Whether you’re a professional real estate investor or just getting your start in real estate investing, distressed properties offer a profitable opportunity in today’s market. Any investor can find opportunities in the distressed property market, you just need to understand how it works.
What is a distressed property?
Distressed real estate is a property that is sold at a discount due to one of five specific conditions: deteriorating physical condition, incorrect pricing, mismanagement, a short-term environmental problem, or excessive debt causing the property to become vulnerable to foreclosure. It is important to note that distressed situations can arise because of property-specific issues, OR owner-specific issues.
Distressed property refers to homes either under foreclosure, pre-foreclosure, or control of the lender/bank. A property becomes “distressed” when the owner falls behind on their mortgage payments and/or property tax bills. Real estate might also become “distressed” during liquidation as part of a bankruptcy or divorce.
What do you need to invest in distressed real estate?
- Capital:
A seller in a distressed situation needs money now. For example, a seller might be midway through renovations and run out of capital, and as such, needs to sell the property in order to pay off their debt and exit the deal before losing the property to foreclosure.
- Experience:
Buyers often have limited information about distressed properties, including the property’s condition and financials. The buyer needs to know what they are getting themselves into despite the limited data available, including how to manage things like costly structural issues, pending evictions, and more. Distressed deals tend to be those with lots of hair on them, something only an experienced investor will want to get involved in.
- Relationships in the local area:
Relationships are very important when trying to invest in distressed real estate. This involves relationships with people who you’ve been on the ground with and doing deals with. Relationships with contractors, lenders, attorneys, appraisers, other investors, and the like are critical when trying to move on distressed real estate. These are the people who will not only help you find deals but who will help you execute your business plan quickly and efficiently to maximize returns for your investors.
- Legal expertise:
Attorneys often get a bad rap, but in commercial real estate, they are invaluable. This is particularly true when investing in distressed real estate, which may have title issues, liens on the property, pending evictions, and other legal complications. It is important to have an adept legal team at the ready who can review all available documentation (and who can dig up information that’s not otherwise readily available) in order to protect your best interests.
- Lending relationships with experience
Investing in distressed real estate requires speed and efficiency in underwriting and strong connections in the lending community. While many sponsors are able to move quickly to conduct their due diligence, without being able to access debt quickly and effectively good deals can be lost for lack of capital. Having good connections in the lending community can make the difference between being in the distressed real estate game and not.
- Reputation:
It is one thing to have experience and relationships. It is a different thing to have a solid reputation. A strong reputation is one of the most, if not the most, important attributes when investing in distressed real estate. Brokers, sellers, and other third parties to a transaction are more likely to work with someone who is highly respected than someone who is either unknown to the market or who has a tarnished reputation for one reason or another.
Advantages of Investing in a Distressed Property
- 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 an 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.
- Potential for High Profits
The potential to make profits with distressed properties is not limited to selling them 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 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.
- Better Financing
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
- Competition
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.
- 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 that are in rough conditions and suffer from neglect. Some might need extensive electrical or plumbing repair, have damaged walls, have foundation issues, etc. Consequently, renovating and improving these investment properties will likely take a longer time than expected and hit your pocketbook quite fiercely.
- Location
We all know that location plays a major role in 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 is required to fix a distressed property, the bad location can negatively impact its value. Rental property in a bad area is still going to generate a low rental income no matter how nice you make it look.
WAYS TO FIND DISTRESSED COMMERCIAL PROPERTIES
There are five great ways to find distressed commercial properties that may be great investments:
- Search commercial investing websites
There are dozens of commercial investing websites, and many of them feature special listings and search filter tools that can help you find distressed commercial properties. Look at your local real estate agents’ pages, too many agents include listings and descriptions on their personal sites.
- Talk to commercial real estate brokers
Commercial real estate brokers can help connect you with distressed properties. Often, they know about properties that haven’t hit the market yet – and those that appear to be in distress before an owner attempts to sell them.
- Talk to lenders
Lenders often know about distressed properties before others do, and many even feature listings on their websites. Check with local lenders online and in person to find out what you can about commercial properties that may be in trouble.
- Network with other investors
Other investors always have their ears to the ground, and that means they know about opportunities that you may not know about. Often, people who aren’t interested in commercial real estate still have the scoop on these types of buildings.
- Send out mailers
If you spot a commercial property that appears to be in distress, or if you hear anything about a property that you may be interested in buying, send out a mailer. Direct mail gives you the opportunity to connect with people in a pressure-free way, too, which means they can reach out if they’re entertaining the idea of selling.
CONCLUSION
Before buying any type of investment property, real estate investors must understand the benefits and risks that may come up along the way. Most real estate investors either love or hate distressed properties, and their opinion depends largely on their experience or what they’ve heard from peers. The truth is, buying distressed properties must be well thought out before going ahead with it. Do your research, keep an eye on the market and you, too, might find a great deal on distressed properties to sell at a much higher price.
As informed investors we should understand the risks associated with real estate investing and that there is no guarantee. Please do your due diligence.
