As the inventory of REOs (aka Bank Owned or Foreclosures) increases, so do the perceived opportunities for new and seasoned investors. Experienced investors know the risks and cover their bases by doing their homework prior to placing a bid. If you are new to this game, play carefully or you may get burned. Here are some pitfalls of REOs:
- Inspect and assume the worse. The banks are selling as-is. They never occupied, never even visited, and have no disclosures to make to you. So make sure you thoroughly inspect the property and assume the worse when it comes to repair and replacement costs. Many of these properties developed roof/window leaks or suffered from vandalism that may include water damage by a previous disgruntled owner/occupant. Beware of costly mold remediation.
- Do not make your highest offer upfront. In most cases, the bank will come back and request a second round of bids (highest and Best) or may counter individually. Please note that we see a trend where banks are pricing properties below market to generate multiple bids. Low bidders are typically wasting their time, unless the property is undesirable.
- Banks are interested in three things: Price, Terms, and Contingencies. They will take a cash offer with no contingencies and quick close, over a higher financed offers subject to financing/appraisal. Beware that some properties may not qualify for financing because of their condition.
- Understand that buying bank owned properties is a legal gamble. You and your Agent may present a contract with all sorts of standard and additional clauses and addendum for your protection, the reality is that once you have an agreement on price and terms, the bank will invariably come back with a Bank Addendum which may not be modified. This bank Addendum will strip and replace any buyer's protection clauses/provisions in the original contract and addendum with clauses in favor of the bank. This is very upsetting for a lot of buyers and agents who do not understand how the game is played. As a buyer, the bank Addendum is basically giving you two choices: walk away from what may be a great deal because most of your protections are gone, or accept the higher risk and sign the bank Addendum and give up the legal protections you had in the original contract your agent submitted.
- If you hired an attorney and your attorney attempts to re-write or modify the bank Addendum to give you more protections (or you ask your agent to do that), in most cases the bank will reject any changes and move on to the next offer. You have to understand that banks want to sell with the least headaches and liability. In rare occasions, they may make certain exceptions to the Addendum such as when you are the only offer on the table for a property that has been lingering on the market.
- Major pitfalls of the Bank Addendum include:
1/ Short inspection periods: typically 7 business days or less. If the deal does not close for any reason, you have lost your inspection fee. The 7 days may sometime start before you even get the Addendum signed by the Bank (see 8/)
2/ The right of the Bank to cancel the contract at any time prior to closing without any prejudice. This may be in the form of a committee and/or investor and/or seller's mortgage insurance company approval clause, or "subject to acquisition of the property by Seller" clause. Or if they cannot deliver clear title.
3/ On cash offers, in most cases your initial earnest/good faith deposit is non refundable if closing cannot take place because of your fault. In this case there may be daily penalties for both buyers and their agent.
4/ Title issues: this is a big one. Beware of the language used to describe the type of title and manner it will be transferred to you. There is a huge difference between a Quit Claim Deed and a Special Warranty Deed. Will the bank clear all liens including the ones that are unrecorded when they have constructive evidence of their existence ? Will they pay delinquent utility bills ? Will they pay all City/Municipal fines, assessments and levies ? Will they pay Code enforcement fines ? I just dealt with a bank owned property that had several hundred thousands of dollars in fines for Occupational License violations computed at $250/day. As a buyer you are responsible to do your homework or hire a Title Agent/Attorney to research the property. Your Real Estate Agent is not trained and licensed to research and advise on title issues. So please don't rely on or ask your agent.
5/ Many addendum state something along the following line: "Buyer shall take title subject to all existing municipal code and/or ordinance violations, and any lawsuits pending for enforcement thereof." As a buyer it is your responsibility to research extent and cost to cure any code violations. Fines and per Diem penalties may be negotiated down with the city but may require a lengthy and costly process in front of a city magistrate. Does the contract allow for that and is the bank going to do this ?
6/ Most addendums indicate that no survey will be provided by the bank. Ordering a survey is imperative to ascertain boundaries, easements, and encroachements. Order a survey.
7/ Most addendum will state something along the line: "Seller is not obligated to complete the sale if sales proceeds to seller are less than $1". What this means is that if in order to deliver title to the property the seller has to pay closing costs and satisfy liens in excess of the purchase price, the bank will not come out of pocket. So if you are making an offer on a property where the liens are higher than price, you may be wasting your time if the bank cannot negotiate them down or transfer the liability to you, the buyer. Beware...
8/ The Bank Addendum will be signed last by the Bank and the Bank reserves the right to accept any other offer until the Bank signs their Addendum. This is also frustrating for many buyers and their agents because you still don't know whether you have a deal until the Bank returns their addendum signed after you sign it. The banks do this to leave their option open to accept a higher offer and also to make sure that the Addendum they sign was not modified by the buyers or their agents.
- Understand that REO agents representing the banks are typically behaving like employees of the banks. They do not care about you or your agent. Their goal is to make their client happy because they have to do volume to make money. REO agents are typically concerned with one thing: close the deal. They are graded by the banks based on their performance. So they will typically continue showing and submitting offers until the last minute, they will typically be inflexible, and they will sometimes appear as behaving unethically... Just remember, they are not your friends, they work for the banks and are a reminder why we need to keep the Banks out of the real estate business. Banks have shown they can't handle their own business: money, how can you expect them to handle real estate?
- If you are a buyer and want to deal directly with the REO Listing agent without using your own buyer's agent: understand you will not save any money and the listing agent still wants to make their main client, the bank, happy. Make sure you hire an attorney for your protection.
- Beware that most REOs have combination lock-boxes on them with identical combinations chosen by the bank's agents or asset management companies. Once the combination is given out, there is no way to know who has access to the property. It is imperative that you keep an eye on the property once you have it under contract and make a final walk-through shortly prior to closing. Taking pictures at the time of your inspection is imperative to document the exact condition the property was in at contract time.
REO properties may be high risk but many buyers have profited. Remember the saying: High Returns are typically tied to High Risks. So play your cards right.
Copyright 2009-2010 - All Rights Reserved - Ben Giordano MBA, CDPE, REOS, MILHM, Realtor
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