What Is A Distressed Property And Should You Buy One?

Some home buyers will go to great lengths to get a good deal on a property. In today’s competitive market, a wallet-friendly fixer-upper can be a savvy, money-saving investment. A distressed property may be the perfect solution if you don’t mind putting in a little extra work.

There are some risks to consider when you invest in distressed properties, but with enough money and patience, you can transform a distressed property into your dream home.

Whether you’re a residential home buyer or an investor, here’s everything you need to know before making an offer on a distressed property.

What Is A Distressed Property?

A distressed property is a real estate owned (REO) property or a home that’s about to fall into foreclosure or already owned by the bank. Distressed properties often occur because of significant life events that can lead to financial hardship, such as a job loss or natural disaster. A lender or owner typically prices distressed properties to sell, and they’re sold “as-is.”

House flippers and real estate investors are more likely to purchase distressed properties because of their heavily discounted prices. But more and more, home buyers are looking at distressed properties to take advantage of their very low pricing.

What Are The Types Of Distressed Properties?

Buying a foreclosed home or a home in the process of foreclosure can be a very different experience from a traditional real estate purchase. As you begin to scan the market for foreclosed properties, you’ll likely notice three main types of distressed properties in real estate.

Foreclosures

One of the conditions of a mortgage is that the homeowner agrees to make payments each month until the loan is fully repaid. If the homeowner fails to make the required payments, the lender can initiate foreclosure and repossess the property. The lender or investor who owns the loan then sells the property to recover the money the homeowner borrowed to buy the house.

A foreclosed property is a home or property a bank or lender takes ownership of because the owner failed to make their mortgage payments, or the property fell into major disrepair. Foreclosure is a common reason why a house becomes distressed. Lenders and investors are often motivated to sell these homes quickly to get them off their books and avoid more losses on the property. They’ll typically sell the home through a foreclosure sale or at auction.

If you’re interested in buying a foreclosed home, work with a real estate agent experienced in the foreclosure process. The foreclosure market is often different from a traditional housing market, and those differences can often feel overwhelming to inexperienced buyers. Working with a good agent can make the process easier to navigate.

Short Sales

Homeowners who are underwater on their mortgage and facing foreclosure may try to sell their homes through a short sale. Being underwater, or having negative equity in a home, means the owner owes more on the mortgage than the home is currently worth. In this situation, short sales are a more attractive option for the owner than having their home go into foreclosure.

A short sale happens when a buyer purchases a distressed property for less than the owner owes on the mortgage. Short sales tend to be more beneficial than foreclosure for all parties. A short sale allows the homeowner to avoid a foreclosure’s more damaging financial consequences, and there is less potential loss for investors. All short sale offers have to be approved by the lender.

Real Estate Owned (REO) Properties

When a distressed property forecloses and a bank or lender takes ownership, the house becomes an REO property. This is the last stop in the foreclosure process for properties. At this point, the property gets sent to auction.

Properties that don’t sell at auctions are considered distressed properties. They have been vacated and are sold “as-is.”

Mortgage lenders are responsible for selling REO properties. They don’t typically want the responsibility of maintaining or repairing these properties and may be willing to sell them at a discount. So if you know where to look, you might be able to snag a good deal with an REO property.

Why Buy A Distressed House?

You can benefit from significant financial advantages if you’re willing to take on the risks of buying a distressed property. Let’s dive deeper into reasons a buyer may be interested in purchasing a distressed property.

• As a real estate investment: Distressed houses are popular among real estate investors. Because distressed properties are purchased at a deep discount, buyers can potentially make a profit as soon as they close. With repairs and upgrades, investors can add significant equity to the home.
• As a fix-and-flip project: A seasoned investor, experienced contractor or traditional home buyer may purchase a distressed property to flip it for resale. By spending less to buy the property, buyers can put more money into necessary home improvements. Once the property is flipped, investors stand to profit significantly from the house.
• As an inexpensive housing option: Traditional home buyers can also benefit from purchasing a distressed property. It may help them find a home in their desired neighborhood that they otherwise wouldn’t have been able to afford. For a buyer who wants to make the house their home, it may be cheaper to buy and upgrade a distressed property.

How To Find Distressed Properties For Sale

If you’re like many first-time home buyers, you may feel home prices are holding you back from purchasing. Because distressed properties have a much more attractive price point, buying one can be a great way to afford a home and quickly build equity.

If you’re interested in exploring this option, there are some ways to find distressed properties available for purchase.

Work With An Experienced Real Estate Agent

First, we recommend working with a real estate agent specializing in distressed properties. The right real estate agent can help you find a property, make an offer and even recommend financing options.

Real estate agents can also access a multiple listing service (MLS). An MLS is a great search tool for traditional and distressed properties for sale, and it can only be accessed by a real estate agent.

Make A Private Offer

You don’t have to work with a real estate agent. You can find distressed properties by doing the work yourself.

Here are some steps to buying a distressed property on your own.

1. Browse neighborhoods: Identify the neighborhoods you’re interested in and drive through them to look for homes with telltale signs of neglect.
2. Search for neglected homes: Look for signs like an overgrown yard, broken lights, missing doors, peeling paint on the home and piles of uncollected newspapers or mail.
3. Research the home’s buying opportunity: Research the homes you’ve identified and find out whether you can buy any of the properties. Look online to ensure the properties you’re interested in are being sold legally.
4. Check the property taxes: Property records are public information. Check to see if the property has overdue property taxes. If a homeowner is behind on their payments, they might be motivated to sell.
5. Consider making a cash offer: A cash offer can give you a leg up when a seller is motivated to get rid of their property and wants to close as soon as possible. Some sellers may even accept a lower offer if it’s an all-cash offer.

You can also browse government agency websites, like the Department of Housing and Urban Development (HUD), the Department of Veterans Affairs (VA) and the U.S. Department of Agriculture (USDA). Fannie Mae or Freddie Mac may also offer lists of REO properties for sale.

Finally, you need to pay attention to the listing codes of distressed properties. Properties can be listed as a short sale or an REO property. Take a hint from how long a property has been listed for sale. If a property has been on the market for more than 90 days, the seller may be even more motivated to sell. But you shouldn’t assume a property is distressed because it’s been sitting on the market longer than most homes in that area.

Pros And Cons Of Buying A Distressed Property

If you’ve considered buying a distressed property, you should also consider its advantages and disadvantages. Each can help you decide whether a distressed home is the right fit for you.

Pros

We’ve highlighted some advantages of buying a distressed house.

• Below-market prices: The big draw with distressed homes is primarily their significantly discounted prices. They often sell for lower prices than they’re appraised for. Everyone likes a deal, and distressed properties are a chance to get a deal.
• Potential for high profits on resale: After getting a discount on a distressed home, you can renovate it and sell it for significantly more than you paid. You’ll earn major profits from flipping the home if everything works out.
• Ability to buy in a desirable neighborhood: You’re in luck if you’re purchasing a distressed property in a desirable neighborhood. Homes in highly desirable neighborhoods tend to appreciate in value faster than in other areas. If you stay in the home, you’ll reap the benefits of living in a prime location while steadily building equity.

Cons

We’ve highlighted some disadvantages of buying a distressed house, as well.

• Unexpected repairs and renovation: Buyers should get a home inspection before buying a distressed property if they’re able to. In most cases, buyers rarely have access to information about the condition and past maintenance of the home. Purchasing “as-is” properties is always risky because they may be in worse condition than what you can see with the naked eye.
• Being outbid at auction: Purchasing a distressed property from an auction can be intimidating. We recommend hiring a specialized real estate agent and showing up with cash, especially if you’re in a competitive housing market. House flipping is very popular, expanding the pool of buyers for a smaller pool of cheap, distressed housing.
• No guarantee the property sale or resale will be profitable: As with any property flip and resell, there is always a risk that the house won’t sell or, if it does, it won’t be profitable.

Financing A Distressed Property Purchase: What Are Your Options?

Borrowing money for a distressed home can be a major hurdle to clear because it’s harder for an appraiser to accurately assess the home’s value in its current condition. The home may even appraise for less than your offer. In that case, you’d need to pay the difference or renegotiate the selling price with the seller.

If you don’t qualify for a traditional mortgage loan, you might consider taking out a renovation loan to fund the cost to purchase the distressed property and its renovations. There are a variety of loan options for house flipping and real estate investing. Speak with a lender to learn more about them and if the lender offers the loans.

The Bottom Line: Buying A Distressed Property Can Lead To Great Rewards, But Be Careful

A distressed property can be a financially savvy investment. You buy at a significant discount and can add tons of equity once upgrades are completed. But distressed homes also have a lot of unknowns. Sometimes you can’t get an inspection done, which may leave you on the hook for costly, unexpected repairs.

Rocket Homes℠ lists distressed properties. If you’re interested, speak to a Verified Partner Agent to help find listings that best suit your needs.