Distressed property: How to find and buy distressed homes

Distressed properties often get overlooked in competitive seller’s markets, but they can be a great opportunity for buyers willing to do their homework. While these properties, whether foreclosures, short sales, abandoned homes, or properties in need of repair, come with their own challenges and significant risks, they can be solid investments for the right buyer.

In this guide, we'll explore what makes a property "distressed," show you where and how to find these opportunities, and walk you through the steps to purchase one if you decide this kind of investment aligns with your financial goals.

What is a distressed property?

A distressed property is a home that’s on the brink of foreclosure, is already owned by a bank, or has been repossessed by the mortgage lender. In addition to these financial issues, these properties often have significant physical issues, such as water or fire damage, or are in general disrepair.

Real estate investors often seek out distressed houses because of the opportunity to buy a home at a lower purchase price. An investor might buy a distressed property to use as a rental home or upgrade and sell it at a higher sale price than what they bought it for.

Distressed real estate is often a fixer-upper or abandoned property that needs major repairs or renovations. Home buyers should consider all the costs and potential risks involved in buying a distressed property before signing on the dotted line.

Is a distressed property the same as a fixer-upper?

Not always. A fixer-upper is the term used to describe a home that needs repairs, updates, or renovations. It may have worn flooring, outdated appliances, neglected maintenance, or other issues that need attention. But the owner may be current on the mortgage and feel no pressure to sell.

A distressed property, on the other hand, usually means the owner is in financial or legal trouble, or the home has already been foreclosed on. The distinction is the financial distress.

That said, they often overlap. Many distressed homes are fixer-uppers because the owners lacked the means to keep them up. And in either case, these homes are often listed as-is. This means the seller is unwilling to make repairs.

Understanding the difference, if one exists, in any home you're interested in is key because it colors the way you need to approach the deal.

Why do investors buy distressed properties?

You may wonder why anyone would choose to take a risk on a distressed property. Usually, it’s because buying a distressed property does come with certain advantages that can make up for the downsides and risks.

Real estate investors, particularly those with contracting experience, often seek out distressed properties because they can get a good deal, paying under market value. Plus, these investors are usually well-equipped to handle any problems they discover on the investment property.

Many investors buy distressed properties and fix them up to either flip the house or rent it out. In general, buyers don’t purchase distressed properties with the plan to live in the home. Distressed properties aren’t usually a great choice for first-time home buyers because they often require experience in renovation or remodeling.

What are the different types of distressed properties?

Many types of distressed properties exist. The key distinction is generally who owns the home, how far the foreclosure process has gotten, and whose approval you need for a sale. Let’s explore the four types of distressed properties you’ll typically find.

Preforeclosures

With a preforeclosure, the homeowner has fallen behind on mortgage payments but the lender has not yet completed a foreclosure. During a preforeclosure period, the owner may still be able to catch up on their payments, or refinance, or sell the home.

Homes in preforeclosure offer an opportunity for buyers to purchase the house directly from the homeowner, before it goes to auction. That can be less contentious. That said, the transaction can still be complicated. There could be liens, unpaid taxes, or even lender approval needed to complete a sale. All this must be researched and navigated for a final sale.

Short sales

Short sales are different from foreclosure sales. Homeowners may avoid foreclosure through a short sale, selling a distressed property for less than they owe on their mortgage. This typically happens when a homeowner has an underwater mortgage or owes more on the mortgage than the home is currently worth. In this situation, a short sale could be a more attractive option for the owner.

A short sale happens when a buyer purchases the distressed property for less than what the current homeowner owes on the mortgage loan. This allows the current owner to avoid foreclosure. Short sales can sometimes result in a good deal for home buyers.

Foreclosures

Many distressed houses are the result of foreclosures or preforeclosures. This happens when a homeowner fails to make their monthly mortgage payments or pay their property taxes.

When a homeowner is delinquent on their mortgage payments, the mortgage lender or loan servicer repossesses the property. Occasionally, the lender may accept a deed in lieu of foreclosure to assume ownership.

In the case of a foreclosure, lenders must sell the house in accordance with state laws. They’ll typically sell the home through a foreclosure sale or at an auction, where buyers can buy the home directly from the lender.

Real estate owned (REO) properties

Properties that don’t sell at the initial auction are known as real estate owned properties, or REO properties. These homes are also considered bank-owned properties.

Lenders don’t typically want the responsibility of maintaining or repairing these properties and may be willing to sell them at a discount. If you know where to look, you might be able to snag a good deal on an REO property.

You can find distressed properties with professional assistance or just by learning where to look. The good news is that when you do find these types of houses, there may be less competition for them.

Here are ways you can find distressed properties that are available to purchase.

Work with a real estate agent

The easiest way to find distressed homes is by working with a real estate agent or REALTOR^® who specializes in these properties. The right real estate agent will be able to guide you through the process of finding and buying distressed properties. They may have more information about the home's condition and any risks you should be aware of. You can also ask them for recommendations on financing options.

Search listing sites and filters

Large listing platforms like Redfin may list distressed properties; however, they’re not always labeled as such. To find them, try search terms such as foreclosure, short sale, bank-owned, investor special, handyman special, cash only, or as is.

To be clear, these terms don’t always equate to a distressed property or discount opportunity. That’s why it’s important to check with the listing agent to find details about the condition of the property and expectations of the owner.

Check public records and banking sites

Notices of default, tax delinquencies, foreclosure filings, and liens can often be found through county property records, tax records, and court filings. That can help you find distressed properties before they’re listed for sale.

Banks sometimes also publish REO listings on their sites. You might have to search each lender separately, however.

Look for government-owned or developer-sold homes

Some homes may be sold through federal agencies. These are government-owned properties they typically acquired through foreclosure. These may be listed through agency-approved brokers or government websites.

You can also look for unfinished homes sold by developers. These might not be distressed in the traditional sense, but they might be priced to move quickly.

Search neighborhoods directly

Distressed properties are often easy to spot since so many are in disrepair. So, one good method is to simply drive neighborhoods on the lookout for boarded windows, overgrown yards, code violation notices, or signs of long-term vacancy. You can then use public records to find the owner and determine whether the home is available. When searching neighborhoods, remember to also look for “for sale by owner” signs.

Can you get a mortgage for a distressed home?

It can be challenging to finance a distressed property because the value is difficult for an appraiser to assess. Often, all-cash payments are a requirement for distressed properties sold at auction, and to bid, you’ll have to prove in advance that you have enough reserves to buy the property.

If you find a distressed property close to foreclosure, consider approaching the seller directly. Many lenders may be motivated to move forward with the home sale to avoid the foreclosure process. Conversely, some lenders could be reluctant to finance distressed homes because of the same risks buyers face.

How to buy a distressed property

Buying a distressed property can be more complicated than a typical real estate transaction. A low asking price can be enticing, but the trade-off is often a need for much more due diligence. Here are things to consider.

Decide whether you want to live in it or flip it

This is an all-important decision. If you’re planning to live in the home, make sure you understand how long it will take to bring the home up to a condition for you to move in. Until then, you’ll be paying a mortgage and rent, or a mortgage and hotel costs.

If you plan to flip it or rent the house out, make sure you have a good understanding of whether you’re in a buyer’s or seller’s market, and you’ll make a good return.

Estimate your repair budget

If at all possible, you should get a home inspection and estimates from professionals. Your budget for repairs should also include a buffer for unforeseen problems and delays.

And don’t forget to factor in permits, insurance, property taxes, utilities, and financing costs while repairs are underway.

Qualify the deal before you bid

Compare your total expected investment in the property with the home’s realistic value once it’s done or on the market. Some of the factors you should weigh carefully are:

• The purchase price
• Closing costs and auction fees
• Repair and renovation costs
• Financing and holding expenses
• The home’s value after repairs
• A reserve for unexpected problems

Make sure the numbers still work if repairs or other costs end up being more than expected or the home sells for less than expected. In other words, include a generous safety margin.

If you plan on living in the house, make sure it will both meet the above criteria, but also that it meets your long-term needs. Distressed properties can take a lot of time and effort to get into livable shape, so it may be wiser to buy a move-in-ready home.

What are the risks of buying a distressed home?

There are many potential benefits to buying a distressed property, but these purchases can be risky. If you’re a first-time home buyer, you should consider whether the risks are worth the potential rewards.

The house may seem like an incredible bargain. But you need to consider whether you’re ready to handle the potential delays, expensive repairs, and inconveniences that often come with distressed properties.

Here are a few of the most significant risks that come with buying a distressed home.

Buying a property as is

The biggest risk of buying a distressed property is that the home is usually sold as is. It’s hard to inspect distressed properties before the sale, particularly if they’re sold at auction.

Even if you do get the opportunity to explore the property, the seller often has a limited budget and might not have room to negotiate any home repairs.

Taking on repair costs

When you buy a property as is, you are typically responsible for taking on all repair costs. Depending on the condition of the property, this can add up. For example, as-is properties can have roof issues, plumbing or electrical problems, mold, faulty foundations, and more.

This is why before bidding on an as-is property, you need to do a home inspection and put together a detailed budget on what it will cost to repair and renovate the home.

Getting outbid at auction

Getting outbid on distressed properties at auction is a common challenge. It can be frustrating and hinder your plans. So, just as you must be ready to buy the property, you also should be prepared to lose the bid.

When you buy a home at auction, you can typically attend online or in person. Online auctions are becoming increasingly commonplace.

But regardless of which path you choose, there’s always the possibility that you could be outbid.

Purchasing delays

Delays for distressed property sales are common. That’s because the sale is not as straightforward as buying a home that is not in distress, which takes an average of 30 – 60 days to close.

One issue is that you’re usually dealing with the lender, and they have to approach the closing process on a distressed property very carefully. Plus, there may be some hoops you have to jump through before finalizing the sale. So don’t count on the usual 30- to 60-day average closing window to hold.

Financing challenges

You may have more difficulty qualifying for a loan for a property in poor condition. Appraisers could point to repairs that need to be done before your loan can close, and the seller may refuse to do them.

For this reason, you should research financing early in the process and not assume that preapproval will automatically apply to a distressed home.

What if you’re selling a distressed property?

Selling a distressed property can feel overwhelming, especially since you’re often facing foreclosure, tax issues, or other financial problems. For success, certain steps need to be taken.

Assess the property

Start by determining the home’s condition and approximate market value. It’s wise to seek the help of professionals. A real estate agent can give you a comparative market analysis, while a contractor or inspector can name repairs that may affect the price.

Then, consider the mortgage balance, liens, unpaid property taxes, and other debts that will dig into your profit.

Weigh your options

Never feel as if you don’t have options. You might be able to complete repairs, sell the property as is, negotiate a short sale, or explore alternatives with the lender.

Making repairs, for instance, could pay off in a higher sales price. An as-is sale might help expedite a sale, but at a discounted price. And contacting your lender to make sure you know all your options is a must.

Price it realistically

Be sure to price your home fairly, in line with its condition and the local real estate market. Pricing it too high can cause it to merely sit on the market while your financial pressure increases.

Be transparent

As a seller, you’re generally required to disclose known material defects of your home. Hiding serious issues can lead to delays, canceled sales, and potential legal problems. That’s the last thing you need.

So make sure you are honest with any buyer about the repairs, liens, or other issues that are attached to the property. It’s better to find any issues than have the buyer discover them on their own. Trust and honesty go a long way in real estate.

Frequently asked questions about distressed properties

You may still have questions. Here are answers to the most common ones.

What is the definition of a distressed property?

A distressed property is one that has serious financial, legal, or physical issues. It could be a home in preforeclosure, foreclosure, a short sale, or bank ownership. Or, it could have major damage from a lack of maintenance.

What are the risks of buying distressed property?

Major risks include hidden damage, limited inspection availability, expensive repairs, title problems, financing challenges, and closing delays. You might have to buy the home as is or make an all-cash deal.

Do people buy distressed properties?

Absolutely. They can be a good deal for those who can take on the repairs or navigate legal issues. Investors often buy, repair, and flip these properties for a profit. With the benefits come significant risks, however.

How do I buy distressed properties?

If you’re planning on buying a distressed property, you need to estimate repairs, research the title and property history, inspect the home when possible, and compare the total cost with its likely value.

Can you get a mortgage for a distressed home?

Yes, but it may be more difficult than for a nondistressed home. Financing often depends on the home’s physical condition and the seriousness of the repairs needed. And some auctioned homes are cash-only sales.

Where can you find distressed properties for sale?

There are many ways to find distressed properties. Search real estate listing sites, foreclosure auctions, public records, government programs, individual banking sites, real estate agents, and local neighborhoods. You can also search sites like Redfin using keywords such as foreclosure, short sale, bank-owned, investor special, handyman special, cash only or as is.

Should a first-time home buyer buy a distressed property?

It depends. If you’re a first-time buyer with no home repair knowledge, a tight budget, or a low risk tolerance, a distressed property might not be for you. However, if you have a strong repair budget, professional guidance and flexible timing, a distressed home might offer a good bargain.

The bottom line: Distressed property can be more than you bargained for

Distressed homes offer a unique buying opportunity for real estate investors, but the average home buyer might want to look elsewhere. You may end up biting off more than you can chew and would be better off taking a traditional route to purchasing a home.

If you’re interested in becoming a real estate investor or ready to start the home buying process, you can get started online with Rocket Mortgage.

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