The Secret to successfully identifying and buying distressed residential homes

Real estate investors are always keeping an eye out for a great deal. One of the best markets to find an investment opportunity with an above-average return on investment is the foreclosure sector. When property owners become delinquent on their mortgage payments, there’s often a potential for a savvy opportunist to acquire the home for well below its going rate on the open market.

That’s the reason why some of the most lucrative residential real estate investment projects are distressed properties, which are ideal for either revamping and then reselling for a profit or maintaining as an income-generating rental home.

Distressed properties typically come about in instances where either the owner is incapable of meeting his or her mortgage payments or property taxes on time and thus must quickly sell the asset, or when formal foreclosure has already taken place and the property is being auctioned as a result.

Keep in mind that this is far from a novel concept—scores of investors looking to get the biggest bang for their buck constantly have their eye on the market for local foreclosures. With the advent of technology, popular real estate search engines like Trulia and Zillow offer an easily accessible database of upcoming foreclosure properties, effectively ramping up the competition and driving the eventual sales price up.

Fortunately, there’s a better approach to landing a profitable investment opportunity: simply broadening the definition of what qualifies as a distressed property in order to find ideally priced homes the competition is missing out on. Here’s a quick overview of property categories to keep an eye out for:

  • Properties owned by individuals who have little choice but to sell in a hurry due to the situation at hand (e.g. a couple undergoing a divorce, military members being stationed elsewhere, people who have been unemployed for a considerable length of time, or heirs that have to partition the property to distribute the proceeds amongst their family)
  • Homes with significant water or mold damage, or that have been otherwise unkept by negligent homeowners
  • Partially renovated houses that were never completed due to financial issues or other technical problems like plumbing or zoning
  • Properties owned by either governmental or private entities that were not offloaded in a recent short sale

Simply put, the best potential investments are properties incapable of being financed for some reason. The original owner is unable to sell the property because would-be buyers aren’t able to get a mortgage on it or is unable to find a purchaser with adequate disposable capital. While this type of properties doesn’t meet the conventional definition of foreclosures, investors can still get them at a significant discount. And due to the fact that the majority of people are unaware of these investment possibilities, there’s less of a chance of the price being driven up by a bidding war.

Finding properties that are worth the money and sweat equity involved in a home flip or long-term rental requires persistence and hard work—simply checking an online property listing database isn’t going to cut it. For investors looking to tap into this sector, getting out on the street, making inquiries, researching leads and oftentimes simply driving around the area to get a visual on potential opportunities is essential.

Searches should be focused on neighborhoods where the local job market is healthy and potential buyers can acquire income sufficient to acquire a mortgage or afford rent payment. Rural areas should be avoided—the houses might be generously priced, but the economic characteristics are less than ideal for long-term profitability. Some common signs of potentially distressed properties include faded or peeled paint or exteriors covered in graffiti, and overgrown or neglected yards. Other tell-tale signs include mailboxes that are bursting with uncollected mail, and front doors plastered with paper notices.

After identifying a possibly distressed property, investors can take a chance and knock on the door. If the owner is in, take the straightforward approach and ask if they’re considering selling their property—the aforementioned signs of neglect may be an indicator they’ve encountered financial problems. If the owner isn’t around, check in with the neighbors to get more details—they may be able to even provide the owner’s contact information. If all else fails, the next stop is the local tax assessor, who can look up the name and address of the homeowner.

After making contact with the homeowner, be polite and straightforward regarding your intentions. The best chance at acquiring a profitable investment is if the current owner is eager to get rid of the property. If they don’t express a keen interest when the topic of selling comes up, chances are it’s a dead end. As a general rule of thumb, the end goal is to purchase the property at 70% (give or take 5%) of the median market value of the area.

Prior to closing, be sure to get as much information regarding the property and surrounding area as possible. Don’t shy away from asking the homeowner questions. Keep the long-term perspective in mind—the market and demographics will fluctuate. If you notice indications that an area is undergoing a transition for the better, it might be a chance to acquire homes before the prices start to creep up.