What To Watch For When Investing In Distressed Property Markets
What factors do real estate investors, home buyers and even private lenders need to keep an eye on when buying homes, and investing in distressed property markets?
Despite some media reports of foreclosures declining, there are still significant numbers of distressed properties across the United States. Some are being foreclosed on due to late mortgage payments, others are bank owned REOs, many are being auctioned off for failure to pay property taxes, and some are being sold off at sizable discounts for other reasons.
The promise of an under-priced deal or even a “steal,” can be alluring, but there are many other factors to keep in mind. Whether investing in distressed properties in New York, Detroit, Cleveland, San Diego, Miami or Fort Myers, look beyond pricing to evaluate the entire transaction’s strength and future performance.
How High Will Property Values Go?
Many parties continue to offer ‘discounted’ and ‘undervalued’ properties. These claims are based on an array of different calculations. A few may be coming online for less than comparable properties today. Most are ‘discounts’ based upon how much less than build cost, or previous sales prices they are going for. Which type of discount are you getting?
For those based upon previous sales prices at the height of the last boom, it is important to ask how high these home prices will go – and how fast.
Based on historical housing cycles, real estate values will match, and exceed their previous highs in a new boom. For example; a $50,000 home in Ohio today, could reasonably be expected to top its previous value of $110,000 in the next 10 to 15 years. In sunny San Diego County or Fort Lauderdale, a $250,000 units might top its previous high of $500,000 plus, and perhaps sooner.
Sustainability & Speed
The pace these properties will appreciate at, and how high they will go, will definitely relate to the sustainability of the appreciation. This is directly linked to rents. There are various factors which drive rents and their velocity. However, regardless of the location, and reason investors are investing in it, rent and housing affordability is one of the best tells.
Some markets are predominately rental markets now. Others have emerged as almost separate asset classes for the wealthy seeking yield and wealth preservation. Still, once rents hit a certain level, they will become less affordable, and few buyers will want to invest in homes serving up negative cash flow. So keep an eye on the affordability indices.
Where is the Local Market at in the Housing Cycle?
All housing may be subject to macro housing cycles, but all markets are also local and turn through phases at different times. Knowing where a given market is in this cycle goes a long way in accurately predicting future performance. Is it already well into new boom territory? Or is it on steady beat, but still just rebounding? Or is it in the pit of distress and ripe for bouncing back?
Indicators to Watch
Real estate investing, and even buying a home, can needlessly be complicated by too much data. However, some key indicators to look at when analyzing future growth prospects include:
- Employment rates
- Wage growth
- Business growth and competitiveness
- Talent pool
- Revitalization plans
Whether buying for long term hold, as a residence, as a combination vacation/rental property, or even for wholesaling and flipping houses, rents play such an important role in the bigger picture. First off, buyers need to verify what real local rents are. Forget asking rents. They can be meaningless. What are units actually leased for now? What are vacancy percentages? How long is it taking to fill vacant rental units?
Local Property Condition Issues
Each market can have its own quirks, and area specific property condition issues. It is important to know what these are in order to avoid being burdened with a dead weight. Some can be bankrupting, while others are simply minor nuisances. Some examples of these issues include:
- Chinese drywall
- Faulty foundations
Termites and foundation problems may sound scary, but where they are typical, they can also be easily remedied. Chinese drywall, on the other hand, may not be easily or affordable to cure. In the case of Chinese drywall, no solid fix may be found, even though there are official guidelines for stripping and rebuilding properties.
All of the above can present challenges in financing. Lenders love to lend in hot spots that are ripe for appreciation. However, they are scared by declining markets. Many will also run from properties with major structural issues. Other local lenders may not care, if the equity is there, but this can limit options. This is critical for buyers and real estate investors to keep in mind. It may not be as much as an issue for them, as for future buyers. This can impact future resale speed and values.
Who Can Help, What’s Better?
Who else can help, and what else can be done to invest more profitably? Can partnerships, incentive programs and commercial investing, or investing in local education help to build up an area? What real estate markets are close by that may be better? For example; is there a slightly stronger market next door which can offer value and more security?
Understanding the answers to these questions is important, but even more so, it is important to know why to ask them. If you know what to look for while investing in distressed property markets, you will have an advantage over your competition.