When I was buying my first property I was a complete investing newbie. I was excited, I was eager to buy something. I also didn’t have much cash and I finally got an offer that fulfilled all my criteria. It was a big run down house – a distressed property. It is a story that is worth a separate article. Looking back — I don’t regret my choice. But…. I learned a lot…
Following up our discussion from yesterday I would like to look at pros and cons of buying a distressed property. Property in need of major renovation.
Buy a distressed property they said…
Many investors will tell you that buying distressed properties can be a gold mine. By distressed they mean the most ugly, smelly one — the one nobody wants to even step into. Why? Because this gives you a good position in price negotiation.
Two houses in the same street
Let’s look at the example. Let’s say that properties in the area are being sold for around £100,000. There are two houses on opposite sides of a street. One of them is new and fresh with asking price £100,000. The other one is in a bad shape with asking price £70,000 and a refurbs needed of around £30,000.
What will be the interest of both them? First one will be interesting for people who would like to buy their residential home and usually are not in a position to buy, and renovate living somewhere else in the meantime. Certainly interest in the other one will be much lower. That is why — if the seller is motivated to sell he might be happy to give you a discount. It is likely that this empty property costs them money every month and they will save money by reducing the price and getting rid of it. As a result if you are lucky you might get a discount of 10–15%!.
That sets the stage for our study. Let’s look at different aspects of investing in such property.
Pros and cons
As you see from the example above, you might save money on the purchase. So you buy cheap. That is great. However right at the start you will face your first problem – financing. Such property will not be mortgageable with a simple BTL mortgage from day 1. It can still be financed in many different ways (i.e. cash, bridge loan, investors money, lease options and many others). But the easiest way — a mortgage at purchase is not available.
The good thing is that returns on run down properties tend to be higher. That is why such strategy is chosen by many advanced investors. It can indeed generate higher returns but… only if you buy below market value — and — your renovation stays within a budget. The first one we can easily control, the later one is harder — especially if you don’t have much experience in refurbs or if you live far away from the property (relying on project managers and builders you don’t control on a daily basis). That is the biggest potential risk of this strategy.
Finally maintenance. We can assume that the maintenance for properties that we just renovated will be less expensive. That, again, is dependent on the quality of works done during the refurbishment.
As mentioned yesterday there is no clear answer which strategy is better. All the arguments above might also sound theoretical. Also, every project, every deal will be different. You can say however that in principle the fresh and ready to go property might create less hassle. On the other hand distressed property might generate slightly higher returns. At Momentum we advice people to start with the easier strategy — buy something that can cashflow from day 1. So if you value good sleep over 1–3% higher return a fresh and ready to go property is a sound investment. But again, make sure you do your proper due diligence and analyse your project before you commit to anything.
Nothing in this world is black or white. There is a whole palette of colours in between. A good option ‘in between’ would be adding value to a nice fresh properties. But that’s a good topic for some other story.
Co-Founder of Momentum Property Education