Investors can struggle to find good deals in a particularly hot seller’s market. As a result, many look to alternative sources to find real estate. This leads many investors to ask me: Ryan, how do you buy REO properties?
REO, or real estate owned, properties have been foreclosed upon by banks. And after this foreclosure, banks categorize these homes on their books as REO assets. Investors can find these homes on the MLS or at auction, and they buy them just like any other: offer, acceptance, and closing.
I’ll use the rest of the article to explain the details of REO properties and how to buy them.
WHAT’S AN REO PROPERTY?
Investors must first understand the bank foreclosure process to understand REO properties.
When banks issue mortgages, the associated properties are collateral for the loans. This provides lenders protection in case of default. If a borrower stops repaying a mortgage, the bank can seize the property and recoup its outstanding balance.
Real estate tends to appreciate, and banks face less lending risk. They know there’s a good chance they’ll recoup the outstanding loan balance via foreclosure and resale. This is why mortgage interest rates tend to be so low.
Once a bank has foreclosed on a property, that property becomes an asset on the bank’s books. But, if the bank plans on immediately selling the property, it will be classified as real estate owned, or REO, property. This allows people examining a lender’s accounting records to differentiate between A) property held for investment purposes and B) foreclosed upon properties intended for immediate sale.
ADDITIONAL POST-FORECLOSURE STEPS FOR REOS
After the foreclosure, the bank needs to sell the REO home. These steps revolve around the occupants of the home. If the homeowners refuse to leave, the bank needs to begin eviction procedures. These procedures vary by state and municipality, but they can be time-consuming and costly. Banks must comply with local eviction laws.
Rather than deal with an eviction-related headache, many lenders run a “cash for keys” program. They approach the current occupants and offer them money to vacate the premises. This A) saves the bank from the eviction process and B) avoids an eviction on the occupants’ records.
Banks can begin the resale process after the prior owners vacate the premises. Typically, banks assign responsibility for the marketing and sale of these properties to local real estate agents specializing in REO sales. For investors, this represents an absolute pro tip! If interested in purchasing REO properties in your market, find, introduce yourself to, and build a relationship with the local REO-specializing agents. These people frequently learn about REO properties well before the banks formally list them for sale, giving investors a substantial advantage in purchasing them.
WHY INVESTORS CONSIDER BUYING REO PROPERTIES
Now that I’ve provided some background on the REO process, I want to explain why investors should consider buying these properties. Simply put, successful real estate investors know how to find deals. In particularly competitive markets, finding good deals can pose a significant challenge.
With REO properties, investors should remember that banks aren’t in the business of selling homes. As a result, many try to clear these properties from their books as quickly as possible. This creates the potential for some serious property bargains.
But, banks also won’t give away these REO properties. Instead, they’ll conduct a cost analysis on each home. They want to know whether it makes more sense to A) sell it “as is” at a discounted price or B) put money into renovating the home to sell it for retail on the MLS. If the after-rehab value doesn’t justify the time and cost of renovations, many banks will instead go with the “as is” sale option.
For investors, this creates a tremendous opportunity. Distressed homes – the condition of most REO properties – do not qualify for traditional financing. Banks won’t issue mortgages for homes that require significant repairs. Consequently, only investors using hard money loans or cash can purchase these properties. This means two things. First, investors have less competition for REO properties than those listed on the MLS. Second, due to the distressed nature of these properties, banks recognize that they must sell them at a discount, generally trying just to recoup their loan balance – not necessarily make a profit.
HOW TO BUY AN REO PROPERTY
Broadly speaking, banks use one of two strategies to sell REO properties. Which one they choose depends on the home’s condition.
The first approach involves properties that A) do not need repairs or B) have been repaired by a bank post-foreclosure. With these homes, banks will sell them like any other property by getting them listed on the MLS with a local real estate agent. From an investor’s perspective, these homes do not offer any better or worse deals than any other homes listed on the MLS.
The second approach involves distressed properties that banks have decided not to renovate. Banks list these properties on auction services because these homes do not qualify for traditional financing. Lenders accrue holding costs for every REO property on their books. Banks also have capital ratios. Selling these properties as quickly as possible increases liquid assets and supports these capital ratio requirements.
For investors looking to purchase REO properties under either of the above approaches, the process is essentially the same as buying any home. You need to make an offer, wait for seller acceptance, then close on the deal.
With that said, real estate wholesalers need to be cautious about purchasing REO properties. Many lenders impose title and deed restrictions on the transaction when selling homes. These restrictions prevent wholesalers from going under contract and then assigning that contract to another real estate investor.
ALTERNATIVES TO REO PROPERTIES
Yes, REO properties can provide opportunities for great deals. But, especially during the COVID-related moratorium on foreclosures of homes purchased with government-backed loans, the supply doesn’t exist. And even when investors find a good REO deal, they can’t count on finding consistent deals.
Instead, we highly recommend that investors pursue off-market properties. These homes face less competition than REO and MLS properties, and investors can find incredible deals.
Becoming a real estate investor can take many routes and if you’re savvy enough, REO properties can be an excellent way into the industry. However, they’re not as easy to do as your standard fix & flip so consider carefully whether you’ve got the time and energy to devote to working with banks and auctions to go this route.
Learn how all this works by attending our next webinar.