REOs and Short Sales: Understanding the Basics
There is a lot of interest in buying foreclosures, including REOs (real estate owned by a bank) and short sales these days. A lot of information—some good and some bad—is circulating about the subject. Often, this information is for sale, promising that you can make a lot of money with little effort once you learn 'the secret formula'.
The fact is that there are no secrets, and making money does require effort.
So: What's a 'short sale'? A property listed as a 'short sale' is one in which the property owner (borrower) is marketing their home, subject to their own lender's approval of the sale. The property's value is less than their loan value (sometimes significantly less), and the seller is asking their own bank to allow them to sell the property 'short' of what is owed.
Clearly, this has nothing to do with the time it takes to close such a deal: we have had short sales in negotiation with the lender for up to 2 years (an anomaly: typically, from start to finish, it's about 3 months on average here in Ventura County). The procedure is a bit more involved than a standard sale in that, understandably, with more than just the seller's eyes to approve an offer, it takes longer to get approval. Because the seller is often short of funds to do any repairs, these short sales often do not cover the termite report or work. Still, they can be a better investment than an REO because you have a paper trail of disclosures that the seller must sign as per real estate law.
What’s an REO? REO stands for 'Real Estate Owned'. These are properties that have gone through foreclosure and are now owned by the bank or mortgage company. This is not the same as a property up for foreclosure auction. When buying a property during a foreclosure sale, you must pay at least the loan balance plus any interest and other fees accumulated during the foreclosure process. You must also be prepared to pay with cash in hand, and on top of that, you’ll receive the property 100% 'as is'. That could include existing liens and even current occupants that need to be evicted.
An REO, by contrast, is a much 'cleaner' and more attractive transaction. The REO property did not find a buyer during the foreclosure auction. The bank now owns it and will take care of removing tax liens, evicting occupants if needed, and generally preparing for the issuance of a title insurance policy to the buyer at closing. Do be aware that REOs may be exempt from normal disclosure requirements. In California, for example, banks are exempt from giving a Transfer Disclosure Statement, which normally requires sellers to inform you about any defects they are aware of.
Is it a bargain? It’s commonly assumed that any REO must be a bargain and an opportunity for easy money. This simply isn’t true.
You have to be very careful about buying an REO if your intent is to make money off of it. While it’s true that the bank is typically anxious to sell it quickly, they are also strongly motivated to get as much as they can for it. When considering the value of a REO, you need to look closely at comparable sales in the neighborhood and be sure to take into account the time and cost of any repairs or remodeling needed to prepare the house for resale. While bargains with money-making potential do exist and many people do very well buying foreclosures, there are also many REOs that are not good buys and are not likely to turn a profit.
Ready to make an offer? Most banks have an REO department that you’ll work with when buying an REO property from them. Typically, the REO department will use a listing agent to have their REO properties listed on the local MLS. Before making your offer, you’ll want to contact either the listing agent or the REO department at the bank to find out as much as you can about the condition of the property and their process for receiving offers. Since banks almost always sell REO properties 'as is', you’ll want to include an inspection contingency in your offer that gives you time to check for hidden damage and terminate the offer if you find it. As with making any offer on real estate, you’ll make your offer more attractive if you can include documentation of your ability to pay, such as a pre-approval letter from a lender. After you’ve made your offer, you can expect the bank to make a counter offer. Then it will be up to you to decide whether to accept their counter or offer a counter to the counter offer. Realize that you’ll be dealing with a process that likely involves multiple people at the bank, and they don’t work evenings or weekends. It’s not unusual for the process of offers and counter offers to take days or even weeks.