There's a saying in real estate investing that you make money when you buy, not when you sell. Meaning finding an undervalued property is extremely helpful in ensuring you make a sound financial investment where you're buying your next home or your investment property.
With real estate values soaring, it may seem impossible to find a property to purchase at a good price. But undervalued properties are still bought and sold frequently even in competitive markets.
Learn what undervalued property is, the reasons a property may be undervalued, and important things to know about buying and selling undervalued real estate as a homeowner, homebuyer, or real estate investor.
What is undervalued property?
Undervalued property is real estate that is being sold for less than it is worth in the respective market. When a property is undervalued, the cost will be lower than the current as-is value or will be a significant discount off of what the future value or after repair value will be after it's been stabilized or improved to meet market standards.
In real estate investing, this could mean renovating the property or increasing the cash flow of a rental property.
As a homebuyer or homeowner, undervalued property could simply mean that the purchase price of the property you are purchasing or selling is less than the appraised value or the market value for the home.
Why might a property be undervalued?
Property can be undervalued for several reasons:
- The homeowner is unaware of the current value and is selling for what they feel it's worth, not what the market says it's worth. (This can make the sales price below market value or overinflate it.)
- The property is in need of repairs or renovations.
- The homeowner is in distress and needs to sell quickly, accepting a discount for a quick closing.
- The cash flow of a rental property is underperforming according to market standards.
Real estate investors can specifically target distressed sellers like real estate owned bank foreclosures or zombie homes -- homes that are vacant and distressed or in poor condition -- in order to find undervalued properties to purchase. In almost every case of buying an undervalued property as an investment, there is an element of distress that can justify a discount in value.
In a traditional real estate sale where a buyer is purchasing a home by getting a mortgage, the lender will order an appraisal. If the appraisal comes back at a higher valuation than the sales price, the property would be considered undervalued because the buyer is purchasing the home at a discount of its true as-is valuation or worth.
Conversely, some lenders may consider a property to be undervalued if the appraisal comes back lower than the sales price because the home's valuation is not justified by the sales price. This can happen in competitive markets where appreciation and lack of inventory are pushing prices high at a rapid rate.
What happens if a property is undervalued after an appraisal?
If a lender-ordered appraisal comes back stating the home is worth more than the sales price, the buyer gets to enjoy the benefits of buying a property at a discount.
However, if the appraisal comes back lower than the purchase price, the bank will not create a mortgage for more than a home is worth. The seller may be required to lower the sales price to meet the appraised valuation, or the buyer can make up the difference with additional money. The buyer can request that the lender order a second appraisal, but whether to do so is ultimately up to the lender.
How can you negotiate an undervalued property?
Snagging a deal isn't always easy, but undervalued properties are out there. If you're a buyer looking to score an undervalued property as an investment or as your next home, start searching for properties that are likely contenders for a distressed sale that can offer a discount on the sales price.
Working with an experienced real estate agent who is well versed in negotiations can help, but if you are negotiating on your own, start by bringing attention to the work that is needed to meet market standards to justify a higher price. You can show the seller comparable properties at or near market valuation and the condition they are in, as well as homes in similar condition and the valuation of properties that are considered distressed.
Make sure to emphasize the solution your sales price can bring as a resolution to their problem, even if it's lower than their asking price.
Where can you find undervalued properties?
Finding undervalued properties can be done by searching the multiple listing service (MLS) or utilizing strategies for finding off-market properties. You can also target a real estate market that has undervalued real estate where home prices have not increased in value based on either the income the property produces or the demand and growth the area is seeing. Some markets take time to appreciate or for investors and owners to realize the potential income the properties there will produce in the future. This can be a great starting point for your next deal.
Buying an undervalued property can be done regardless of the current market. While it's not always easy, there are opportunities out there. Knowing what undervalued property is and how to find and potentially negotiate a deal is the first step. Start marketing and searching for the right opportunity, and prepare to conduct due diligence, and make offers.