The ability to grab correct comparables is an essential skill. So what to do with REO sales when deciding on good comps?
Comparables are tricky for any investor, and it never gets easier. Let’s say you’ve found the perfect potential property, and you know part of being a good investor is doing your homework to find good comps before making an offer. But while doing your research, you seem to keep pulling up REO properties. But are REOs good comps for real estate investing, or is it nothing but insufficient data?
There are pros and cons to using REO properties as comparables when investing in real estate. Still, overall they’re a critical element of your flipping data that needs to be included. Otherwise, you’ll fail to get an accurate understanding of market conditions and may end up overestimating your profit potential.
There are some potential drawbacks to using REO properties as comparables when investing in real estate. We’ll get into those soon. First, let’s talk about what makes a good comp and what you need to understand about REOs before using them as comps or choosing an REO. Let’s dive in.
What is an REO?
Real Estate Owned (REO) is a term that refers to a property that is owned by the bank or other lending institution. Typically, REOs are properties that, for one reason or another, never sold at a foreclosure auction.
Are REOs the Same as Foreclosures?
There is some debate over whether or not REOs and foreclosures are the same things, but in my opinion, they should be considered separate categories.
Generally speaking, REOs are properties that have been owned by the bank or other lending institution for one reason or another and have not yet been sold at a foreclosure auction. On the other hand, Foreclosures refer to properties that have been sold at a foreclosure auction.
However, since foreclosure is both an event and a process, it’s a little difficult to say definitively “yes, they’re the same as an REO” or not. Think of it like this: A foreclosed property is either in the process of being auctioned off OR has sold at an auction. An REO was a property that had been foreclosed on, but when it came time to auction off didn’t net any bids for whatever reason.
What are Comps?
Comparables, or “comps,” are recently sold properties that are similar to yours. Real estate investors and lenders use comparables to make informed decisions when considering whether or not to invest in a property. By looking at recent sales data, investors can get a good idea of the market conditions in an area and decide whether or not it’s worth investing in. Additionally, by looking at comparable properties, investors can get an idea of what type of property they’re looking for and what the expected return on investment (ROI) will be.
A Few Benchmarks for Finding Good Real Estate Comps
I have pretty strict rules for finding comps:
- No further than 1 mile from your property.
- Not sold longer than one month ago.
- Has a similar location (a property in a busy area won’t be the same as a house in a quiet neighborhood)
I use these rules to find three recently-sold comps and three comps that are currently on the market. If I can’t find any properties that match these rules, I’ll start to expand either my timeline or radius. However, once I start messing with these numbers, I know that my comp data won’t be as accurate.
What are the Risks of Using REO Properties as Comps?
Besides the property falling outside of my benchmarks listed above, the biggest drawback for using an REO as a comp is that it’s too variable. Has the bank owned it for weeks, months, years? When was the last time it was put up for auction? What condition was it in when it went up for auction compared to what it looks like now? It’s often outdated data that’s not reliable enough for new investors to use it as a comp.
There’s also the risk that the property could be in a less desirable location. It’s essential to do your research before investing in any property, but using REO properties as comps can make it harder to make an informed decision.
Should I Avoid Using REOs as Comps?
However, just because it’s too variable for newbies doesn’t mean they’re not “good” comps. At The Investor's Edge, we use REO properties when assessing deals all the time. There are two reasons: supply vs. demand and ARV. Really, though, it all boils down to the fact that a property’s value is what a buyer is willing to pay for it.
Buyers don’t care who sells the home – what they care about is the property’s condition. This is why we have expanded our pool of comparables to include REO properties that are “move-in ready.” Including REO properties in “move-in” condition gives us a more accurate view of the actual market value than if we had disregarded all REO comparables.
To achieve a correct calculation of the ARV of your property, REO properties are essential to use as part of your comparables.
In our experience, throwing out REO properties as comparables creates an artificially inflated property value for your home. And a property with an artificially inflated value rarely sells. This can put the borrower in a world of hurt, having to keep the property on the market for a while, with time slowly eating away at potential profits. Often, refusing to use REOs as comparables (resulting in a less-accurate ARV) results in the borrower having to foreclose on a property not being able to find a buyer.
What’s an ARV?
ARV stands for After-Repair Value and is the estimate we and other hard money lenders use to determine a property’s value. With a traditional lender, the amount of money you can borrow for your mortgage is based on the property’s current appraisal value. However, hard money lenders look at the value of the property once it’s back to salable condition, giving you more money to work with to get the repairs you need to be done with one loan.
How Do You Use REOs as Comparables in Real Estate Investing?
When investing in real estate, it is important to use comparables when making decisions. Comparables are pieces of real estate that you can use as a benchmark to measure the potential profit from flipping the property.
There are a few things you should keep in mind when using REOs as comparables:
- The property must be in good condition and have been well maintained.
- The market conditions must be similar.
- The loan terms must be comparable.
Questions You Need to Ask Yourself Before Using an REO as a Comp
- Does the property have a similar location and/or size?
- Is the property in good condition?
- What is the current market value of the property?
How Do You Determine If an REO Property is a Good Investment?
Your interest has most likely piqued (or, at least, mine had) when looking at REO properties, even solely as potential comps for another property. There is no one-size-fits-all answer when it comes to deciding whether or not to invest in real estate so determining whether or not to add REOs to your investment portfolio requires a little forethought.
Every individual has different needs and wants, so the best way to determine if buying an REO property is right for you may vary depending on your situation. However, some key factors you may want to consider when evaluating an REO property include:
- Are there any significant renovations or repairs that could impact the property’s value?
- How long has the REO been on the market?
- Are there any pending legal proceedings affecting the property or its tenants?
- What is the history of foreclosures in this area, and how does that affect potential buyers’ interest in an REO property?
While there are no guarantees in investing, taking these factors into account can help you decide whether or not an REO is a good investment.
Pros and Cons of Investing in REO Properties
- REO properties are typically cheaper than other types of real estate, making them a good starting point for investors who are looking to get into the market at a low cost.
- REOs have been in the market for some time, meaning that they have been through the process of being sold and may already have some repairs or updates made that could be advantageous to an investor.
- REOs can be more difficult to sell than other types of real estate, as there may be less competition, and potential buyers may be more hesitant to invest in a property that has been in the market for a more extended period of time.
- Repairs or updates that have been made to an REO property may not have been done in a fashion that is compatible with the current market, which could lead to difficulties selling the property.
- Foreclosures in an area can also impact the interest of potential buyers, as many people are reluctant to invest in properties near areas where foreclosure rates are high.
The Bottom Line
In general, it is essential to do your due diligence when investigating any property before making an investment decision. However, using REOs as comparables can provide valuable context for your analysis and help you make an informed decision about whether or not an REO property is a good investment.
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