Real estate has its cycles, and different sectors don’t always move in lockstep. On the commercial side, CMBS loan delinquencies ticked up to 4.7% in April 2024, with office loans leading the rise as that sector continues facing headwinds. On the residential side, a limited supply of around 67,000 homes entered foreclosure in Q1 2024, making distressed homes harder to come by.
Regardless of market dynamics, investors seek distressed real estate for its potential to generate outsized returns. This strategy isn’t for everyone. It requires expertise in identifying undervalued assets, managing transactions, and handling repairs and renovations.
What is distressed real estate?
Distressed real estate refers to properties that can be acquired below market value, typically because there is something “wrong” with them. The sellers may be in a difficult situation, like facing foreclosure or needing to offload the asset quickly. Or the property itself requires fixing up, which the current owner is unwilling or unable to do.
The trade-off is that you’re taking on someone else’s problematic situation. However, if you have the right skills and willingness to put in effort, distressed real estate investing allows you to find overlooked, profitable deals that other buyers pass over.
Types of distressed properties
Common examples of distressed real estate assets include:
Foreclosure or pre-foreclosure
These are properties where the current owners can’t keep up with their mortgage payments. Pre-foreclosure starts after three to six months of missed payments. Foreclosure can take several months to over a year and is when the bank finally repossesses the home.
Real estate-owned property
Once the lender forecloses, the property becomes a real estate-owned (REO) property. Banks typically want to get this non-performing asset off their books as quickly as possible.
Short sales
If the homeowner owes more on their mortgage than the property is currently worth and can’t keep up with the payments, they negotiate a short sale. This negotiation with the lender avoids foreclosure and when they give up the property.
Tax-delinquent properties
If owners fail to pay their property taxes, the local government places a tax lien on the property. Investors can buy these assets at tax lien or tax deed auctions.
Pros and cons of investing in distressed real estate
Distressed property investing can be profitable, but it isn’t for everyone. Pros and cons you should consider:
| Pros | Cons |
| Lower purchase price: Distressed assets are often available at reduced prices due to urgent sales needs or property conditions. | Buying a property as is: The trade-off is that buyers take on all existing issues and defects. |
| Potential for higher profits: Buying at a lower cost can lead to greater profit margins after rehabilitating and selling or renting the property. | Property can sell quickly: Urgent situations may require acting swiftly, creating pressure for rushed decisions. |
| Less competition: Fewer investors are willing or able to handle the challenges of distressed properties, which could reduce bidding competition. | Getting outbid at auction: Foreclosure auctions are highly competitive, and you risk losing the property to another bidder. |
| Value-add potential: Distressed properties often provide opportunities to add value through renovations and improvements. | Damages and repairs may need extra investment: Neglected distressed properties typically require extensive, costly renovations. |
| Diversification: Diversify your real estate strategy with options if conditions change elsewhere in your portfolio. | Purchasing delays: Negotiating with lenders on short sales and other distressed deals can lead to lengthy closing delays. |
How to find distressed property listings?
You can find distressed properties through methods such as:
- Auctions: Interested buyers can attend these events in person or participate online. Auctions are advertised in advance, giving you time to research the properties and prepare for bidding.
- Tax records: You can purchase properties with delinquent taxes online or through the local tax assessor’s office.
- Multiple Listing Service (MLS): A licensed real estate agent can provide access to lists of distressed properties listed on the public market.
- Real estate-owned property and bank listings: Banks often list these properties on their websites or through real estate agents.
- Probate courts: Sometimes, a deceased person’s estate must sell real estate to settle debts. If the estate lacks funds to maintain these properties, they can be distressed sales. Checking filings at local probate courts can uncover opportunities.
- Distressed property sites: Several online platforms specialize in listing distressed properties, including foreclosures, REOs, and properties in need of repair.
- Government agencies: HUD (U.S. Department of Housing and Urban Development) lists foreclosed FHA-insured properties online.
- Local foreclosure listings: Local newspapers, online property platforms, and court listings often advertise upcoming foreclosures.
11 Tips for success in distressed real estate investing
If you are looking at buying distressed properties, here are our best tips:
1. Drive for dollars
For residential real estate, this strategy involves driving through selected neighborhoods to identify properties showing signs of neglect or distress. Finding undervalued properties this way can help you beat the competition, but it can be time-consuming and may not yield results.
2. Understand the foreclosure process
Distressed properties in foreclosure go through distinct stages, each presenting different opportunities for investors:
- Pre-foreclosure: The lender issues a Notice of Default (NOD) for missed mortgage payments, and the property enters pre-foreclosure. Check public records/specialized data sources to identify pre-foreclosures. You can approach homeowners during this time to attempt to negotiate a purchase.
- Foreclosure auction: If the default remains unresolved, the lender schedules a foreclosure auction where they sell the property to the highest third-party bidder.
- Bank-owned/REO: Any remaining unsold assets become REO properties owned by the lender. Banks look to offload these quickly, allowing investors to purchase directly.
You can find properties that are in pre-foreclosure using public records or specialized software. Check with your local county recorder’s office for Notices of Default (NOD) and lis pendens filings, which indicate the initiation of foreclosure and related lawsuits affecting the property’s title.
3. Bid on homes
Real estate investors can bid on distressed property through these avenues:
- Foreclosure auctions
- Tax lien/deed sales
- HUD FHA-insured foreclosed homes (bid through a registered agent)
4. Conduct due diligence
Before investing in a distressed property, you’ll want to evaluate its potential value and identify any risks or issues that could impact your investment. If you uncover any potential pitfalls, you’ll have the bargaining power to renegotiate or walk away from a deal. Common due diligence areas to examine include:
- Property inspection: Hire a licensed property inspector to comprehensively assess the property’s structural condition, systems, defects, code violations, and needed repairs.
- Title search: Order a full title search to examine ownership history, liens, judgments, surveys, and easements.
- Review records: Check ownership records, permits for renovations/additions, outstanding code violations, and any pending legal claims or lawsuits.
- Comparable sales: Analyze recent comparable sales of similar properties in the same neighborhood to assess pricing and value.
- Development plans: Research approved development, rezoning, or construction projects that could impact the area and property values long-term.
- Location evaluation: Evaluate amenities, school quality, walkability, and transportation access to understand potential appeal to future buyers/tenants.
- Operating costs: Assess potential long-term costs such as taxes, insurance, utilities, and maintenance/repair reserves.
- Tenant diligence: For commercial real estate properties, review tenant leases, rent rates, terms, and tenant financials.
- Zoning compliance: In the commercial property space, verify current zoning, land-use compliance, pending changes, needed permits, or other regulatory compliance factors.
- After-repair appraisal: Hire an appraiser to determine the property’s expected market value after renovations.
5. Learn about the underlying market drivers
Understand the factors that influence property values in the area. These include local economic conditions, employment rates, population growth, and real estate market trends.
Research these drivers by checking municipal reports, chamber of commerce data, census figures, and economic forecasts from local universities or public policy organizations.
6. Develop strong relationships
Build a network of other investors, wholesalers, real estate agents, and contractors. Leverage local real estate investment clubs, meetups, and networking events to make these connections. A strong local network can tip you off to off-market deals, connect you with trusted contractors, and provide mentorship from veteran investors.
7. Secure financing
When you are dealing with motivated sellers and distressed real estate, you need to be able to act quickly on opportunities. Line up financing options ahead of time so you can make competitive offers before other buyers. Options can include:
- Traditional bank financing like conventional mortgages and commercial loans.
- Hard money loans from private lenders who can close quickly with less stringent qualifications.
- Investor capital by partnering with equity investors to pool funds.
8. Consider partnering with a private equity firm
Working with a private equity firm can help with capital and expertise to manage and renovate distressed investments. This collaboration supports tackling larger-scale projects.
These companies can often negotiate better deals and get early access to distressed properties before they hit the broad market. Their investment processes and due diligence help reduce risks, especially on complex distressed deals.
Private equity also tends to have longer investment horizons, allowing enough time for extensive renovations and repositioning of distressed commercial real estate assets.
9. Negotiate effectively
To negotiate the best deal, evaluate the property’s value and recognize the seller’s motivations. Make a compelling offer that addresses your needs and the seller’s while being ready to compromise to close the deal.
10. Renovate or rehabilitate the property
Make any repairs or upgrades to increase the property’s value and appeal. This allows you to reposition the property for sale. Focus renovation efforts on:
- Prioritize renovations with the highest ROI, such as kitchens, bathrooms, and curb appeal upgrades.
- Obtain proper permitting and renovate to current code standards.
- Consider phasing major rehabs to maintain partial rental income during construction.
- Align renovation choices with your intended exit strategy -flip vs. rent.
11. Market strategically
With renovations complete, develop a marketing strategy to position and capture the full value you’ve unlocked in the distressed asset:
For residential properties:
- Hire a real estate photographer and videographer to showcase the property’s upgrades with high-quality media.
- Leverage online marketing platforms and social media to maximize listing exposure.
- Use email marketing to send property information to your investor network/database.
For commercial properties:
- Partner with a licensed broker to develop tailored marketing materials.
- Have a property website and 3D tours for larger assets.
- Highlight cap rates, operating expenses, and rental upside in your marketing.
Conclusion
Distressed real estate investing can be a profitable investment strategy. Finding good deals takes work, and you’ll want to thoroughly inspect properties before buying them to make sure they’re worth it. However, the potential profits are huge for investors willing to roll up their sleeves.
If done right, finding distressed properties at lower cost and fixing them can yield major gains. Investors with the right mix of expertise, persistence, and a solid game plan can capitalize on this path to outsized profits.
