If you are a fan of reality TV, you have probably noticed an overabundance of house-flipping shows, and each show paints a picture of a little hard work followed by nearly risk-free profit for those who endure. You may not be surprised to find out that sometimes reality TV is anything but real. Even if you are not looking to build a career as a home flipper, you might be in the market to purchase a short sale or foreclosed property. These properties are often called distressed properties.
Regardless of where you dabble in the financial marketplace, one obvious but key fact is worth noting: Financial risks that work out in your favor are sometimes handsomely rewarded, and those that do not are almost always severely punished. This begs the question: Is a distressed home a risk worth taking?
In January 2012, one out of every 624 homes was served with foreclosure paperwork. Once the federal government settled with the nation's largest banks concerning the robo-signing scandal, a new stock of foreclosed homes hit the market. By the end of the first half of 2012, foreclosure documents had been served to more than 1 million homeowners, according to RealtyTrac. Although some believe bargain basement prices for distressed properties may be ending, a large inventory still exists.
Who Should Consider Distressed Properties?
Distressed properties often come with baggage. This could be in the form of mild to severe property damage, unpaid HOA fees, taxes, second mortgages and various other liens. Distressed properties are rarely move-in ready. Significant renovation and repair costs could eliminate any potential profit. Homebuyers with the time, skill and experience to conduct large-scale renovations will find these properties a better value.
Since distressed properties are bank owned, the amount of time it takes to accept or decline an offer can sometimes be weeks or months. Approval time often lengthens with title issues or other questions of ownership. Sorting out these details is best left to experts.
It Is Not Easy Anymore
Low prices and an improving economy have caused investors to go after distressed properties. Because of this, a bidding war among aggressive investors can leave individual homebuyers on the sidelines. In cases where an individual beats the dueling investors, the price is often much less of a steal than it would have been.
According to the Wall Street Journal, experienced foreclosure buyers often bid significantly higher than the asking price. Just because it is distressed does not make it a bargain. Sometimes a traditional sale will yield a better price with faster results.
How to Purchase
Before wasting valuable time making offers and waiting for an answer, make sure you have the loan approved on your end.
Let a Contractor See It
If you are not doing the repairs yourself, ask a contractor to go with you. You need to know how much it will cost to renovate before you can make an offer.
Cushion Your Budget
You should have professionals take a detailed look at the home, but understand that the actual final cost of renovation will likely be higher than estimates. Add 10 to 20% to your renovation budget.
Know Your Price
Offer a realistic price that fits your budget. Those looking for the deal of the century are not going to get the property with such fierce competition.
Understand the Investing World
The real estate investing world will not always be fair. Sometimes homes are listed at lowball prices to attract sales leads while others will have a "secret" price known only to the insiders. Do not get frustrated when you encounter injustice. Simply move on to the next home.
Headaches, frustration and the feeling that nobody is working on your deal are all normal. On one hand, do not expect everything to happen overnight. On the other, don't be surprised if sudden decisions are called for.
The Bottom Line
Distressed homes are not the bargains they used to be, but there are still deals to be had. Work with a professional who has experience with distressed properties and above all else, know you budget. With distressed properties, the money you shell out at closing is only the start of your financial outlay. However, when you find the right property at the right price, it will all seem worthwhile.
More From Investopedia