Possible Options To Provide to Distressed Sellers

When dealing with sellers of distressed properties, there are many options the seller can consider. It is up to us, as real estate investors, to provide them with options in an ethical and moral way so that they understand what they can do with their house besides accepting a “cash as-is offer”. There are pros and cons to each option and depending on how the conversation goes, I may cover any and all of the following information with them:

Option 1) The seller comes up with the money to repair the property so that it will pass all inspections and put in the necessary updates so that it will show well with homeowners interested in living in that area so the seller can get full market value. The downside to that option can be that the seller may not have the time, money, or experience to make repairs/updates. They will also have to manage contractors that may rip them off/overcharge them for repairs. The majority of banks cannot or will not lend on distressed properties and the property is not eligible for conventional financing so they will have a tough time selling it to a homeowner/end-buyer if the property needs work.

Option 2) The seller makes minimal required repairs to the property and rents it out. The downside to that is that managing tenants can be quite a headache. Let’s say the seller expects to clear $400/month in cash flow. One bad tenant can easily set him back $10k and can be a very stressful situation if he has to evict them. So any cash flow he was hoping to make is eaten up easily by one bad tenant and he will have to either be an expert in property management or hire an expert to mitigate that risk.

Option 3) The seller can partner with someone that can take care of all of the repairs and split the proceeds of a sale at full value according to what is decided as fair with the partner. There are very good legal protections that can be put in place to protect the interests in this kind of partnership. The down side is that the seller will not receive full value at sale because they will be sharing a portion of the proceeds with the partner that actually does the work.

Option 4) The property is sold as-is for a cash price and can just be done with it. Let’s say the property is worth $150k and needs $25k in repairs. So the total cost would be $175k to the buyer. However, no one is going to buy the property at a $150k price if it needs work. They are going to want a discount if they have to do the work themselves as no one is going to want to do a bunch of work for free. For a $150k house with $25k in repairs, you’d have to sell a property at let’s say $75k. The buyer will give $75k to the seller as cash to walk away from the property and then the buyer is going to spend his time and money to fully rehab and update the property, at which point he will turn around and either sell it at a profit or hold onto it and rent it out. That may sound steep but there are hidden costs the investor has to pay:

a) The opportunity costs of buying and working on that house versus possibly getting a better deal somewhere else,

b) The costs of securing and maintaining the property while it is vacant,

c) Cover any electric/gas/water bills while the investor is repairing and trying to sell the property,

d) Taxes accrued while he owns the property,

e) The commission he has to pay a realtor on the backend + closing costs he has to cover at the sale,

f) Financing costs if he had to borrow hard money – those loans can be very expensive for distressed properties,

g) Holding costs are unknown and can only be estimated. If the investor sells the property 2 days after listing it on MLS, there will be barely any holding costs, if the house takes 4 months to sell the holding costs will be substantial. That factor is outside of the investor’s control due to economic factors, the Federal Reserve, lending rates, quality of demand in the area, etc.

Option 5) Owner finance it: The property is sold on terms instead of a cash price. The owner gets a down payment and mortgage payments instead of renting it out and receives rent and a deposit. The owner acts as a bank and forecloses if the buyer doesn’t make required payments. There is a lot of federal law with Dodd-Frank that makes this difficult but not impossible but you really have to be careful from a liability standpoint with this option.

I have experience with all of these options and if I don’t know the answer to a question, I have expert contacts at my fingertips that can get any issues for these options resolved. I would tell you at this point to present any/all of these options as possibilities to distressed sellers and see what makes the most sense for them. At that point you can take further steps to go in the right direction that will resolve the seller’s problem ethically.