Distressed property: What you should know

If you’re looking to buy a new piece of property, the sky-high prices of today’s hot housing market might look a bit scary. However, those overwhelming price tags are typically attached to homes that are in good condition. To find a more budget-friendly deal, you might want to search for what’s known as a distressed property.

What is a distressed property?

A distressed property will cost less than other similar-sized homes in the area. But there is a reason for that discount: Typically, the home is either under foreclosure, or the lender is trying to sell it. The most common reason for a home to be classified as a distressed property is a homeowner who couldn’t pay the mortgage or the property taxes.

Distressed property sales make up a small portion of the overall housing market. According to data from the National Association of Realtors, distressed sales accounted for less than 1 percent of all transactions in each of the first two months of 2022.

Types of distressed properties

There are several types of distressed properties in real estate. Here’s a rundown of the most common kinds you might find in your search.

Foreclosures

A foreclosed property is the most commonly known type of distressed property. In this scenario, the homeowner has failed to make his or her monthly mortgage payments for many months in a row, and the lender has officially filed a default notice.

Some people buy homes that are in preforeclosure — typically when the owner has hit the 90-day past-due point in payments — and others buy them when they are fully foreclosed at public auctions.

REOs

REO stands for real estate–owned, which is synonymous with bank-owned. If a property is described as an REO, the lender is the seller. In this case, the home went into foreclosure, and it did not sell at auction. So now, the lender is working to recoup some of its losses.

Short sales

In a short sale, the lender has not yet taken the property back. Instead, it has worked out a deal with the current owner to sell it for less than it’s worth. In this scenario, the property is on the path to foreclosure, but a short sale can avoid that final piece of the credit-destroying puzzle. So, the property is technically distressed, but it’s likely on the earlier end of that stress.

Pros and cons of buying a distressed property

Buying any property is a major purchase with a long list of pros and cons. But buying a distressed property comes with a different set of advantages and drawbacks. While a low list price can be especially appealing, be sure to weigh these considerations before heading down a road that leads to a distressed property.

Benefits of buying distressed properties

Lower price

The main appeal of a distressed property is money. If a lender isn’t receiving any mortgage payments, it’s going to want to accelerate the sale timeline to get the property off its books. Once a borrower defaults on the loan, the lender is looking to figure out a way to get cash for it and move on. You, as a buyer, might be able to enjoy a significant discount.

Potential for future profits

The adage of “buy low, sell high” rings true in real estate investing. Distressed properties are a prize for anyone who knows how to navigate the world of buying fixer-uppers and flipping them. You might be able to buy a property at a discount, accumulate some sweat equity and sell it for a big gain to boost your bank account.

Risks of buying distressed properties

Potential for serious repairs

A lot of distressed properties are sold as-is, meaning the buyer doesn’t get to ask for any repairs prior to closing the deal. If the previous homeowner couldn’t afford to make mortgage payments, it’s safe to say that he or she also couldn’t afford to invest in the upkeep of the property. While you might be confident in your DIY skills, you could be acquiring a property that is going to require a serious amount of time — and money — to bring up to speed.

Title issues

The previous mortgage might be wiped away on a foreclosed property, but what about the property taxes? If you wind up purchasing a house with unpaid taxes, it might fall on you to settle the bill. Be sure to think about additional financial issues you could inherit from a delinquent owner.

Long time to close

You might think that buying a distressed property reduces some of the transaction time, but it’s actually the opposite. Short sales, ironically, can take a long time — up to a full year in some cases. If you’re hoping to get started on the necessary work soon, so you can either move in or sell, be ready for some bad news: You’ll probably need to wait.

How to find distressed properties

If you’re interested in exploring distressed properties, it’s wise to find a real estate agent who has experience navigating this potentially rocky terrain. That way, you will have an expert on your side who can help you understand which listings — if any — are a smart investment.

You can browse for distressed real estate on your own, too. Popular sites like Redfin and Zillow include foreclosures in their databases. RealtyTrac is an online destination solely for distressed properties, where you can find information about recent activity in preforeclosures, REOs and auctions to gauge how much money distressed properties are selling for in certain markets.

In some cases, you can also browse REO listings directly from the lender. For example, big banks like Bank of America and Wells Fargo have dedicated bank-owned websites.

Bottom line

At first glance, foreclosures, REOs and short sales can look like incredible bargains. If you’re operating with a small budget, finding one of these lower-priced homes might seem like your best option to become a homeowner. Be careful, though. Distressed properties can create distressed owners who feel the worries of needing to invest loads of money to make the home livable.