Have you ever looked at a distressed property—a truly distressed property—and been thrilled with the idea of buying it, renovating it, and renting it?
It can be an appealing notion, especially if you’re an investor with an imagination.
With so many areas undergoing revitalization, the idea of taking a cheaper distressed property and making it something valuable in an up-and-coming market seems attractive.
But is it actually worth it?
To really answer the question, we have to first get on the same page about exactly what is a distressed property and what makes it different than, say, a regular fixer-upper.
Think of it this way. Your average, everyday fixer-upper is a property where an investor can see some subtle changes and improvements in their mind’s eye and know that those improvements will increase the value. This would include basics like quality paint, new flooring, maybe removing a wall or moving some rooms to change the flow of the house. An investor can see minor changes that are relatively small-dollar improvements and know that those changes will help them meet their ROI.
Whether an investor intends to hold for long-term or to try for a quick turnaround sale, these types of properties are ideal because of forced appreciation. If an investor can perform the right renovations and do them inexpensively, then the return comes from the forced increase in value. This allows them to pay more and consider more properties with lower discounts.
On the other hand, a distressed property, for the sake of this discussion anyway, is one that has a few more warts than your average ole fixer-upper. Those warts could be fire damage, water damage, foundation issues, and years or even decades of neglect and vacancy. A distressed property comes with its own set of issues, and they are truly unique.
Those issues are often enough to scare even experienced renovation investors away from a deal. They are simply too big, there are too many unknowns, and they come with increased risk. So, why the appeal?
Along with risk, they often promise an even bigger reward. It takes nerves of steel to walk into a distressed property in need of a complete overhaul and smile like you know this is going to be a home run.
With all of the unknowns, the questions and the risks, these highly distressed properties hold a promise that is very enticing. So what does an investor need to know before embarking on a challenge like this? We’ll start here and see where this list takes us.
4 “Must-Knows” Before Taking on a Distressed Property
1. Low market price doesn’t mean low-cost.
New investors often make the mistake of buying the cheapest properties on the market, thinking that they’re going to make the best investments. It’s not bad logic: Reduce your costs by saving on the property, and you’ll earn more, right? Not so fast!
A low-cost price tag for a property does not always mean the property isn’t as valuable. You can rightly assume the quality isn’t there, at least when you buy it as-is. You can assume the property is discounted due to the condition and work needed. But that does not mean that you ignore basic investing 101.
An investor still needs to know the basics of how they are going to earn a return on a property. A cheap property in a bad area is still going to demand the same low rent no matter how nice you make it. Therefore, you cash flow won’t be as good. Ask me how I know this!
Obviously, a distressed property has that nice low price tag because it has some problems. Those problems have to be fixed. Even if that initial price tag looks nice, you have to know that you’re about to need to go through the costs of getting it to a place where it pays off. And you have to be open to the fact that the payoff simply may not happen with that property, no matter how low-cost and attractive the price may be.
Maybe you aren’t going to go through the full lengths a flipper would, but it still adds up—and you don’t necessarily have the…