What is a Distressed Property? 10 Types of Distressed Homes Defined

Ever wondered what is a distressed property in real estate? Perhaps you want to know about the different types of distressed properties?

Either way, you’ve come to the right place!

We’ve come across many a distressed property over the years, so are well-placed to walk you through everything you need to know, especially if you’re considering buying a distressed property. 

What Is a Distressed Property? Our Distressed Property Definition

A distressed property is a home that’s either under foreclosure or being sold by the lender at a lower price compared to other homes on the market. This unfortunate situation typically arises when the homeowner is unable to meet their obligations, particularly in terms of keeping up with mortgage payments.

In addition, there are other situations that can result in a distressed property, such as:

• Damage from natural disasters
• Abandonment
• Divorce

These external factors can lead to a homeowner’s inability to maintain their property and uphold their financial obligations to the lender.

For example, let’s say that you’re looking at a certain property with standing water in crawl space areas. This is a red flag that the homeowner may be dealing with financial difficulties and unable to maintain their property adequately. In this case, the home would likely be considered a distressed property.

Now you’re aware of the distressed property meaning, let’s look at how this differs to the actual sale of the distressed property.

So, What Is a Distressed Sale in Real Estate?

A distressed sale typically happens when a property, often a home, is sold in urgency by the distressed homeowner who is under financial pressure. The homeowner might be facing foreclosure due to missed mortgage payments, or they might need to relocate quickly for a job, which leaves them no time to wait for a typical home sale process to unfold.

Because these homeowners are under stress to sell, they often list their properties at a price that’s below the market average to attract buyers quickly. This type of sale can attract real estate investors in search of properties to flip, as well as buyers who are in the market for great deals on distressed properties.

Knowing how to find distressed properties in your area is a great way to get a home for a better value than you usually would, which is great for those of you into real estate investing.

Note that distressed properties may still be sold at fair value for cash. If this is something you’re interested in, and you’re local to South California, contact us today!

10 Different Types of Distressed Properties

We bet there’s a category below you weren’t aware of!

1. Foreclosure Auctions

Foreclosure auctions represent one of the most common types of distressed properties. A foreclosure occurs when a homeowner fails to make their mortgage payments, prompting the lender to take legal action to recover the unpaid debt.

The property is then auctioned off, usually by the county sheriff, to the highest bidder. This auction often takes place at a public location, such as a county courthouse, or online.

These homes can be a great find for a savvy buyer or real estate investor, although they come with a high level of risk.

Note that selling a house in foreclosure means that the lender is probably looking to recoup the remaining balance of their mortgage. This could mean that the house might be listed at a higher price than its current market value. Therefore, it’s always a good idea to conduct thorough research and have the property inspected before making a bid.

2. Pre-Foreclosures

Pre-foreclosures represent the initial stage of the foreclosure process, occurring when a homeowner defaults on their mortgage but before the property is officially foreclosed by the lender. During this stage, the homeowner still retains ownership of the property, but they usually have a set period to rectify their financial situation.

If the homeowner can’t make the outstanding payments or sell the property within this period, the lender may proceed to foreclosure. However, some homeowners opt to sell their home during the pre-foreclosure stage, often at a lower price, to avoid foreclosure.

For example, a homeowner who knows they can no longer afford their mortgage payments may list their property for sale to try and recover some of their investment before it’s too late.

3. Short Sales

A short sale is, in essence, a seller’s last-ditch effort to avoid house foreclosure.

When a homeowner owes more on their mortgage than the current market value of the property and can’t keep up with the mortgage payments, they might negotiate with their lender to sell the property at the lower market value, hence the term “short sale.”

It’s often more cost-effective for a lender to agree to a short sale than to carry out a foreclosure, which can be a lengthy and expensive process. Plus, short sales are usually in better condition compared to foreclosures, as they are still inhabited, and thus maintained, by the homeowners.

However, if you’re eyeing a short sale property, remember that buying one is not like a standard home purchase. It often involves a greater deal of bureaucracy and can take several months to close, as you’re negotiating with the lender and not just the homeowner. 

Also, selling distressed property in this way can be complicated and daunting for homeowners. For example, they might need to provide a hardship letter explaining why they can’t keep up with the payments or obtain approval from multiple lenders if there are more than one mortgage on the property. But if you’re patient, you could end up with a real gem at a significantly reduced price.

Additional reading: Short sales 101

4. Bank-Owned REOs 

Bank-owned real estate owned properties (REOs) are homes that have already been through the auction process but received no bids or the bids did not meet the lender’s reserve price. As a result, the ownership of the property reverted to the bank or lender.

Banks are NOT in the business of owning homes, so they often list these properties for sale, typically through a real estate agent.

REOs can be an attractive option for buyers because the bank will usually deal with any outstanding liens or back taxes before selling. The bank may also allow for a home inspection and might even finance the mortgage or offer attractive terms to sell the property quickly.

However, in this scenario, the bank will be selling a house as-is and will not make any repairs before selling. The buyer, therefore, assumes the risk for any hidden issues or damages. Plus, because the bank is looking to recover as much of the unpaid loan as possible, the asking price might be higher compared to other distressed properties.

5. Government-Owned REOs

Government-owned REOs are properties that have gone into foreclosure and been bought by a government agency. This usually happens when the original homeowner defaults on a government-backed mortgage, such as a Federal Housing Administration (FHA) or Veterans Affairs (VA) loan. 

The government agency takes over the home after the foreclosure process, seeking to sell it to recover the unpaid loan amount. These homes can be an excellent opportunity for potential buyers, especially first-time home buyers or those looking for affordable housing options.

Government agencies often offer these properties at lower prices compared to the market rate to promote homeownership and revitalize neighborhoods. Buyers can also take advantage of government-backed loan programs, such as FHA or VA loans, to finance the purchase.

However, similar to bank-owned REOs, these properties are typically sold as-is. Additionally, the process of buying a government-owned REO can be long and complex, requiring a thorough understanding of the guidelines and regulations involved.

6. Tax Liens

Tax lien sales arise when the seller fails to pay their property taxes. In such cases, the local government can place a lien on a house. This lien ensures the government’s right to sell the property to recover the unpaid tax amount.

The tax lien sale process often involves an auction, where investors can purchase the lien by paying the owed taxes. The investor then holds the lien against the property. The original property owner typically has a period in which they can repay the tax debt, including interest, to the lien holder to retain ownership of their property.

Also, note that there are different types of liens, and knowing which type takes precedence can be crucial for potential buyers.

For example, a senior lien is more valuable than other liens because it has priority in case of a property sale. Junior liens are subordinate to any senior liens, meaning they will only be paid if there is any leftover money after satisfying the senior lien.

7. Tax Sales

Unlike tax lien sales where investors purchase the tax debt, in tax sales, the property itself is sold to the highest bidder at auction to recover the unpaid taxes.

This allows the government to recoup the delinquent taxes while offering investors the opportunity to acquire property, often below market value. However, as with other forms of distressed property sales, potential buyers should approach tax sales with caution. The properties are often sold as-is, without the opportunity for a prior inspection. 

Depending on the jurisdiction, the original owner may have a redemption period where they can reclaim their property by repaying the owed taxes plus interest. Thus, investors need to thoroughly understand their local laws surrounding tax sales before venturing into these investments to mitigate potential risks.

8. Divorce Property

Divorce property sales occur when a couple decides to end their marriage and sell their shared property as part of the settlement process. In most cases, the proceeds from the sale are divided equally between the parties, although the exact distribution may vary based on the terms of the divorce agreement.

Buyers can sometimes find attractive deals in divorce sales, as the parties involved may be motivated to sell quickly to finalize their separation. However, these sales may also come with their own set of complexities, as disputes between the divorcing parties can potentially complicate the transaction.

For example, one party may want to sell the property quickly, while the other may wish to hold onto it, leading to disagreements.

Additionally, there could be financial issues involved, such as unpaid mortgages or liens, that need to be addressed before the sale can proceed.

9. Abandoned Property

Abandoned properties are homes or buildings that have been vacated by their owners, either due to financial difficulties , natural disasters or ongoing issues that have made the property uninhabitable. These properties can sometimes be found in a distressed state, with little to no maintenance or upkeep for an extended period.

For example, let’s say you’re looking to sell your house after fire has damaged it, and your insurance company denied your claim. In that case, you may no longer have the financial means to repair or maintain the property and may choose to abandon it. 

The same is true for owners who are selling a house with foundation damage following an earthquake or other natural disaster. These properties can be challenging to sell on the traditional market, making them potential candidates for distressed property sales.

In some cases, you’ll find property owners selling a house with termite history as an abandoned property, as the infestation may have rendered the home uninhabitable. The same could also be true for people selling a house with mold issues, which can pose health hazards and require costly remediation. 

Similarly, some property owners are looking to sell a house with water damage that is beyond their means to repair. These properties can often be found at a lower price than similar homes in the area, making them an attractive option for investors or buyers looking to renovate and flip the property.

Whatever the case, abandoned properties can present unique opportunities for savvy buyers who are willing to put in the time and effort to rehabilitate them. However, these properties often come with inherent risks and require careful consideration before making an investment decision.

For buyers, a good rule of thumb is to assume that the other party is selling a house that needs repairs beyond their means, and conduct thorough inspections to identify any potential issues. It’s also essential to have a clear understanding of the property’s legal status and any outstanding debts or liens that may affect the transaction.

 10. Bankrupt Property

When a person declares bankruptcy, their assets, including their property, are often sold to repay creditors. This can lead to properties being sold off at a fraction of their market value.

Note that the process for purchasing a bankrupt property is closely regulated by bankruptcy laws, often necessitating the involvement of a bankruptcy court. Additionally, while properties may be sold below market value, they are also often sold as-is.

Before investing in bankrupt properties, conduct thorough due diligence, which could include:

• Full property inspection
• Analysis of market trends
• Consultation with real estate professionals familiar with bankrupt properties

If your home falls under one of the categories above, you can always consider a cash sale. If you’re in Southern California, get in touch with us so we can discuss your options further.

Pros & Cons of Buying Distressed Properties

Investing in distressed properties can be a high-risk, high-reward venture. Although these properties often come at discounted prices, they also present unique challenges that potential investors need to be aware of.

Here is a basic overview of the pros and cons that come with purchasing distressed properties:

Pros:

• Potential for high return on investment: Distressed properties are typically sold at a lower cost than their market value, which means investors have the opportunity to make a substantial profit upon resale.
• Less competition: Given the complexities and risks involved, there’s usually less competition for these properties compared to conventional real estate investments.
• Variety of options: From tax sales to abandoned properties, there are numerous types of distressed properties, providing investors with a wide range of opportunities.

Cons:

• Increased risk: The risk of unforeseen issues such as undisclosed liens, structural problems, or legal challenges can be high.
• Additional costs: Renovations and repairs can be expensive, especially if the property is in a state of extreme disrepair.
• Complex acquisition process: The buying process can be complicated and time-consuming, often requiring navigation through legal proceedings and extensive paperwork.

What Are Distressed Properties? Our Conclusion

Distressed properties, while presenting unique risks and challenges, offer significant opportunities for savvy investors seeking high returns.

If you have the patience, knowledge, and fortitude to navigate the complex acquisition process and manage potential pitfalls such as necessary renovations, legal hassles, and unforeseen costs, these properties can be a valuable addition to your investment portfolio. 

However, remember the importance of conducting thorough due diligence, consulting with real estate professionals, and fully understanding the implications of your investment.

At the end of the day, your goal should be to turn a distressed situation into a victory, transforming a struggling property into a success story.