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How to Evaluate Distressed Real Estate Opportunities

Published on November 10, 2012, by in Real Estate.

distressed-saleDistressed Real Estate has become a prevalent investment theme since the sub-prime collapse. With investment funds targeting the acquisition and resale of foreclosed homes earning returns beyond 120%/year, investors have begun looking at how it is that they can enter the market for such opportunities. That being said, before an entrance strategy can be evaluated, we need to be sure that there is enough of a tangible recovery to realize some safe returns in this recently volatile market. To do this, we can use a set of three key indicators to understand how it is that the real estate market is responding to current market conditions.

The simplest metric to use when evaluate a property investment is the square footage value metric. By dividing out the cost of the property itself against its size, we come up with a number we can use to effectively compare different sized lots, and lots in different locations. From there, we can increase our sophistication by tracking both the historical square footage value, as well as the comparative square footage value against assets that we would consider to be interchangeable. For example, if we have two different properties, both of which with the same amenities and location-based benefits, but with different square footage values, we might be able to see that there is an opportunity to buy up an under appreciated neighbourhood.

The second strategy that many real estate investors use to evaluate the buying opportunity associated with the real estate market is to evaluate how many months of inventor is available to meet the market demand. As a simple supply and demand equation, a higher period of available inventory suggests a slowing down demand, perhaps in conjunction with a buying opportunity.

In today’s market, it is interesting to notice how it is that this inventory metrics has substantially improved to reflect an overall recovery in the market. For example, in Florida, inventory levels have decrease from 14 months to being less than 5. Such an improvement in demand suggests that there was at once point (and might still be) a major opportunity for investors to buy up real estate, and flip it into a more profitable market at a later date.

The last way for an investor to evaluate the real estate market is to look at how it is that increased demand is being met by the market itself. Specifically, by tracking the activities of builders, an investor is able to see how strong that future demand is, and whether or not there will be any supply shocks to the market later one. While aggressive building is indicative of a strong market demand, it also represents an increase to supply that will not really manifest until the project is completed (3-5 years later).

As such, investors need to be aware of when there might be an impending supply shock to the market, which will result in a price drop. While such a drop could still be mitigated by rental income, it is important to remember that decreased housing value will also impact the price of rent that can be charged. We therefore need to be able to understand just how much inventory will be added to the previous metric with the completion of the new housing projects, and then determine if the timeline of the opportunity itself.

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