Is Buying a Fixer-Upper or Condemned Property Really Worth It?

As a kid in Ohio, one of the best ways to pass time in the family car was to look for an old, fallen-down barn or farmhouse. Once spotted, I could wickedly yell, "Look, sis! Your dream house!" It was a game of sibling "gotcha" that happened too quickly to be considered truly bad behavior by my parents.

But memories have a way of warping, particularly if they are related to real estate. Fast forward to today's reality home makeover shows, combined with rising home prices, and suddenly, the thought doesn't seem so funny. There's now a certain irony in that childhood game.

Such home rehabilitation shows give us the intangible ability to dream. If the break-no-sweat, barely working home improvement hosts can turn a room around in one hour, we reason, surely, we could make a quick trip to the hardware store and transform a home within days - right?

Regardless of how much we say we believe in the message, the seed is planted. Add to it the rising cost of homes, and what emerges can best be described as the Son of Extreme Makeover trend: Perhaps, a rather run-down home could be purchased and renovated, providing the buyer with a previously unexplored entrée to home ownership.

While it sounds like a great idea, in reality, buyers of homes with lots of work are going to face many obstacles. One of the largest may be obtaining financing. "Real issues arise when a city has condemned a property and determined the property is not up to code," explains mortgage broker Kevin Casey. "This is usually shown on the preliminary title report."

Homes in such extreme states of disrepair are tough to finance. Lenders are used to a standard set of repairs, such as roof replacement, foundation work, termite or other pest control, and updates to items like sewer laterals, which prevent future problems.

But the closer a home gets to that childhood vision of disrepair, the less likely a bank will fund a loan. "A lender won't loan money on something that severe," says Shelley Puentes, another mortgage broker. "The work basically needs to be done prior to the sale."

Puentes says that if key systems aren't working - for instance, if the house has no running water, or if electricity has not been on in awhile - lenders will shy away. "In the case of running water, how does a lender know whether there are leaks in the pipes? The answer is, you don't know until water is running through them. So lenders shy away, because it is too risky," she explains.

If a buyer still hopes to make their mark in the home market with such an extreme fixer-upper, their only option may be cash. "You basically have to buy the house in cash, because the house can't be financed until the work is done to it. And of course, you can't fix it before you get the loan."

Of course, the difference between a house with potential (worth funding), and a home considered too run-down (that isn't worth funding), varies from lender to lender. So, many homes will be in a gray area, suitable for some lenders, not suitable for others.

Even if the buyer can obtain a preliminary loan approval to purchase the home, other financial details can unravel the deal.

Pam Sapena, an East Bay appraiser, says buyers purchasing a property with lots of deferred maintenance need to be aware of several financial consequences. "If there's a lot of deferred maintenance, I would try to figure out how much it would cost to bring it up to an average condition."

But that is just one small piece of the appraisal. Since the worth of a home is based on what it would sell for, a comparison with similar homes in the same immediate area carries a lot of weight. "Most weight is on the comparison sales analysis. I would look for a similar home in the same area," she explains. "Our job, as appraisers, is to give an appraisal based on the market."

For instance, Sapena recently appraised a home where the sub-floor was missing. "The previous owner had started to remodel the home, and stopped mid-way." While the buyer was able to obtain financing, one of the reasons they could was that, according to Sapena, "The new buyer had enough money to fix it up."

But she cautions against assuming that that is all that is needed. "The cost of repairs doesn't always equal the value. You have to look at other houses and figure out what the house is worth with those particular features missing."

For example, a house with a missing sub-floor in a particular neighborhood might be appraised to sell for about $30,000 less than similar homes in the neighborhood that have a sub-floor in place. But the replacement of the sub-floor may only cost $20,000. Conversely, the repair could cost $30,000, (and need to be done), but only bring an additional $20,000 in value.

The biggest problem, however, might be in finding such a home in the first place. "I would guess that only about one out of 20 homes I appraise is considered a 'fixer upper' of any kind," Sapena notes. "Most are in fairly standard condition. So if buyers want to find a fixer-upper, they're going to have to hunt for them."