Buying distressed commercial property can be hugely tempting for retailers looking for inexpensive property or investors aiming for high returns. Especially for first-time buyers looking for a great deal, distressed properties are enticing. But buyers should be on their toes. Purchasing any property comes with risk – and the risk associated with distressed properties is sometimes purposefully obfuscated or shrouded in mystery.
What is a Distressed Property?
A distressed property is a property that is under foreclosure or already owned by the lender. Due to the status of these properties and the lender’s desire to sell fast, distressed properties tend to be less expensive. The low cost often means greater profit margins for investors.
The lender’s sale of a distressed property is called a distressed sale, and there are three main reasons for distressed sales.
Commonly, distressed properties are under foreclosure because the renter has stopped paying their mortgage. However, owners facing foreclosure have options – such as deed in lieu of foreclosure – to protect them from the proceedings.
Foreclosed properties are sold directly by the lender or at auctions.
If the property is not sold at an auction, it is referred to as a Real Estate Owned (REO) Property and is considered a distressed property. Since lenders don’t want to hold these properties and be responsible for the upkeep, they will advertise REO properties at discounted rates to promote a quick sale.
If an owner is underwater on a property – meaning they owe more than its appraised value – they may opt for a short sale. A short sale occurs when an owner sells their property for less than they owe on the mortgage to avoid foreclosure.
A major risk of purchasing distressed properties is the repairs. Required repairs and renovations are par for the course in any property purchase. But it is not uncommon for distressed properties to be left in disrepair, or even neglected, before it is under foreclosure.
And, even if the owner utilized the property before foreclosure, critical problems could have been concealed from them. While inspections before purchase can mitigate this risk, only in the renovation process will the full scope of the property’s damaged be revealed. Padding your budget for unexpected repairs is necessary when venturing into the market of distressed real estate.
Buyers should also be conscious of lis pendens when considering properties. A Latin phrase that translates to “suit pending,” a lis pendens is a public notice of impending litigation attached to the property.
A lis pendens is a red flag to potential buyers, foretelling future or ongoing litigation that a new buyer may be responsible for or implicated in. Since litigation can go on for months or even years, distressed property buyers should avoid pursuing properties with a connected lis pendens.
When to Buy a Distressed Property
Is it ever worth it to purchase a distressed property? While distressed properties carry greater risk, they too can bring abundant reward. The reduced property price can easily fatten an investor’s profit margin or give a business owner extra to invest in renovating and personalizing the property to their brand.
So when is it worth it? If the value of the distressed property after repairs is greater than the sum of the acquisition cost, estimated repair cost, and the holding cost (for investors). This value – the after repair value (ARV) – is the property’s market value after stabilization, meaning the property has completed renovations, is operating at between >80-90% occupancy rate, and has a net income that can cover debts. Achieving stabilization transforms a formerly distressed property into a hot commodity.
If you’re considering purchasing a distressed commercial property, turn to the commercial real estate experts at Richards Rodriguez & Skeith. Our attorneys can see you through the entire process and ensure you’re liability protected. Contact us today for more information on how we can help you in the market of distressed properties.