Bumpy Ride for Distressed Property Buyers

• January 27, 2017

So, you want to jump on the distressed property bandwagon? Well, hang on; it can be a bumpy ride. I've purchased over 260 of these properties. The first three or so were the real estate equivalent of elementary school-skinned knees, huge learning curve, lots of unexpected bills. The next dozen properties were like high school and college: still a lot of learning, but definite progress and profit potential. Ask anyone who has done a lot of deals. You don't really hit the grad-school equivalent of real estate investing until property number 20. Even then you'll still learn something new every day, but you'll have the experience and resources to see you through.

When individuals who haven't completed an elementary education in real estate investing want to begin with something as challenging as a distressed property, I'm tempted to shout, "Put your money under your mattress!" There are a lot less risky ways to invest in real estate. What are the signs that an individual is on the road to probable disappointment or disaster? He or she says one of the following:

"Foreclosures must be easy to find. I read about them every day in the paper and everyone seems to be buying them."

Everyone seems to want to purchase foreclosures, but very few are successful. Good quality properties at a sufficient discount are in short supply relative to the demand. Oh, there are plenty more coming down the pike from the shadow inventory, but the banks are releasing them at a very low rate to avoid damage to their balance sheets.

My company purchases about 6 properties per month, however, good value ones are so difficult to find that we average 48 offers for every one that we have won over the past two years. And that win rate is with a full time staff. There is simply no free lunch; finding high value quality properties is real work. Most buyers over pay because they don't fully calculate the true costs of getting the property renovated and rented.

"I think it is safe to buy; the market must have hit bottom by now."

In fact, the double dip is already here and property values in the majority of U.S. cities are projected to go down farther before they hit bottom. Realty Trac reports that we currently have $1.5 trillion and 41 months of existing inventory to work through, not even considering the shadow inventory. It will be difficult for the market to recover before we clear out the toxic loans.

Most respected economists project that it will take 3-7 years in most regions before the backlog of foreclosures is off the books and the market turns around. Moody's Economy projects that it will be 2033 before California returns to its prior peak. It is critical to buy in a region and neighborhood that is at low risk of further declines. One gauge is to find out how much negative equity there is in a particular neighborhood and how much it has declined so far. The more it has declined from the peak, and the more negative equity there is, the more likely it is going down farther.

"The only cost after purchase should be just a little paint and carpet."

I wish I knew how many times I have heard this from a new buyer or an agent. In fact our company spends on the average an additional 17% of purchase price before a property is leased or ready to sell. And these are properties that need just cosmetic attention! Some of the typical costs that are in addition to the initial rehab estimate are: closing costs, debt service, taxes, insurance, advertising, lease up fee, property management fee, utilities and additional surprise real rehab costs, just to name a few. What one thinks is a nice rent ratio at purchase turns out to be something considerable less by the time the first rent check is deposited.

"How hard can it be? I think I'll do it myself."

I won't say turning a distressed property into a profit maker is rocket science, but there are many moving parts, and the cost of mistakes and delays is high. I highly recommend getting an experienced partner or purchasing from a reputable source with a lot of experience. Don't reinvent the wheel; your elementary education will be too expensive. Wait until you're a graduate-level investor to purchase and turn distressed properties on your own. All indicators are that distressed properties are here to stay for quite a while-you have time to learn without breaking your bank.

I enjoy assisting new investors and welcome your questions.