Investing in distressed property may be one of the most profitable property investment strategies.
Various definitions of distressed property can be found, but all point to property that is burdened by financial problems, and mostly to property that is under foreclosure or has already been foreclosed and has been repossessed by the lender or the government and are sold in auctions.
The reason that the lenders and the government are selling these properties in auctions at lower than market prices is because that none of them are set to hold and manage property, and their primary concern is to cash-out the sooner the possible.
The term distressed property refers also to properties that are in poor condition, and are often burdened with financial problems as well.
In the current environment, with new-build developments being cancelled or halted, due to the global credit crunch, more and more investors are turning to distressed property for acquiring cheap investment property, as this type of property can be bought at a significant discount from prevailing market prices. Investing in distressed property or repossessed property can be highly profitable, especially in the case of bulk acquisitions, as they can allow investors to push for even higher discounts.
There are several advantages and risks involved in distressed property investments. These advantages and risks are outlined below, as well as the the major steps involved in the process of acquiring distressed properties.
Advantages of Investing in Distressed Property
Investing in distressed property or repossessed property has the following advantages:
1. This is one of the best ways to acquire cheap investment property
2. Instant equity by buying at a significant discount below market value
3. Lower risk because the significant discount achieved provides a comfortable cushion against further drop in housing prices
4. There’s no developer risk to worry about
5. Potential for large quick profit by reselling quickly at a lower discount than the one achieved when the property was acquired
6. Potential of immediate income, as there maybe tenants in place already paying rent
7. Huge capital gain potential, if the market recovers soon after acquisition
Risks of Investing in Distressed Property
Although the strategy of investing in distressed property has several advantages, it also carries and risks that should be given special consideration by property investors targeting double-digit returns.
Repossessed and distressed properties are increasingly available during times of economic crisis and falling property prices. The risk is that during such times it is difficult to re-sell quickly the property and make profit unless a significant discount is offered.
Of course, buying at a 30% discount and selling as quickly as possible at 20% discount can still leave a large quick profit. However, note that within a falling price environment, in which prices may be falling 10-20% annually, the re-sale of the property needs to take place as soon as possible so that the 20% discount from market value at the time of resale will still leave a 10% profit to the re-seller. Consider that if by the time the resale occurs market prices are already 10% below the price purchased by the re-seller, a quick re-sale at 20% below the value prevailing at that time will leave almost zero profit to the reseller. The major risks associated with investing in distressed property can be summarized as follows:
1. Risk of rapid decline of the value of the property and the instant equity gained by buying below market value
2. Difficult to sell property environment
3. Problematic property, the problems of which need to be carefully evaluated in terms of assessing required refurbishment costs and maximum price to pay
4. Risk of not finding a tenant due to the overall economic environment or due to poor location and/or condition of the unit
5. Risk of underestimating repair costs and vacancy loss, as well as overestimating potential rental revenue
How to Buy Repossessed Property
1. First the investor needs to locate property bargains for sale from various entities that may have repossessed property such as HUD, Real Estate Owned (REO) Departments of banks, property agents and VA (Veterans Administration). The internet is a very good resource for finding listings of repossessed or distressed properties.
2. Careful inspection of the distressed property is necessary before turning to repair contractors for cost estimates and to surveyors/valuers for property valuation.
3. Once a decision is made to give more serious consideration to the property, it is necessary to get a valuation of the property and estimates of required repair costs. The latter is of particular importance, if the property is old and/or in a poor condition.
4. It is important to set a maximum price to bid, which allows for a comfortable cushion against the risk of any further drop in market prices. This price needs to take into account prevailing market trends and prices at the time of the auction, any required repair costs, tax liabilities, legal costs, insurance costs, potential buyer fees, stamp duty, and any other costs, as well as a vacancy loss factor and operating costs, in case the investor plans to hold it and rent it out as opposed to re-selling it quickly.
6. Arranging mortgage financing before the auction (once the maximum bid is determined by the property investor), is very important, because the investor will lose his/her deposit in case a mortgage can not be obtained after a successful bid.