The following is a summary of the distressed properties market relating to the US only. Whilst IPIN's expertise extends to distressed assets internationally, we are currently only active in several US states owing to the ethical stance of our Income Generating Assets strategy and the opportunities provided by the US Section 8 housing programme.
What are distressed assets?
In general, distressed assets are real estate properties that require a capital infusion or can be purchased below market value. Many times, the property owners have let the property fall into disarray, reducing its ability to generate cash flow or serve its purpose as a home or office location. Other times the owners have stopped making mortgage payments entirely forcing the lending institution to either take back possession of the property or serve notice that, unless the debts and other obligations of the property are repaid within a specified period, it will foreclose or short sell the property to the highest bidder in an attempt to recuperate as much as it can from the sale of the asset.
The current situation in the US
The subprime mortgage crisis was a precursor to the worldwide recession that began in 2007. During the US property boom of the middle of the last decade, irresponsible lending facilitated borrowers purchasing property-based debt under the mistaken belief that capital gains would outweigh otherwise unmanageable debt burdens.
As interest rates began to rise around 2005, the market witnessed a sharp decline in housing prices, leaving many borrowers unable to keep up with repayments on their mortgages. Defaults began to soar, with a domino effect on mortgage-backed securities, private sector investment and public sector credit facilitating.
The property market in the US consequently collapsed leaving lending institutions with crippling debt in the form of real estate assets proving increasingly difficult to resell in a market starved of available credit and requiring capital to keep the assets in respectable condition. These assets were named “toxic assets”.
Purchasing options for distressed assets
With respect to the opportunities below we refer to assets as both non-performing mortgages and foreclosure properties.
Non-performing mortgages are where the borrower has defaulted for typically 90 days or more and runs the risk of foreclosure. In an attempt to avoid the foreclosure process, lenders will offer investors varying options to purchase below fair value in order to suit their requirements in an attempt to minimise losses.
Foreclosure is the legal act of filing a notice of default in the public records and a lawsuit against the borrowers with the intent to retain or publicly auction the given asset unless defaults are repaid. Typically foreclosure proceedings will begin after a minimum period of default of 2 months although owners do have the right to attempt to settle or make back due payments up to a certain point (this varies from state to state).
In foreclosure, assets can be auctioned, purchased as a short sale (purchased direct from the lender for less than the outstanding debt before the property goes to auction) or purchased as an REO (Real Estate Owned by a bank) if the property has failed to sell for the required amount at auction and is retained by the lender.
Distressed asset opportunities
With US banks now dealing with around $1 Trillion in existing and potential write-downs and the majority in the midst of a liquidity crisis themselves, they are unable to process the current volume of foreclosures with allocated budgets and resources and so are forced to desperately sell selected assets at ultra-deep discounts with liens (legal claims on a property) removed in order to generate cash flow.
This has created a unique environment for investors with even small sums of available cash to make ethical and profitable investments within the distressed space. It is important to note that there is very little available debt for investment into distressed property. Most investments in distressed property are made all cash.
Purchasing REOs is widely viewed as the perfect solution for purchasing a property for occupation whilst buying non-performing mortgages allows the implementation of various exit strategies including re-structuring mortgage notes and allowing homeowners to stay in homes they would otherwise have lost whilst generating significant returns.
Risks to purchasing distressed assets
Whilst buying distressed real estate assets is a common strategy it is absolutely vital that investors conduct their own significant due diligence prior to purchase. It is perfectly conceivable that distressed properties are distressed for valid reasons ranging from exceptionally undesirable locations through to chronic states of disrepair where renovation costs could easily outweigh any advantages to purchasing at below market value.
If the property is being purchased privately to rent out at a later stage, the purchaser opens themselves up to common risks associated with letting property such as ongoing maintenance costs, the inconvenience of responsibility, unreliable tenants or the inability to find them.
Increasingly, distressed real estate assets are purchased and offered fully renovated and / or managed for leasing purposes. This approach carries obvious benefits and securities, especially for purchases made outside of national boundaries or for investors wanting as hands-off an approach as possible.
*This page is provided for information purposes only and should not be construed as offering advice. IPIN Global is not licensed to give financial advice and all information provided by IPIN Global regarding real estate should never be treated as specific advice or regulations. This is standard practice with property investment companies as the purchase of property as an investment is not regulated by the UK or other Financial Services Authorities.
- Wednesday 28 January 2015