Real Estate Owned (REO)
Bank-owned property that failed to sell at a foreclosure auction
What is Real Estate Owned (REO)?
Real estate owned (REO) is a bank-owned property that failed to sell at a foreclosure auction. When homeowners fail to pay their mortgages, they can either sell their property immediately and offer the sale proceeds to the bank or give it up to the bank for foreclosure.
Foreclosure refers to a legal process wherein a bank, or any lender, assumes ownership of a property that’s been defaulted on and attempts to sell it to recover their money.
The lender holds a foreclosure auction wherein prospective buyers can bid on the property, which is finally sold to the highest bidder. Sometimes, even the highest bid falls short of the amount the lender has to recover. In that case, the lender or bank assumes ownership of the property until it can sell at the desired price.
Summary
- Real Estate Owned (REO) is a bank-owned property that failed to sell at a foreclosure auction.
- Banks usually do not prefer holding REO properties on their books because they add to the bank’s risk, and they often sell them for much less than their market value.
- Banks clear all property taxes and liens for REOs to ensure a fast and smooth transfer of ownership.
How do Banks Sell Real Estate Owned Properties?
Banks usually do not prefer holding REO properties on their books because they add to the bank’s risk. If banks hold many properties under foreclosure and are unable to find suitable buyers for the same, it means that the real estate market is in an unfavorable state.
These properties are almost always sold at a discount since the bank only seeks to recover the amount of money that the borrower failed to repay in the past. If no one is willing to buy even at the discounted price, it means that the property’s lost its value in the years between the issue of loan and the foreclosure auction.
Banks prefer to sell REO properties in bulk, and at a greater discount than when they try to sell them individually. It is because a bulk purchase of such properties in one go saves the bank money and time.
An alternate way for lenders to dispose of foreclosed properties is by letting them out on rent.
In fact, the U.S. government-sponsored home mortgage corporations Freddie Mac and Fannie Mae adopted an initiative in 2012 to allow investors to purchase several foreclosed properties and let them out to families on rent.
Known as the REO to Rental Pilot Initiative, it was rolled out in places that were hard-hit by the unfavorable real estate market, such as Chicago, Phoenix, Los Angeles, Atlanta, and parts of California. The move received positive results.
Advantages of Buying REO Properties
1. Discounted price
Lenders are eager, and sometimes even desperate, to dispose of their REOs. They only care about recovering the amount of the loan that their borrowers failed to repay. They do not care about earning a profit out of selling these properties.
Banks do not offer the entire value of the property as a loan; they usually maintain some margin. Therefore, the amount that they seek to recover is generally much less than the market value of the property.
Consequently, the minimum price that they ask for the REO is much less than its market value. It would be a great saving for prospective buyers to get a property at such a discount.
2. High return on investment
REOs provide good returns to both landlords and real estate flippers. Landlords can purchase an REO at a huge discount and lease it out to tenants at market rental rates. Eventually, the landlord will be able to cover the cost of buying the property and will earn a steady rental income.
Flippers, on the other hand, can buy REO properties at a huge discount and resell them to prospective home buyers at the higher market price.
3. No outstanding taxes or liens issues
When buying a regular property, outstanding property taxes and unpaid mortgages of the previous owner are some issues that might discourage prospective buyers from purchasing a particular property, because the new homeowner needs to deal with them.
With REOs, however, banks clear all property taxes and liens to ensure a smooth transfer of ownership.
Disadvantages of Buying REO Properties
1. Competitive buyers
Investors, landlords, and prospective home buyers are aware of the various advantages of REOs over normal residential properties. It provides a sound investment with high returns and does not come with any title or liens disputes. In that case, the market for such properties is concentrated with buyers.
2. REOs are sold “as is”
Often, homeowners who defaulted on their payments leave the property in need of repairs. Since banks do not spend money on repairing the house, the burden of the expense will fall on the new owners. It does not create any issue for flippers who wish to resell, but it does affect individual buyers who plan to live there, as well as future tenants.
Related Readings
CFI is the official provider of the Commercial Banking & Credit Analyst (CBCA)™ certification program, designed to transform anyone into a world-class financial analyst.
To keep learning and developing your knowledge of financial analysis, we highly recommend the additional resources below:
