It’s possible to make money with Real Estate Owned (REO) properties if you avoid numerous pitfalls, setbacks and other financial traps. Here’s the reality: The process is stacked against your financial success. Here’s what you need to know to ensure that you can successfully invest in Reo properties – profitably.
What is an REO?
Real Estate Owned (REO) is property that has been taken back by the lender. It doesn’t matter whether the property is located in a judicial or non-judicial state; the end result is the same. When a homeowner is unable (or in the case of so-called strategic defaults) – unwilling – to abide by the terms of their mortgage agreement, the lender initiates foreclosure proceedings. Once the homeowner exhausts all of their legal options to retain possession of their home, an auction is held (the lender’s winning bid is normally the amount owed by the borrower), the homeowner moves out and the lender gets the property back. Once the lender regains control of the property, it becomes known as an REO.
REO Headaches for Lenders
Lenders feel a financial squeeze long before a property becomes an REO. The reason? The FDIC requires lenders to maintain adequate reserves for all of their performing assets. When a Notice of Default (NOD) is filed, that asset is by definition non-performing. Once this definition is met, banks are required to have between 3-8 times the amount of non-performing loan balances in reserves (depending on their credit rating). Since banks are able to borrow 10 times their performing balance at very low rates, they lose 10 times the loan amount in borrowing power plus the reserves. Based on these economic realities, you’d think banks would be giving away houses at steep discounts in order to get them off their books, wouldn’t you? Unfortunately, this isn’t normally the case.
Lenders Motivated to Move REO Properties
It’s no secret that banks are in business of making money. Many people have the misconception that lenders stay up late praying that borrowers will default. While this might be true of certain low balance, high value properties, the overwhelming majority of loans don’t fit into this category. Banks are in a daily race to profit or perish. In order to achieve this goal, lenders borrow low, lend high and do their best to ensure that monthly payments flow into their coffers on a regular basis. When these payments don’t materialize, lenders are forced to foreclose and take properties back, adding them into their REO inventory. For the reasons mentioned above, lenders should be highly motivated to unload these properties as quickly as possible.
BPO: Opportunity for Pricing Shell Games
Lenders have to unload REO properties as quickly as possible. In order to make this happen, lenders routinely turn to real estate professionals to give them a rough estimate of the property’s value. Instead of getting a full-blown appraisal, many lenders will request something called a BPO - a Broker’s Price Opinion. Not nearly as detailed as a full property appraisal, this is nothing more than the opinion of the broker giving it.
Here’s why the BPO is a pricing shell game: Lenders have to sell these non-performing assets as quickly as possible. Real estate brokers earn very little for BPO work; their real profits come from listing and selling properties. The Brokers providing these BPO’s, will come in with the highest-possible figure, many times at or very near fair market value, with the hopes of getting the listing.
Condition and Value of REO Properties
BPO figures are typically pie-in-the-sky figures designed to woo the lender’s listing business. I know brokers are supposed to be a little more honest about how they pass judgment on a property’s value, but they have to put food on the table. Is it right to play these games? Absolutely not...
There’s a very good reason playing pricing games is bad idea: Most REO properties aren’t worth anywhere near the inflated BPO values. The reason? Many REO properties are distressed. Their former owners were more worried about solving their financial crisis than they were with fixing a leaky roof or making other needed repairs. Fast forward several years later… the property has probably been vacant for an extended period of time, adding to the list of repairs needed to bring its value back up. The broker making the BPO is either blissfully unaware of repair costs or chooses not to say anything for fear that they’ll lose the listing.
The Average REO Buyer
Most first-time REO buyers aren’t wise to the games played by brokers and lenders. As a result, they’ll either pay too much for an as-is property or -- if the property is fairly priced -- they’ll get into a bidding war with other first-timers. The result is the same: A first-time REO homebuyer will become the proud owner of a property that probably needs extensive repairs. What happens next is a shame: Due to insufficient funds after the over priced purchase, the property either never gets rehabbed, or if it is, the repairs don’t go far enough, leaving the buyer with a property that doesn’t increase in value. This hurts the property values of surrounding properties, which tends to leave the rest of the neighborhood looking tired and run down.
How to Avoid Being an REO Victim
There’s a good way to avoid being victimized by the REO scam: Do your homework. Understand that REO properties can be great investment opportunities, but only if you:
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Understand how to estimate before- and after-repair value
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Pay only what the property is truly worth -- not the amount that a “helpful” real estate brokers says a property “should” be worth once needed repairs have been made
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Take the time to learn all the ways that lenders and real estate professionals play games with REO values
I’m not saying REO properties are a bad investment; they’re not. It is possible to pave the road to your financial future with well-timed, properly executed REO purchases. But you have to play an active role in your success, relying only on cold hard facts. If the numbers tell you an REO investment makes sense, do it. Otherwise, walk away as quickly as possible. There are profitable REO deals out there. You just have to find them.
Joe Abbascia helps real estate investors at all stages of their investing careers to learn effective strategies to buy properties wholesale and capitalize on profitable opportunities. Profits are available in any market. You just need the right tools. Learn more about Joe and how his unique investing style can help you reach the pinnacle of success by visiting PropertiesCentralWholesaleDeals.com– today.
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