A distressed property is a home nearing repossession because the owner struggles to pay the mortgage and property tax. Usually, they’re motivated to sell at significantly below-market prices. A property might also become distressed due to impending liquidation in the face of a divorce or bankruptcy.

There are three types of distressed properties: foreclosure or pre-foreclosure, real estate-owned (REO) property, or short sale. The lender repossesses a foreclosed property due to the owner’s inability to make mortgage payments. The lender then auctions the property as-is to the highest bidder.

If the lender cannot auction the property, it takes control of it, making it an REO property. REOs sell at significantly reduced rates. If the owner owes the bank more than what the property can fetch, they may agree to sell it at a markedly low rate and avoid repossession.

Most banks are more than happy to have someone else come in and take over ownership of non-performing property. Consequently, they may offer distressed property buyers lower mortgage payments and interest rates. Many investors prefer to invest in distressed properties because of their value-added opportunities, allowing them to maximize their return by renovating and reselling.

Because of the decent profit potential associated with distressed properties, they attract fierce competition. Also, buying property as-is carries significant risk. Distressed property investors often take on all the issues a distressed property comes with. Action properties move fast. With rush decisions come costly investing mistakes.

One should perform proper due diligence to avoid mistakes when investing in distressed property. That includes researching a property’s history. Ascertaining why the property is distressed in the first place can reveal how motivated the seller is. It also helps one avoid ending up in the same position as the current owner.

There are other ways to find distressed properties other than auctions. A multiple listing service (MLS) is one such way. It lists all distressed properties per State. Banks also often list repossessed properties.

Not all distressed properties end up in the market. Seasoned investors look beyond the obvious places for hidden opportunities, like the local tax records. The tax assessor’s records would list properties whose owners are struggling to meet their tax obligations. Probate courts are also a great place to fish for distressed properties. Probate courts settle debts of deceased persons, and properties that end up there are prime candidates for distressed sales.

Another way to find distressed property is to “drive for dollars.” It involves driving through one’s neighborhood in search of neglected properties. One of the telltale signs of distress is neglect, which can show through tall or dead grass, broken or boarded-up windows, or an overflowing mailbox.

Distress should not be the sole reason to purchase a property. Although problems often translate into opportunities, it’s not always a given. Some damages are so extensive that one can’t possibly make a decent return on investment from repairing them. Moreover, purchasing a distressed property in a stagnant neighborhood makes it harder to recoup one’s investment.

Distressed property investing is a risky business. Proper due diligence and a good understanding of the local property market can help sidestep many of the pitfalls of distressed investing. Also, hiring a home inspection expert is an inexpensive way to get an accurate picture of what one is dealing with in terms of damages and the extent of repairs needed before committing.