Distressed properties, such as foreclosed or short-sale residences, have historically been a popular target for home flippers and real estate investment professionals. Where others see peril, they see profit, and in the eight years following the Great Recession many were more right than wrong.
But lately, distressed properties for sale have declined, with the delinquency rate on U.S.-based single-family residential mortgages sliding from 6.15 percent in the first quarter of 2015, to 4.84 percent in the first quarter of 2016, according to CoreLogic.
That trend continued through the second quarter of 2016, CoreLogic reports.
“Foreclosure inventory plunged 25.9 percent in June from the same time last year, while completed foreclosures were down 4.9 percent,” the data analysis company says. “The number of completed foreclosures as of this past June (38,000) represents a decline of 67.5 percent from the peak (117,835) in September 2010.”
About 1 percent of all U.S. residential properties holding a mortgage were in the foreclosure process in June — that’s the lowest foreclosure inventory rate in nine years, CoreLogic says.
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So with fewer distressed properties available, and an army of seasoned and savvy professional investors still in the market for new foreclosed and short-sale properties, that begs the question: Should average investors even consider dipping their toes into the distressed home market right now?
It all depends upon which real estate industry insider you ask.
“Buying a distressed property can be a great investment if you know what to look for,” says Mark Ferguson, founder of Invest Four More in Denver, and a real estate investor who has flipped more than 100 properties. “But just because a property is distressed does not mean it is a good deal. Banks who sell their foreclosures are trying to get as much money as they can for their properties, and do not simply want them off their books.”
Ferguson says the two most important things new property investors need to know when dealing with a distressed sale are what the home will be worth when it is fixed up and how much the repairs (and there are always repairs) will cost.
“It makes no sense to buy a home for $130,000, make $30,000 in repairs and have a home worth $160,000,” he adds. “You need a reward or motivation to go through the repair process, plus it will take more cash to buy a house that needs repairs.”
Ferguson says he likes to see at least a 20 percent spread between the repaired price minus the repairs and the final price tag on the home.
“I would want to buy that $160,000 house for $104,000 if it needs $30,000 in repairs,” he says.
The reason you want such a high reward for buying a distressed property is that it takes more cash to buy them, Ferguson adds.
“Most banks will not lend on houses that need a lot of work,” he says. “Those banks that do lend on those houses will almost never lend money for the repairs, just the purchase price.”
The mantra for newer distressed property investors might well be, “no pain, no gain.”
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“For the most part, distressed investment has provided a good return,” says Adam Jernow, owner of WayFinderPM, a property management firm based in New York. “However, the lessons are usually learned from the disasters.”
“One property flooded and also caught fire,” he says. “In both cases it wasn’t the flooding that ruined the deal, it was the operator (the person running the deal). Consequently, you have to choose carefully if you’re not running the project yourself.”
If you’re chomping at the bit to get going, aim low, home style-wise, Jernow advises. And always place your bets on good neighborhoods.
“I started with ugly apartments in great areas,” he says. “My first was an awkward apartment in New York City’s Soho neighborhood. It was priced low and other buyers didn’t want the risk. But I wanted the risk and the reward.”
Jernow says the apartment did well as a rental and then eventually as a sale.
“To make it work, I found reasonable contractors, worked with the co-op board and neighbors to achieve a better apartment and I read a ton online about renovation mistakes,” he says.
Also, if and when you pursue a foreclosed property, avoid bidding on properties at foreclosure auctions, which many new investors try to do.
“The problem is that buyers have to bid sight unseen — they don’t have access to the property,” says Brian Davis, a real estate investor who owns 15 properties, and co-founder of SparkRental.com “Unless they have inside knowledge, they’re bidding without knowing the condition of the property.”
That’s one reason why nearly all homes fail to sell at foreclosure auction, and the bank ends up taking the property back themselves, Davis says.
“A more viable option for invest in distressed homes is to contact homeowners in foreclosure and make an offer to buy the property before it goes to auction,” he says. “The “We buy ugly houses” crowd has been using this model successfully for years. They come out, inspect the property, and make a lowball offer with the promise of a fast, cash settlement.”
Most homeowners in foreclosure don’t have any equity, making distressed properties a numbers game, Davis adds.
“Occasionally the lender will accept a short sale, but in most cases investors can only make money on distressed homes with plenty of equity,” he says.
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It’s a tough time to enter the distressed property investment market, with foreclosures on the decline. That said, there’s always a recession around the corner, unfortunately, and by studying up now, you’ll have a leg up on the competition when, equally unfortunately for the homeowner, the next round of distressed homes hits the market.
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Distressed Property: A Clean Play for Investors? originally appeared on usnews.com
