What is a Distressed Property?
What is a Distressed Property?
When a property owner is unable to make mortgage payments as agreed, the lender seizes the property in foreclosure and typically resells it at auction. If the lender is unable to do so, the ownership reverts to the lender, and the distressed property becomes an REO (real estate-owned) property.
Some lenders try to sell REOs on their own, while others work with real estate agents to list and sell the property.
In general, distressed properties fall into one of the following categories[1]:
- A short sale to avoid foreclosure.
- A property at some stage of the foreclosure process.
- An REO.
- A tax lien sale.
More rarely, a distressed property could be an unfinished structure where construction halted due to a financial problem.
Pros and Cons of Buying a Distressed Property
For real estate investors, there are several advantages and disadvantages to investing in distressed properties.
| Pros | Cons |
| Can often buy properties at a steep discount; with high potential profits. | Properties are typically sold “as is” and may require extensive repairs or renovation[2]. |
| May acquire property in an otherwise unaffordable neighborhood. | The buyer may have to pay off other liens (mortgages, back taxes). |
| Bank-owned properties may have favorable financing options. | The buyer must have the cash to pay the auction price in full on the day of the auction. |
The process for buying a distressed property is different depending on whether it is a short sale, a foreclosure, or an REO. These are some things to keep in mind about each property type:
Short-Sale/Pre-Foreclosure
- The seller complies with property disclosures and inspections.
- The buyer can use mortgage financing.
- The lender must approve the sales agreement if the sales price does not cover the outstanding mortgage balance and closing costs in full.
Foreclosure Auction
- No inspections or disclosures are available; the buyer gets the property as-is.
- The buyer must be able to pay the purchase price in full on the day of the auction.
- The lender can buy the property at auction if they believe the price is too low.
- The buyer should do a title search before the auction or risk being liable for other mortgages and liens.
REOs
- Lenders can negotiate the sales price, down payment, closing costs, and escrow length; mortgage financing is an option.
- The buyer will get a clear title to the property.
- The lender cannot provide disclosures, but inspections are allowed. However, the lender typically will not perform repairs, so the property is sold as-is.
RELATED: Foreclosure.com Review: How Can It Help Real Estate Investors?
How to Find Distressed Property
Multiple listing services (MLS) and real estate sites such as Zillow list many distressed properties. A real estate agent with experience in distressed properties may also be a good resource; an agent can also do a comparative market analysis to help buyers determine a competitive offer.
Distressed properties draw a wide range of investors prepared to pay in cash, so potential buyers need to bring a solid offer.
- Check local newspapers for auction notices or use sites such as Auction.com, RealtyTrac.com, and RealtyBid.com to find tax and foreclosure auctions. Distressed property sites such as Foreclosure.com are other good resources.
- Search bank and lender websites for REOs; many major banks (Bank of America, Wells Fargo, M&T Bank, BB&T, CitiMortgage, for example) manage their own listings.
- A surprising number of government agencies own distressed properties. In addition to the obvious ones (HUD, FHA, VA), check the IRS, USDA, and FDIC sites[3]. The U.S. Marshals website lists property seized by the FDI, DEA, and ATF.
- Network with local foreclosure and probate attorneys for leads on potentially distressed properties.
- Real estate wholesalers often know the distressed property market better than anyone. They do the legwork of scanning auctions and tax sales; they may even have distressed properties in their pocket that have not hit the market yet.
Takeaways
After the real estate crash of the late 2000s, the market was flooded with distressed properties. Although the housing market has mostly recovered, investors can still find motivated sellers and good deals on distressed properties.
Many lenders and government agencies maintain their own distressed property listings and may even offer favorable financing terms. Buyers at tax and foreclosure auctions, however, need to be prepared with cash on the day of sale.
Sources
- Eberlin, E. (2018.) 7 Times You Can Get a Property Below Market Value. The Balance Small Business. Retrieved from https://www.thebalancesmb.com/types-of-distressed-properties-2124840
- Lerner, M. (2014.) Pros and Cons of Buying a Distressed Property. Realtor.com. Retrieved from https://www.realtor.com/advice/buy/pros-cons-buying-distressed-property/
- United States Department of Agriculture. (n.d.) Properties for Sale by the USDA-RD and USDA-FSA. Retrieved from https://properties.sc.egov.usda.gov/resales/public/home
