How to Minimize Your Risk When Investing In Distressed Property
Real estate professionals should be careful about investing in distressed property when the property are in neighbourhoods with lots of crime and poverty because the property can be too risky, even though distressed property values are lower.
Generally, you’d think that distressed property is where the best deals are. If you aren’t careful you can end up with a property in poor condition and that can’t be repaired profitably.
The attraction to pursuing distressed property is that they are cheap. Highly motivated sellers that are behind on their mortgage payments live in distressed property. Motivated sellers close quicker and price their property for less.
You might be on a beer budget and have champagne ROI taste. This appetite for high returns is risky. Your investment in distressed property might blow up in your face; You could be left with no cash and a property that is full of write downs. Write downs are losses. Write downs are when the value of the property is less than what you purchased it.
Losses can happen because you can’t find good tenants. When you purchase property in impoverished, high crime, low educated neighbourhoods with high vacancy you are left with poor tenants.
Unless you are flipping distressed property you rely on cash flow. Watch out and pick distressed property in a good neighbourhood. Good neighbourhoods have lower vacancy rates and people that can hold a job because they are educated. Try Neighborhood Scout to research profitable neighbourhoods.
Property in a lot of areas in the United States have high cap rates. Balance high cash flow properties for negative characteristics that can come with the neighbourhood.
Not all distressed home owners want to sell their property. Many want to stay in their home. Help them refinance their mortgage by building relationships with lenders. You can earn a finder’s fee.
Some distressed property are not worth your time
You can get distressed property that are in such poor condition that they are unable to be redeveloped profitably. Since you could be buying distressed property sight unseen and and that are out of state, you might buy a building that doesn’t produce cash flow.
Sometimes it is considered predatory to only do deals with highly motivated sellers that are experiencing financial distress. Many articles advocate using principled negotiation, which is finding win-wins. Other online articles recommend highlighting the pain the seller is experiencing, making it tough on the seller, and using a more aggressive close. The second type of negotiation is closer to predatory than the first because there is no empathy for the seller. There should be a focus on solving a real problem for the seller. Once you know what problem you are solving for a distressed seller the deal will be easier to close.
You might consider yourself a problem solver providing a solution to someone in a tough situation.
The transaction cost might not be worth the investment unless you purchase in bulk. Lower net present value of purchasing one unit compared to the work to close the deal (sourcing a principal seller and the risk of dealing remotely) might require you to purchase more properties to make your business profitable.
The more you deal in bulk the more you run into fraudulent sellers. Don’t accept spreadsheets listing properties as verification that the seller is real. Try to get proof of ownership so that you know that you are dealing with the principal seller. You might have to sign a NCND (Non-Circumvention Non-Disclosure). Even after signing this document fraudsters can still steal your buyer and cut you out of the deal. Rely on the real estate marketplace’s Urly Bird Grade, which is a consensus as to how trustworthy the seller is who you are dealing with.
The main risks you experience when buying distressed property are whether it is in a good neighborhood that can still be profitable given it’s crime rate, income and education. The condition of the property is also a concern because it might not be well kept.
What are your experiences purchasing distressed property?
This post was initially published on Access The Flock Real Estate Marketplace.