How To Calculate The Value Of A Distressed Property (Explained)

Determining the value of a distressed property can be tricky.

Unlike traditional home sales that are based on market value, distressed properties are often sold under duress at below-market prices.

And these prices depend on a number of factors.

In this post, I’ll shed some light on how to calculate the value of a distressed property.

Factors That Impact Distressed Sale Price

The distressed value of a property is usually based on a number of factors. It is not simply a percentage of the market value. 

Here are some common factors that influence the price:

Property Condition 

The condition of the home is the biggest factor that determines the distressed value.

Poorly maintained properties or those with significant deferred maintenance will sell a lot lower compared to updated, move-in ready homes.

The costs of necessary repairs and renovations should be assessed. 

Things like faulty electrical, plumbing issues, HVAC replacement, roof repairs, etc. can be expensive fixes that sellers will account for in their pricing.

The worse the shape the property is in, the lower the distressed value is likely to be.

Market Conditions 

The state of the overall housing market also has an impact on distressed home prices.

When demand is low and there is a buyer's market, distressed sellers have less leverage and buyers can negotiate lower prices more easily. 

In a competitive seller's market, a distressed home may sell closer to market value since inventory is low. 

Seller Motivation

The circumstances and motivation of the distressed seller also has a huge impact. 

If the owner is under financial strain and requires a quick sale, such as a foreclosure or bankruptcy, they typically have less negotiating power and leverage with buyers. 

The greater the pressure to sell fast, the more discount a buyer may receive.

Also Read: Selling A House In Preforeclosure

Potential Risks/Liabilities

Distressed properties often have legal or financial issues that can decrease their market value. 

These may include outstanding mortgages or liens that still need to be cleared, overdue back taxes, or other legal problems (e.g. title disputes). 

Buyers will build in a discount in their offer price to account for the hassle and risks associated with taking on these kinds of liabilities.

Resolving problems like these can also delay closing timelines.

Determine Recent Comps in Your Area

Researching what other similar distressed homes have recently sold for in the same market can give both buyers and sellers a good sense of value to benchmark against.

Look for sales of similar sized homes - condos, townhomes, single-family homes, etc.

Compare the condition of those homes as well:

Were they renovated, being sold "as-is", in good condition or poor condition? 

Also note any major differences in square footage, number of bedrooms/bathrooms, age of the home, upgrades or renovations.

Adjust your estimated price for your own home accordingly if it is very different from the comparable sales in a way that impacts value, either positively or negatively. 

Doing this helps you estimate a realistic distressed value based on the most relevant sales data in your area.

The 70% Rule

As a general rule of thumb, distressed properties often sell for around 70% of the market value for comparable homes in good condition. 

This depends on many market factors, but can be a helpful starting point to estimate.

For example, if similar non-distressed homes are selling for $300,000 in your neighborhood, you might estimate the distressed value of your home to start around $210,000 (70% market value). 

This gives you an initial benchmark, which you can then adjust based on your property.

Closing Costs

Closing costs like title and transfer fees and agent commissions also take a large chunk out of your net proceeds from the sale.

So you must budget the closing costs when pricing the home initially and setting a minimum acceptable sale price. 

These expenses will reduce the actual money the seller takes home at closing. 

The listing price should be set high enough so that the final sales price nets the minimum proceeds the seller requires after subtracting all  closing costs.

Negotiating Offers

If you can, price the property competitively from the start - at the lower end of the estimated fair market value range so that you can attract more buyers.

Be prepared to provide recent comparable sales to buyers to support your listing price tho. 

Also, build in some room to negotiate, knowing that offers still may come in below your price. 

Factor this potential into your minimum acceptable price so that you can counteroffer higher if you receive low offers initially.

Other Ways To Calculate The Value Of A Distressed Property

Apart from the Comparative Market Analysis (CMA) approach, there are a couple of other methods to estimate the distress value of a property:

Cost Approach

The cost approach estimates the distress value by considering the cost to replace the property with a new one with similar features.

It involves calculating the following:

• Replacement cost of the land
• Replacement cost of the building
• Depreciation

Distress Value = Replacement Cost of Land + Replacement Cost of Building - Depreciation

This approach is good for special-purpose properties or when there's no comparable sales data in the area.

Income Capitalization Approach (For Income Properties)

The income capitalization approach estimates the distress value by considering the property's potential income generation.

Here's how it's done:

• Estimate the property's future Net Operating Income (NOI)
• Apply a capitalization rate

Distress Value = NOI / Capitalization Rate

This is a good approach for income-producing properties such as apartments, office buildings, and retail centers.