What is a distressed sale?
A distressed sale occurs when a property, stock, or other asset needs to be sold quickly. Difficult sales often lead to a financial loss for the seller who, for reasons of economic constraint, must accept a lower price. The proceeds from these assets are most often used to pay debts, medical bills or other emergencies.
Key points to remember
- Distressed sales occur when the seller has to sell an asset urgently, often to pay debts, medical bills, or other emergencies.
- A short sale is a form of distressed sale in which the owner attempts to sell his property even if the current market value is less than the amount owed to his lender.
- Distressed sales often result in financial loss to the seller because buyers realize that the seller is in a rush to obtain funds and offer a lower price.
- Buying a property by foreclosure or a distressed sale can mean that the property is in poor condition.
How Distressed Sales Work
Mortgage borrowers who can no longer afford payments for their mortgaged property can choose to sell their property to pay the mortgage. Examples of situations where distressed sales occur include divorce, foreclosures and offshoring.
A short sale by an owner can be considered a distressed sale. Here, the owner attempts to sell his property even if his current market value is less than the amount owed to his lender. This can happen if the owner is forced to leave the house and cannot wait for the market value of the property to recover. The owner may have a new job that requires immediate relocation. A divorce could force a house to be sold in order to liquidate property which must be shared between the parties. A lender must generally accept a short sale before being able to proceed, as such a transaction would remove the collateral which guaranteed the mortgage.
How A Distressed Sale Can Lead To A Net Loss
If a distressed sale is made for a property such as an ancient art or a collection, the seller may choose to take offers that are less than the value of the object. The seller can request offers by announcing the item, or the seller can offer the item to a pawnbroker.
When the seller of an item deals with a pawnbroker, he will likely receive offers that are less than the value of the item. The pawnbroker makes a low offer because he intends to resell the item for a higher price and make a profit. The trade-off with accepting an offer that is below market value is that it will provide the seller with immediate money. Even if an item is valued at a higher value, a pawnbroker will still look for a way to make a profit.
There are times when potential buyers can take advantage of the circumstances that forced a seller to make a distressed sale. The buyer may be aware of the seller’s immediate need to complete a transaction and receive payment. This could lead to offers significantly below the value of the property.
If an asset is sold in the context of a distressed sale, the valuation of the asset is considered artificial because it has not been sold under real competitive market conditions. In the case of real estate, for example, the sale price cannot be used as a comparator to establish the real value of the asset.
Buying a property in difficulty
Buying a distressed property means you have a good chance of buying it at a price below market value; however, there are drawbacks. First, if the seller was in a hurry to sell, it is unlikely that he would have made repairs to the house to increase the selling price. New owners may need to spend a substantial amount to bring the property to the desired state.