What is a distressed asset, and how can you maximize your return when buying a distressed property?
Many people are rethinking their investment strategies as interest rates stay low and economic conditions remain uncertain. To improve returns, investors need to seek out assets that are not only priced low but also have a high potential for profits.
If you’re looking for a deal in real estate that offers many benefits, including passive income, stable cash flow, tax advantages, diversification, and leverage, now is an excellent time to consider investing in distressed assets.
What Is a Distressed Asset?
A distressed asset is property that’s priced below market value, typically due to solvency or cash flow issues on the part of the asset’s current operator, manager, or owner.
In real estate, distressed properties are often listed for sale by the lender who financed the purchase when the buyer was unable to make their mortgage payments, which results in reclamation by the financial lender.
Distressed asset opportunities are good bargains for well-positioned real estate investors. They typically arise when the seller is encumbered and the market is relatively cool, creating an opportunity for investors with available capital.
Investing in Distressed Assets During an Economic Downturn
Distressed assets are often considered counter-cyclical investment vehicles that are excellent diversification options when the public market is volatile.
Since future returns are determined by the forecasted future cash flow of an asset weighed against the price paid for that cash flow, investors can capitalize on a lower acquisition cost while maximizing the forecasted future cash flow through expert property management.
The Pros and Cons of Buying Distressed Assets
While there are many advantages to investing in distressed real estate assets, you should also understand the potential pitfalls to minimize risk. Here is what you need to know:
The Pros of Investing in a Distressed Property
1. Low Price
Since most sellers want to make a sale quickly, buyers often have an advantage at the negotiating table and can get the best possible price. Purchasing distressed properties can help you generate the cash flow you need to make more investments.
The low price also means that these assets can be acquired with lower-than-average capital. Also, you can often get better financing terms, such as lower interest rates, closing costs, and mortgage payments.
2. High Potential
Many distressed properties have a good amount of deferred maintenance, which can work in favor of the investor. Unlike homebuyers, who are more concerned with the current state of a property, investors can focus on the property’s future growth potential and market value to take advantage of the low price.
In particular, you can get a bargain when the mortgage and interest rates are low and use the savings to renovate the property and increase its market value. You can then turn it into an income property or sell it in the future for a profit.
3. High ROI
The low price point of distressed properties means that they won’t be a significant financial burden on the investor. Yet, they can still be sold for large sums after the necessary upgrades are made to increase their value.
Of course, you need to do your due diligence and run the numbers before making a purchase. Don’t forget to factor in the cost of repairs and financing to make sure that you’ll come out ahead.
The Cons of Investing in a Distressed Property
1. High Renovation Cost
Some distressed properties require substantial upgrades to improve their resale value. The renovation cost can become a burden for some investors if they don’t take it into account when making the purchasing decision.
Besides money, repairs take time and attention. You may have to consider the impact of a period of negative cash flow as the renovation takes place, which can limit your ability to take on other investments.
2. Bad Location
Many distressed properties are located in less-than-ideal neighborhoods, which can limit the resale value. As such, you need to be extra cautious and dedicate time to researching the location’s real estate trends, average monthly rent, and appreciation rates.
3. High Competition
Thanks to the low average price and high potential return, this investment strategy is quickly catching on among savvy investors. As such, you could face tough competition and need to be prepared to pay more or walk away from an opportunity.
Optimizing Your Investment in Distressed Assets
Here’s how you can realize value from a distressed property and avoid potential pitfalls:
- Consider broader market and pricing dynamics to identify and acquire distressed assets at an optimal moment.
- Do your research to make sure that the property is not only cheap but also has a high potential for profits after renovation.
- Perform an investment property analysis to estimate the after repair value (ARV) so you’ll know exactly how much you can rent or sell it for after renovation.
- Minimize hidden costs by first conducting a property inspection to avoid unexpected issues during and after the renovation.
- Use a reputable contractor and factor in the time needed for the renovation. Mishaps and delays can become costly as you won’t be able to rent or sell the property while it’s under repair.
To maximize the ROI of your investment, partner with experts who have the resources, experience, and knowledge to oversee the property selection, purchasing, renovation, management, and sales process.
Here at Lifeafar, our team of investment and management professionals has experience maximizing the value and return of distressed assets and can help investors find the best real estate investment opportunities based on their capital, time horizon, and risk tolerance.
Complete the form below to see how we can help you maximize returns while avoiding common pitfalls without the legwork or guesswork.
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