I’d like to rephrase that to: “With great value comes great responsibility and the good kind of risk”
So many properties coming on the market today are distressed properties, foreclosed, at massive discounts to market, selling “as is” and often times in questionable condition.
BusinessDictionary.com defines “distressed property” as:
The opportunities are obvious, and sure, you can buy a properties for pennies on the dollar “as is” but here are some points to consider:
- the worse the condition the harder it is to assess value
- the more the costs of improvement
- the longer the time to either rent or re-sell
- Value not subject to local comparables
- Not finding a bank to finance the sale because of the condition
On this last bullet it’s necessary to point out that Fannie Mae, Freddie Mac, the Federal Housing Administration (FHA) and the Department of Veterans Affairs (VA) recently developed a classification system for housing condition ranging from C1 (the best) to C6 (the worst), but only C6 is unacceptable to the agencies in “as is” condition. Nonetheless, many lenders require a C4 or better.
But what should your purchase strategy for distressed properties be?
Here are a few interesting items to consider:
- An inspection report from a licensed expert will help in the decision as to whether to buy the house but will not eliminate uncertainty regarding how an appraiser will classify the condition of the house. If the house is classified C5 or C6, a loan may not be available.
- If the sales contract has a mortgage contingency clause, which is a standard provision in some states, the buyer who can’t get a mortgage because the property is classified C6 or C5 will get his earnest deposit back and the deal is canceled. However, the thwarted buyer will not be reimbursed for the cost of the inspection or the appraisal, which might total about $700.
- If a property is being sold “as is” and the standard sales contract does not have a mortgage contingency clause, I would pass unless the seller agreed to return my earnest deposit if the property is classified C6 by the appraiser. You could be more conservative and require the return of the deposit with a C5, which would avoid a mortgage problem because most lenders will accept a C4 or better, but it may substantially reduce the number of sellers who will deal with you.
- While accepting a C5 will give you access to more houses, you must find one or more lenders who will accept a C5. You would be well advised to do this in advance of purchase.
As with all investment categories and types, there are always elements of risk at hand, real estate is no different. We’ve all been able to witness first hand what a downturn in a particular sector of a market can do.
But fear of risk itself should never be a reason to avoid good buying or selling opportunities when it comes to Real Estate, and education and research is the cure for doubt, what’s left after that is just indecision. I wonder if there is a cure for that?