rewire the entire electrical system, update old plumbing, or even rebuild the foundation. This could turn what you thought to be a guaranteed money maker into a money pit. Thus, property investors need to devote a lot of time and energy on the budget, timeline, and contractors to ensure staying on budget and on schedule.
Before buying any type of investment property, real estate investors must understand the benefits and risks that may come up along the way. So, do you think investing in a distressed property is a smart investment decision? Let us know in the comments below. Mashvisor offers real estate investors with investment tools to help them make smart decisions and find the best investment properties. To learn more about our product, click here.