The word “discount” gets tossed about all the time in the distressed property marketplace. The term “discount” means something different to each person unless it is carefully defined in a given situation.
The newbie investor may feel they are getting a good deal in tying up a property that is listed at 50% off the original loan balance. The problem is the original loan balance is essentially meaningless to the deal. Discount needs to be determined off current market value within the specific market. The average discount from market value for a bank-owned property is around 26% nationwide, while a short sale may on average be settled with a 15-20% discount from market value. The specific typical discount values for a foreclosure and a short sale will vary considerably from market to market and neighborhood to neighborhood, as well as lender to lender.
Different markets may also show a different picture of whether short sales or REOs are typically more profitable depending on the amount of competition for deals in the area. If there are a lot of REO investors and relatively few working short sales, the competition on the REO end may very well drive the price up when the property comes on the market, while short sales may continue to command large discounts. In markets where there is relatively little foreclosure activity the fact that a property is “distressed” may have little, or no, impact on the listing price for the property because the property can sell quickly with little discount.
To determine an appropriate discount for a given market or neighborhood have a local agent list comparables of recently sold, similar properties in the area. If there is a wide range of prices for similar properties the lower ones probably represent the price for comparable short sales or foreclosures, and higher prices probably represent resales to retail buyers or buy and hold investors.
Whether a deal is a good one or not will also depend upon the investor’s exit strategy. A buy and hold investor may be happy with a 10 to 20% discount off market value because the strategy is to hold the property for appreciation and rental income. A wholesale investor will need a deeper discount-perhaps 50% off current market value– in order to build in a margin for profit and expenses in flipping the property to another investor-buyer who will rehab the property and sell to a retail buyer or will hold the property for appreciation. The rehabber who must get a hard money loan in order to fix a property before will typically need at least 40 to 45% off current market value less rehab costs in order to make the deal profitable and to pay off the hard money loan.
Therefore, the answer to the question about what discount means will depend on the market and the kinds and numbers of buyers who are attracted to that market. The discount should always be determined from current market value, not from the existing mortgage balance.