By Ethan Roberts
As property values rise, more and more consumers are seeking bargains in bank-owned (REO) properties. Today we’ll look at what these properties are all about, and how one should go about buying them.
What is an REO?
When a borrower defaults on his or her bank loan, the bank forecloses on the home and it goes to a foreclosure auction. But sometimes the home doesn’t attract a buyer at auction and remains unsold. It then becomes as REO property and is re-listed for sale either on the Multiple Listing Service (MLS) of the city in which it’s located or on an auction site such as Auction.com.
The lender and real estate brokerage then work together to get a home ready for sale, clearing liens, removing belongings (and even occupants) from the home, and determining a fair price for the re-sale.
In the past, it was true that little to no work was ever done on these properties and they were almost always sold as-is. However, in recent years, a number of entities, including Fannie Mae and Freddie Mac, have begun to do some cosmetic work on REOs, such as painting, re-carpeting, and installing basic fixtures. The problem for the investor and owner-occupant alike is that making these improvements raises the sale price, thus reducing the amount of “sweat equity” (the increase in value that an investor creates through his or her own hard work) for the investor. It’s often better—in other words, more profitable—to look for properties on which no work has been done.
It’s also true that occasionally, a bank (or even Fannie or Freddie) may be forced to make repairs if the FHA or VA appraiser makes that work a contingency for approving the loan. In general, REO sellers don’t like having to do this, which is one reason that they prefer all-cash or conventional mortgage deals.
Get Pre-Qualified First
Realize that in the REO game, cash offers beat those with a mortgage, and a conventional mortgage beats an FHA or VA loan. If you have an FHA or VA loan, you’re going to have a tougher time landing a bank REO, as you’ll either get rejected from multiple deals by cash or conventional borrowers, or because the homes need have too many repairs to qualify for your loan.
Regardless of the type of loan you take, you must get pre-qualified before making any offers. The banks will not even consider taking your offer without a pre-qualification letter from a reputable lender.
Find a Qualified Real Estate Agent
Work with a real estate agent, broker or Realtor® who specializes in, or at least sells, bank REO properties. He or she will have the most expertise in assisting you through the process.
I have had customers over the years ask me how they can buy REOs directly from the banks to get a better price. While this may have been possible a few decades ago, it rarely is today. The banks typically work with a handful of brokerages in each city who sell their REO properties, making the process much more efficient.
Think about it: If Bank of America has several hundred thousand REOs on their hands, they can’t have every investor in town coming into their offices to talk to the manager about buying one. The best way is to have your agent set up a computerized search with the exact specifications you’re seeking, and then jump on any new listings quickly before they sell.
Don’t Make Low-Ball Offers
For some reason, first-time investors and homebuyers often assume the banks are going to give away their REO properties. Perhaps this idea comes from some television program—or it’s just wishful thinking. The reality is that bank REOs are often listed at least 10% or more below current market values, and these homes typically sell for at least 95% of that price. Banks will usually reject a low-ball offer—one that’s far below the asking price—made on a recently listed property, and it’s also likely that they’ll accept another, higher offer.
However, sometimes if a property hasn’t sold within 30 days of being listed, the seller will drop the price another 5% or 10%. Watch for these price changes, and try to get your offer in as quickly as possible after the price reduction occurs. Just realize that the seller has just dropped the price and probably isn’t anxious to see a low-ball offer at this time.
The only time a bank is apt to accept a low-ball offer on an REO is if the property has been sitting on the market for a very long time, and there aren’t any other offers on it. However, these are the properties that typically need the most work, or have problems that make them more difficult to re-sell or rent.
Have the REO Inspected
Once your offer is accepted, you’re usually permitted 10 days to conduct the various inspections. These will include a general home inspection, a wood-destroying organisms (WDO) inspection, and in some cases a lead-based paint or radon gas inspection.
Should the inspections detect more problems than you realized from just a cursory examination of the home, you’ll have to decide whether or not to continue with the purchase. Sometimes you can ask the seller to make some repairs. But as I mentioned before, many of these REO homes are sold as-is, and unless the appraisal makes the loan contingent upon a specific repair, the seller isn’t likely or even obligated to agree to make them.
Be Ready to Close
As the day of closing draws near, get ready for it. Have the funds you need to close already set up in a liquid account so you can wire transfer or bring them on closing day. Buy your materials and set up your workers in advance, except for items that are non-returnable. Every so often a title problem can delay or prevent an REO closing, so you want to be able to return any and all materials.
Finally the big day arrives. Bring proof of identity and any necessary funds to the closing, and relax. You made it! You bought a bank REO.
Now the real fun begins!
Ethan Roberts is a real estate writer, editor and investor. He’s a frequent contributor to InvestorPlace, and his work has been featured on MSN Money and Reuters. He’s also written for Seeking Alpha, Investopedia, The Fiscal Times, ForSaleByOwner and Smarty Cents, and was one of five contributing editors to The Tycoon Report. He’s been investing in real estate since 1995 and has been a Realtor since 1998. He also teaches classes on investing in residential real estate.
