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REO stands for the term "Real Estate Owned". This is a banking term used to describe real estate that a bank owns, typically because it was taken back from the homeowner through the foreclosure process.
In a good real estate market, REO's are not very common. However, in a market like San Luis Obispo County, CA is experiencing where 72% of the homes going into escrow are either a REO listing or a short sale, the banks have a very definite role in the current real estate market.
If you are a first time home buyer or an investor - you will no doubt be looking at the REO market for the best possible bargains available today.
First, lets look at how a home becomes an REO property.
When a bank forecloses on a home, it is typically because of non-payment of the mortgage. The process of taking the home back is known as the ‘foreclosure process', which ends when the home is auctioned in a non-judicial foreclosure - which is the most common type of foreclosure in California. When no one bids at the auction, ownership reverts back to the bank that brought the action. When the bank takes the property back, it refers to these properties as "Real Estate Owned", or more commonly REO.
Why Wasn't the Home Bought at Auction?
The biggest reason a San Luis Obispo County home does not receive any bidders at the auction is because the amount of the debt is more than the home is currently worth. In the current REO driven market of the Spring of 2008 it is rare that a home goes to auction with any equity in it.
Most investors will not bid on a property that has anything less than 30% equity in it. Most first time buyers will not bid at auction because it is an intimidating affair that requires seasoning. Homes bought at auction require cash or certified funds and not a pre-approval letter from a lender.
Many REO's are in poor condition and will require a lot of rehab - which is why it is dangerous to buy a REO home with less than 30% equity - sight unseen. However, once these rehab REO properties go on the market and ample inspections and due diligence can be performed, these same REO properties can be literal gold mines for either the investor or first time home buyer.
Why Won't the Banks Hold the REO Properties?
Banks are not in the business of owning real estate - they are in the business of financing it. An REO tells the world that the bank made a bad loan - it is considered a liability and not an asset on their balance sheet. Every day that the bank owns and controls a piece of real estate, it costs the bank money.
Insurance costs and claims is a major detraction to owning REO properties. Regardless what they sell the property for - they are typically taking a hit financially. Not only do they have issues with their insurance carriers and their financial reports the federal government can penalize banks if they have an excess amount of REO inventory on their books. It is typical for banks to borrow money from ‘The Fed' and when the numbers don't look right, the bank will have to pay more for the money they borrow. When the bank has too many REO's, the Federal Government and the stockholders look at the bank as being poorly managed. There are also numerous re-occurring costs associated with maintaining the property - taxes, insurance, sewer, water, electric and HOA bills...not to mention the staff of people needed to administer the entire process.
Banks don't have locksmiths or contractors on call to take care of their properties. So they have to hire property preservation companies to maintain the property - putting the banks at the mercy of the contractors hired to look out for their best interest. The banks often have to rely on third parties to act as their eyes and ears on the ground at the REP property, when often times the party selected is interested in their own bottom line first.
Time is a great enemy of the bank. It is not like they can take it back from auction one day and then price it and market it the next day. There is typically a pre-marketing period that can take a month or longer before the home is actually fit and ready to be sold at a ‘fair price'.
Even today in the Start of 2009, the banks really are not prepared for the vast volume of homes that are coming through the foreclose process. Often times an important middle manager is given the added responsibility of managing a portfolio of REO Properties for sale, along with their other more important job. This causes a great deal of stress on behalf of the managing banker - who often does not coordinate activities with other departments of the bank that should have an impact on what is going on.
Then the bank has the additional expense of hiring a real estate agent to sell the property. This is an added expense that can really add up - especially when you multiply it by the number of homes going to auction every week.
What Makes an REO a Great Deal for the Investor or First Time Home Buyer?
Since most REO properties will require some work, both real estate investors and first time homebuyers know that they can gain instant equity with a little bit of sweat...or as it is known "sweat equity".
Because the banks are typically willing to do whatever it takes to get the property sold, these investors or first time homebuyers can typically work out a pretty good deal on a property for sale in San Luis Obispo County or anywhere else in Southern California.
For those who have a good REALTOR® in their corner to help identify the right properties as soon as they come on the market and who can negotiate a fair deal with the banks, there is a lot of money to be made buying and selling REO properties.
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