Diamond in the Rough: How To Achieve a Great ROI By Recognizing Distressed Properties

There is an old cliché plot in cheesy horror movies (though it has probably been parodied more often than it’s been executed in earnest) where a rich relative has just died and some distant nephew and his family acquire his inheritance. Before they can get their money, they have to spend the night in the deceased relatives’ home. The family travels to a creaking old mansion on the outskirts of town; windows busted, wind howling through the eaves and enter, determined to get their money, and we watch as they suffer through a terrifying night.

Now sure, that is one way to do it. If they were smart however, they would have eyeballed the mansion, realized it was a distressed property, and immediately renovated it as a fix-and-flip.

Buying distressed properties and fixing them with the help of an equity-based hard-money loan is a growing market – and with good reason. You can take advantage of low prices and slow-growing neighborhoods to realize a significant return on your investment. However, the trick is to understand what differentiates a cheap house that isn’t going anywhere (which so represents a dangerous use of your money) from a distressed property (that could provide a great return on investment). This is what really makes for a smart real estate purchase.

Understanding What Makes Distressed Properties

Distressed properties are almost any property that is currently selling for less than what it could eventually be worth. In other words, Properties that are priced below their market value.  This can happen for a variety of reasons, including:

  • The house is underwater and the owner has to sell
  • The house has been foreclosed upon (leading to a “short sale”)
  • The house is run-down and in need of pricey repairs
  • The house is in a blighted neighborhood with low property values

All of these examples hold potential – though some more than others, as we will see:

How Hard Money Loans Can Help With Distressed Properties

So, you’ve bought a distressed property and are holding it as equity. Many banks and traditional lenders still won’t give you the funds you need in order to fix it up. This is where hard-money loans come in. These loans are as good as cash and aren’t always contingent on credit or history; they give you the money you need to turn a profit.

Before buying a run-down house, make sure you inspect it and consult with a good contractor. There could be a lot of hidden problems with your distressed property. The goal is to make a reasonable profit, considering that flipping could take a year or more. Distressed and undervalued is good, but a house “on its last legs” is bad news. The rule of thumb is: if it is reasonable to fix up, then you may have a good opportunity.

In the case of underwater or foreclosed-upon houses, there might not even be much that requires fixing. The money that you save by buying these houses can be spent on turning a good house into a great one (with great market potential). Many of these houses are in good areas and may have belonged to owners that might have just been going through a temporary rough patch.

One key is to look at property values and history. When we talk about buying in a blighted or down-market neighborhood, we don’t mean that you should buy simply because you are getting the property at a low price. It is important to do the research and see if this is a neighborhood that has a chance to become an up-and-coming area. If every building on the block is in foreclosure, you aren’t investing in the future— you’re making a bad gamble. But some neighborhoods are ripe for development in the form of urban infill. If the neighborhood is near public transportation, has a solid infrastructure, and can be developed without requiring a ton of teardown, then it has a chance. Under these circumstances, a distressed property can be a great investment.

Why California Is a Great Place To Buy

As we know, California was hit particularly hard by the foreclosure market. As terrible as that was, it also resulted in a proliferation of distressed properties on the market. In other words, the time to act is now. Fix-and-flip for distressed properties is hot, but the availability won’t last forever. A hard-money loan from an equity-based vendor who understands the market is a great way to turn a distressed property into a wonderful source of accomplishment, pride, and income.

Your real estate assets are your best investments for the future. At Socotra Capital, we’re proud to be the premier direct hard money lender for California real estate. Contact us today to learn more about how we can help.

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