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Lessons from the Pros - The Broad Market

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What is an REO? I Hear Rumors That They're Missing

Tue, Nov 3 2009, 12:06 GMT
by Diana Hill

Online Trading Academy

A couple of weeks ago, I was in the corporate headquarters of Online Trading Academy in Irvine, CA, having a meeting regarding the real estate education Online Trading Academy is offering. In that meeting, we were discussing real estate education, its importance in today's market and a variety of buying strategies. I kept using the acronym REO, and finally someone in the meeting with no real estate background, but a desire to understand, asked me what the acronym stood for.

I've found that we know what we know and we expect everyone else to know the same things. As I've gotten older, and hopefully wiser, I found that we know what we know and that many others may not have that same frame of reference. With that said let me explain what an REO is.

REO, stands for "real estate owned." "Owned by who?" you may ask. A banking institution. These properties are also known as "bank owned properties." How does the bank acquire these properties? These properties fall under the umbrella known as foreclosed properties. Typically, when a bank forecloses on a property it will go to a foreclosure auction (that's a topic we'll cover in future articles); if the sale at the auction is unsuccessful, then the bank repossesses the property. The bank will now list the property on their books as an REO, and these REO's are now categorized as "non performing assets."

After repossession, the property now classified as an REO, will sometimes go through the process of being sold by the bank through their "asset management department" if they have one. Some of these properties are sold to groups of investors who will take many properties (40-100+) off the bank's hands all at one time.

Most of the time, however, the bank will remove liens and other expenses on the home and then open them up to the public for sale, usually through an auction company or real estate brokers. As a generality, the REO's on the open market are in poor shape, in need of repairs and maintenance.

So as real estate investors, we can see that there are opportunities to buy these distressed properties for lower than ARV (after repaired value). But many investors are looking at the market and the record-breaking foreclosure activity for the last 14 months and are wondering, where are all of the REO's?

It's a valid question. In normal market conditions, when a bank repossesses a home, the usual process is to have a listing agent put the property in the MLS (multiple listing service) within 30 days. This means that in normal market conditions, it's a relatively short period of time where virtually every marketable REO finds its way to the local MLS for sale. Today, that's simply not the case; it's likely that between 450,000 and 500,000 properties repossessed over the past year are still not on the market. With buyers hungry for housing bargains, and agents and brokers chomping at the bit, it begs for an answer.

Here are some other reasons the lenders and servicers of loans admit the process is taking longer than in the past, and many of the answers are for legitimate reasons:

1. Many of the properties have title issues that need to be resolved

2. Many of the properties are in a state of utter disrepair

3. A few states have extended the length of the eviction proceedings

4. A number of states have strict redemption rights' periods, which prevents the lender from reselling the property

5. The sheer volume of REO activity

But you may ask: Are there other things that could be slowing down the process? A popular theory is that many banks are holding the properties off the market in order to defer losses. There's some accounting logic to this theory, as in most cases banks aren't required to adjust asset prices until the actual resale of the property. Another idea is that the industry is holding back the inventory to create leverage with the government in order to force the creation of a "toxic bank" or RTC (like the entity that was created in the late 70's for the savings and loan melt down).

My opinion on the missing REO's is two fold; it's probably a combination of all the reasons listed above, as well as the banks holding back some of the inventory so they can create demand.

Whatever the reason, we're going to continue to see a record number of REO's at least for the next year - there are good bargains out there if you know where to find them, how to evaluate them, and how to resell them.

Published on  Tue, Nov 3 2009, 12:10 GMT