Hands-on real estate investors have been buying distressed properties for a quick profit for a very long time. Over the years, investors fine-tuned their methodologies, when it became quite apparent that the use of hard money was easily accessible and came with reasonable loan parameters regarding the working capital required to accomplish their investment objectives.
Generally speaking, real estate investors generate their anticipated profits from:
- Sweat equity, which helps build value and reduce the home’s Loan-to-Value
- Buying an underpriced house
- A bit of luck, or
- Even personal intuition as to an upcoming upgrade to a neighborhood or town.
The real estate market categorizes distressed properties into three primary types -a Short Sale, a Foreclosure, and a Real Estate Owned property. Each type of distressed property comes with unique benefits and risks that differ from the others. Hard money borrowers that are considering jumping into the distressed property pool must assess the specific risks and benefits before making a final purchase decision.
Purchasing an Auctioned Foreclosure
A foreclosed property that is bought from a public sale/auction occurs when the highest bidder has the opportunity to buy the property. Foreclosure sales usually have many competitive bidders, one of which can be the lender who is foreclosing the property. In fact, any lender holding a lien position can bid up to the amount of the debt owed on the property.
The primary benefit of buying a foreclosed property at auction is there is always a possibility of picking up a great deal. Real estate investors assess the value of any given property (including the Loan-to-Value) by using the valuation method that best suits their investment model. Buying a foreclosure include these risks:
- No inspection prior to sale
- The payment of delinquent property taxes
Defects of Title
Buying a foreclosure, especially at a public auction, is NOT for the faint of heart. Amateurs should enter these buying opportunities with a qualified agent or legal counsel.
Purchasing a Short Sale
When the real estate market faltered around 2008, short sales became a go-to option as home prices fell dramatically, and quickly. This was a time when properties were being sold for a price that did not even cover the existing debt on the property. This type of distressed sale:
- Allows the buyer a chance to inspect the property ahead of closing
- Typically has a clear title
- Requires the seller to pay the delinquent taxes
This type of distressed sale purchase requires patience as the lender must give their consent to the transaction -a sale where they receive less money than they are owed.
Purchasing a Real Estate Owned Property (REO)
An REO gives distressed property buyers a chance to buy a foreclosed property directly from the lender. This typically happens when a lender offered the highest bid at an auction and they become the property’s owners. Purchasing an REO is less risky because a buyer:
- Can inspect the property
- The title risks are mitigated.
- The lender is responsible for unpaid taxes
An REO purchase often requires the buyer to pay for purchase upfront, in cash. A drawback regarding an REO purchase is that the property may need significant repairs which remains the responsibility of the buyer. It is noted that lenders who own these REO’s prefer to sell to buyers who have available cash for a quick closing.
Hard money lenders are a great source of financing for distressed properties. Seasoned, insightful investors often find profitable opportunities using hard money financing. But, be forewarned, amateurs should think twice before choosing to go it alone.