Distressed Sale

Distressed Sale Meaning

The distressed sale is a sale transaction that involves the sale of an underlying asset valued below its intrinsic value, and the owner of the asset is ready to sell the asset for a price less than market value and bear the loss in order to liquidate his investment immediately.

How Does Distress Sale Work?

Here we discuss how it works in various situations.

#1 – In Real Estate

The important thing to understand is the meaning of distressed assets, which, in the case of real estate, is a distressed property. In simple words, a distressed property is basically an old, damaged, run-down property, with broken structures, damaged interior, and not fit for end-use without significant renovation.

The seller of the distressed property agrees to sell the property to the buyer at a lower price. It majorly happens when the owner/ seller of the property does not have enough funds to renovate the property and also might going through economic crises such as not able to repay his debts or other financial emergencies. Thus, he sells the property at a lower price and bears the financial loss just to liquidate his investment quickly.

On the other hand, the buyer of the property buys the distressed property for two reasons:

  • For long term capital appreciation; or
  • For trading the property at a profit

If the buyer of the distressed property anticipates a significant price rise in the future due to the development potential of the geographical location, the buyer may renovate the property and hold it as a long term investment.

Else, the buyer of the distressed property, will acquire the property from the seller at a lower price, incur the cost of renovation to make the property fit for the end-use and then sell it to a new buyer at a profit. It is how distressed transactions happen in real estate.

#2 – In Business

Similar to real estate, distressed sale transactions can also be witnessed in the case of the business. A distressed business is a business that is consistently making losses or on the edge of winding-up or insolvency.

The owner or seller of the business sells the business at a significantly lower price in order to liquidate the residual proceeds from the investments. Due to this,  the seller incurs a financial loss by selling the business at a lower price. The buyer of the business buy it for two purposes:

  • If he anticipates that the product, service, or brand of the business has significant potential to generate the profit, then he buys the business to continue it and make profits out of it.
  • Else, he sells the parts of the business to get a better price than the price paid for the purchase of the business, which results in trading profit.

#3 – Stocks/Portfolios

Many times, investors short sell their stock portfolios. When a stock hits below the lowest bearable price or stop-loss point, the investor short sells their stocks even at a loss just to protect their investment value to reach zero.

Example of Distressed Sale

Distressed transactions are majorly evident in business as well as in real estate transactions.  For instance, a sale of the business which is consistently making losses and almost on the edge of winding-up is an example of distressed sale.

Or, Let us say, selling a run-down house for less than its market price, where the owner is ready to bear the loss in the sale is another example.

Distressed Sale

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Advantages

#1 – To Seller of Distressed Asset

The distressed sale provides a cushion to the maximum loss that may incur by the owner of the asset. Though in the case of sale of such assets, the seller bears the financial loss, however, the extent of the loss can reduce by selling the asset immediately at a lower price instead of hoping for a better price. It is applicable in the scenarios where the price of the asset consistently falls (say stocks), and the owner of the asset continues to hold the asset in anticipation of the price rise.

Distressed sale transactions can be the possible exit strategy for the holder of the asset who is in urgent need of finances and ready to sell the asset to encash its price.

#2 – To Buyer of Distressed Asset

  • Capital Appreciation: If the asset has the potential to outperform in the long run, that long term capital gain can provide significant appreciation to the buyer on the money invested.
  • Option to execute a profitable trade: The buyer of the distressed asset gets the property at the lower prices, and by trading the asset at a better price with the new buyer, he earns a trading profit on the asset.

Disadvantages of Distressed Sale

#1 – To Seller of Distressed Asset

The key disadvantage is that the seller is not limited to the extent of the loss he bears due to the sale of the asset. The seller short sell to encash the investment immediately to meet his financial needs, and bear the opportunity loss of the capital appreciationThe Capital AppreciationCapital appreciation refers to an increase in the market value of assets relative to their purchase price over a specified time period. Stocks, land, buildings, fixed assets, and other types of owned property are examples of assets.read more the asset could have generated for a longer holding period.

#2 – To Buyer of Distressed Asset

The possible disadvantage of the distressed sale for the buyer would be the wrong selection of assets or buying at the wrong price due to a lack of effective due diligence.

Conclusion

The distressed sale transaction involves the sale of the distressed assets generally at a lower price than its fair market value because the seller of the asset wants to liquidate his asset immediately.

This article has been a guide to Distressed Sale. Here we discuss how distressed sale works in real estate, business, and Stocks/portfolios along with the example, advantages, and disadvantages for the seller and buyer of distressed sale. You can learn more from the following articles –

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