What is a Distressed Sale?
A distressed sale refers to the sale of assets – such as securities and property – very quickly and generally at a loss to urgently cover significant debts. A distressed sale is made when the seller is going through financial pressure and is in dire need of funds to meet urgent requirements. The proceeds from a distressed sale are used to pay for medical expenses or other emergencies.
In a distressed sale, the assets are sold at large discounts to make them attractive to buyers. Hence, the seller experiences a financial loss after a distressed sale. A buyer trying to value an asset should know the conditions of an asset’s sale as the asset valuation in a distressed sale does not reveal its true value. Such a sale does not happen in an open and competitive market; hence, the sale price does not reflect the market value.
- A distressed sale refers to the urgent sale of assets – such as property and securities – to quickly cover urgent debts, medical expenses, and other urgent expenses.
- As the sellers want to quickly sell their assets, they are sold at a lower price than the actual value. Hence, distressed sale leads to a financial loss for the seller.
- The assets purchased in a distressed sale often require repairs, as the sellers do not perform any repairs knowing that they will be selling. Hence, buyers may have to spend a significant amount to repair the assets.
How It Works
A distressed sale transaction can occur in a business that is making losses consistently or is on the verge of insolvency. The business owner sells his/her business at a substantially lower price than the real value to liquidate the residual earnings from the investments.
Hence, by selling the business at a price lower than the market value, the business owner experiences a loss. A buyer purchases the business because of the following two reasons:
- The buyer expects that the products or services offered by the business offer great potential for generating profits. Hence, the buyer buys it to continue making profits.
- The buyer sells a part of the business at a price higher than paid, and thus makes a profit.
Distressed sales can also occur in the stock market when investors short sell the stocks that are at the lowest acceptable price for the investors. The investors do so to protect the value of their investment from hitting zero.
Advantages of a Distressed Sale
- Property owners looking to quickly sell their property will meet the short-term goal of paying off their debt, evade foreclosure, and keep their credit.
- Generally, a distressed sale takes the form of the short sale in which the lenders allow the owners to sell their assets at prices lower than what they owe and also waive off the remaining loan amount. However, the amount waived off may be taxable if the owner is liable to pay the full loan amount as per the mortgage agreement.
- The buyers, through a distressed sale, are provided with an opportunity to buy an asset at a significant discount from the market price.
Limitations of a Distressed Sale
- The owner sells his/her property or asset at a price much less than its fair value. Furthermore, the owner misses out on the opportunity of future gains in case the value of the asset goes up.
- A distressed sale negatively impacts the credit score of the asset owner, although not as much as a foreclosure would.
- New owners of an asset sold in a distressed sale may need to spend a significant amount of money towards the repair of the assets, as the seller wanted to quickly sell them and probably would not have done any required repairs.
Requirements of a Distressed Sale Execution
A lender may allow the asset owner to pursue a distressed sale if he/she has encountered at least one of the below hardships that have caused the owner to not meet the mortgage obligations.
- Declining real estate value
- Medical expenses
- Business failure
- Health problems preventing the owner from maintaining paid employment
- Death of spouse
Generally, the cost associated with the conduct of a distressed sale, such as any real estate cost or attorney fees, is covered by the lender.
CFI offers the Commercial Banking & Credit Analyst (CBCA)™ certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following resources will be helpful: