Should I Buy a Damaged House?
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Despite the challenges of affordability and availability of homes, homeownership is still part of the American Dream. With these limiting factors, finding a place to call home may require unconventional thinking. Are you considering buying a damaged house?
Purchasing a property that needs work can be a great idea, but you must consider several factors. Let’s take a look at the parameters to help determine whether buying a damaged house is a good idea for you.
Determine the Cause of the Damage
The term damaged can mean different things to different people. It could range from minor cosmetic repairs such as painting, flooring, or drywalling to more involved damage such as fire, water, or even structural damage resulting from termites or weather conditions.
Understanding the cause and potential recurrence of the damage is a critical element in your decision to buy a damaged house.
Furthermore, the extent of the damage a buyer takes on will depend on their ability to complete the required work. Discussing the scope and cost of the work with a contractor prior to buying a damaged house is essential to avoid financial distress. If the buyer is handy and available, they can save on some of the labor costs by doing the work themself. However, buyers should be aware that permits may still be required for DIY repairs, along with the timeline and cost of obtaining them.
In addition, the future usage of the property will factor into the purchase decision. And investor will look at a property differently than a resident who plans to occupy the property.
Assess the Extent of the Damage
Before making a commitment to buy a damaged property, a buyer should assess the extent of the damage.
Some investors tend to favor severely damaged properties. Their philosophy is the more damaged the property, the better. As long as it has “good bones,” it works for them. They see this as an opportunity to complete the property from almost the foundational level.
Other investors, often newbies, who want to start with minor cosmetic repairs until they have developed their skills or have a good team in place to assist with the renovations.
Deciding on the level of repairs is a personal and financial decision. It all depends on the skill, finances, time, and tolerance of the buyer.
In addition, if the buyer is going to occupy the property, time will be a critical concern. The buyer must have a detailed understanding of the extent and timelines of the repairs.
Does the buyer need a place to live while the renovations are underway? Will they have the ability to potentially carry two mortgages? What happens if the work is more than they bargained for? These are just a few factors to consider when buying a damaged home.
You can conduct an assessment during the initial property tour or a home inspection. Buyers should take a contractor with them to tour the property and to discuss and evaluate their vision for the renovation.
With the property owner’s permission, a buyer could also have a home inspection company conduct a home inspection during their initial tour prior to an offer. However, my professional recommendation is to conduct the home inspection after the buyer has a fully executed agreement of sale with the seller. If a buyer opts to conduct their inspection before having the executed agreement, they run the risk of losing the home to another buyer.
Estimate Repair Costs
If the damage assessment does not scare the buyer away, it’s time to put numbers into the equation.
Sometimes, the buyer’s vision exceeds their wallet.
A written estimate should be obtained from a licensed contractor. The estimate should detail the work to be done, and it should include the costs for materials and labor. A good contractor estimate should include a contingency fee. This is money budgeted for unforeseen events, such as rising material costs or discovering additional damage once work begins.
The second part of the cost analysis is the after repair value (ARV). Investors need this to determine if the purchase is a good deal. As the saying goes, “if it doesn’t make dollars then it doesn’t make sense.” Buyers also need this if they are using funding such as a 203K loan (often called a renovation loan), a home equity line of credit (HELOC), hard money financing, or other types of financing.
Potential for Hidden Issues
Regardless of the initial assessment, the potential to uncover hidden issues begins once the demo is underway. Opening or knocking down walls, removing carpets, changing a property layout, etc. all run the risk of finding things that were not part of the original assessment.
The inspection may uncover potential issues such as mold, asbestos, or structural damage. In addition, termite or pest damage, water leaks, or knob and tube wiring can require extensive repairs.
This is where the contingency fee comes into play. Depending on the extent of the new issues, this could delay the project or even blow the budget completely. The project may require additional permits and other professionals, and the list goes on.
4oDelays can lead to additional carrying costs as well as price increases on materials. Be prepared for the worst and hope for the best.
Funding Your Purchase
The type of funding used to purchase the property may depend on the extent of the damage and the property’s intended use.
Although cash is king, this may not always be the best route. Tying up all of their liquid assets may not be wise for a buyer and is often financially impossible.
Securing funding through a private lender(s) or a traditional bank may be more feasible.
A buyer should discuss the available loan products with a loan officer during the assessment phase to determine the most suitable option. There are several financing options available when it comes to purchasing a property. Traditional routes include FHA 203K, HELOC, hard money loans, DSCR loans, or joint ventures/partnerships.
Insurance Considerations
The property condition may render a property uninsurable. This could be an issue for a few reasons.
If the property is uninsured and someone gets injured, the owner risks being sued. If further damage occurs to the property, the owner could incur additional expenses beyond their ability to cover. In addition, vandals could damage or completely destroy the building.
Insurance providers may require vacant property insurance, which could be expensive.
Zoning, Permits, and Regulations
Buyers should investigate the current property use and future intended use before moving forward with acquiring a property.
It’s not uncommon for owners to illegally convert a property to a different use type. Buyers should ensure that the property they’re considering is correctly zoned for their intended use.
If the home is in a community or a historic neighborhood, there may be restrictive covenants that do not allow certain renovations or alterations to the property.
Negotiation Leverage
A damaged property may give a buyer leverage when it comes to the price.
Properties with extensive damage often have a smaller buyer pool. Those interested buyers will find every reason under the sun to justify a lower purchase price for the property.
Again, if it doesn’t make dollars, it doesn’t make sense.
The end use also is a factor here. If the buyer is an investor who does their own work, then the repairs will often be less costly than another buyer hiring a contractor to do the work. An investor may be willing to pay more for a house, knowing they can turn i around for a quick profit.
Additionally, the knowledge and motivation of the seller will also come into play here. Does the seller need to sell or want to sell? How invested in the property is the seller? Knowing the answers to these questions can give a buyer negotiation chips as well.
Resale Value and Market Demand
The timeline of how long you’re willing to hold the property can impact your financial terms and your options for renovations.
If the property is being purchased as a fix and flip,the after repair value (ARV) plays a very high part in the acquisition cost.
However, if the property will be held and leased, the return on investment (ROI) can be spread out over time.
Finally, if the buyer will live in the property then the purchase will need to be supported by the ARV for the lender to fund the purchase.
Demand in the area and the availability of inventory in the area will also play a vital role in the resale value. The more people expressing interest in the area, the greater the likelihood for a significant return on the home.
On the flip side, if there is low demand in the area, this may not be the best place to purchase a property and attempt expensive repairs. Buyers should consult with an expert real estate agent to assist with comparables for the area as well as advising on current market trends for the area.
Time Commitment
Renovations rarely finish within the allotted time.
This could be the result of material delays, labor shortages, weather delays, or government regulations. Delays happen and it’s a buffer must be built into your timeline.
Even if the buyer is doing the work, life happens and delays are often inevitable.
From the start, set a realistic timeline and adjust it throughout the project. If your damaged home requires extensive renovation, establish specific goals and deadlines throughout the project to keep the renovation on schedule.
In addition, consider a good contractor and or a project manager. While this will be factored into the costs, it could be less expensive than a project that is delayed or has issues.
When Buying a Damaged House Might Be Worth It
With all of the above being considered, it may be worthwhile to buy a damaged house if the purchase price and repair costs still result in a good investment.
If you have experience in renovations or access to skilled professionals or if the home is in a desirable location with high appreciation potential, it could be an excellent investment.
Consult with an excellent real estate agent. Do your due diligence and gather as much information as possible. Weigh the pros and cons of the purchase and make an informed decision.
