Properties that have suffered from damage and neglect are some of the most popular investments for one simple reason: they usually sell at a discounted price. Because of this, many investors are always on the lookout for rundown homes in their markets.
And while damaged and distressed properties do often present great opportunities, they can also come with a high amount of risk. So if you’re interested in putting money into neglected houses, then there are a few important pieces of information that you need to know.
Do: Keep the end result in mind
One of the most common problems that newer investors run into with distressed real estate is scope creep. Scope creep is the steady growth of a project’s goals until it begins to include far more than initially intended.
Scope creep is dangerous in real estate, especially when you’re rehabbing a home. What may have once started as a simple paint and repair job can quickly turn into a massive renovation project that includes redoing rooms that don’t need extensive work. If you allow this to happen, then you may seriously exceed your budget and allotted timeline by the time you finish working on the property.
If you’re planning to flip the house, this can seriously impact your bottom line and put you in the red. If you’re planning on renting it, scope creep can force you to significantly increase your monthly rent just to cover your expenses. To avoid these problems, it’s important to always keep the end result, including your finances, in mind.
Don’t: Overpay for the property
Finding a distressed property and an owner who wants to sell is one of the greatest feelings in the world, especially if you’re a new investor. It can feel like everything you’ve worked for is finally paying off. Unfortunately, this is where many investors make a critical error.
When you’re excited about a property listing or an off-market deal, it’s easy to abandon your logical thinking and approach the deal emotionally. As a result, you may unintentionally twist the numbers to make the deal work. This is the leading cause of financial loss in real estate investing. Whether you’re wholesaling real estate or fix and flipping, getting a house under contract at the wrong price will turn a great deal into a bad investment.
To avoid making this mistake, always approach your comps objectively. This may be difficult, especially early in your career, but it’s an essential skill if you want to succeed as a real estate investor. A comping tool that gives you data from the multiple listings service will make it easier, but always remember that just because something seems like a deal doesn’t mean you should buy it. If you pass one property up because the numbers didn’t work out, there’s always a better one out there waiting.
Do: Take inspections seriously
Finding out that a property has a fatal flaw isn’t a feel-good experience, but damaging your relationship with a cash buyer after they find an unexpected repair is even worse. Discovering a serious problem after you’ve closed on a property yourself is a true nightmare.
Before you ever sign a contract on a property, tour it and do your own thorough inspection. If the property has a basement, look for signs of water damage, foundation cracking, and mold. If possible, take a ladder and look at the roof to make sure there aren’t weak spots that can cause leaks.
Then after you sign the real estate contract, hire an inspector, especially if you’re going to close on the property yourself. Most importantly, listen to what the inspector says and keep a copy of their report. Countless investors have lost serious money because they didn’t take their inspector’s concerns seriously.
Don’t: Skimp on repairs
If you’re going to fix and flip or renovate a property to add it to your rental portfolio, then take your repairs seriously. Otherwise, you’ll lower the overall price of the house when you resell it and an inspector sees through your surface-level renovations.
If you plan on renting the house, cutting corners will cost you more money in the long run. As wear and tear exposes subpar work, you’ll have to invest time and money redoing the same repairs.
Low-quality repairs will also impact your tenants’ quality of life, which can lead to vacancies or trouble keeping consistent renters. Cheap repairs will only benefit you in the short term, but they’ll inevitably cost you a serious amount of extra time and money down the road.
Do: Research the neighborhood and local area
A common mistake that investors make is buying distressed properties in distressed neighborhoods. While you may be able to get a good deal on one of these properties, you may not be able to sell it for a profit. If the area is undesirable enough, you may not be able to resell it at all.
When you conduct a comps analysis on a property, make sure you pick comps that are in the same neighborhood or one close by with similar conditions. Comping is a great way to estimate the value of a house, but neighborhood characteristics are a hidden factor that can have a significant effect on a property’s after repair value. If you don’t pick your comps carefully, they may not account for this critical information and you could end up paying too much for a distressed property.
Don’t: Over-improve a property
Another key mistake that fix and flip investors sometimes make is over-renovating a property, making it a bad fit for its surrounding area. In the same way that you should research a neighborhood before buying in it, you should understand the typical property value in a neighborhood before you start working on a house.
Otherwise, you could improve it to a level where it no longer fits in with the houses around it. If this happens, the people who would normally live in the neighborhood may not be able to afford to rent or buy your house. Conversely, the people who can afford your property may not be interested in living in the neighborhood. You could end up stuck with a house that’s overvalued.
Investing in distressed properties can be an exciting venture, especially as you begin envisioning all the things that a neglected house can become. It can also be a lucrative way to invest in fix and flip properties or build a rental portfolio. However, buying distressed homes is a strategic venture that requires calculated decision making.
Remember, when you buy distressed properties, you should always be careful about how much you pay for them. Take your comps seriously, pay attention to tax records and how they’ve increased over time, inspect the property, and research development trends in the surrounding area. If you’re wholesaling, these steps should be sufficient to ensure you can assign the contract to a cash buyer.
If you’re making repairs and flipping the property or keeping it as a rental, it’s important to take your repairs seriously without investing too much in the property. Watch out for scope creep, keep a close eye on your budget, and then turn the property into something beautiful.
Distressed properties can be a dangerous form of investment if you don’t take them seriously. However, if you take your time, make informed decisions, and walk away from bad investments, there’s almost no limit to how rewarding rehabbing distressed properties can be.