REO stands for “real estate owned” and refers to properties that have been foreclosed on and taken back by the lender, usually a bank. REOs are properties that failed to sell at foreclosure auctions and for which the lender took ownership. Banks and lending institutions end up with these properties on their books and must manage and dispose of them – hence why they are called “real estate owned.”
Understanding how properties become REOs and what happens to them afterward can be useful whether you’re looking to invest in real estate or simply want to understand more about the foreclosure process. Here is an in-depth look at what REOs are, how they are created, and what banks do with these properties in their inventory:
What Leads to REOs?
Before a property becomes an REO, it goes through the foreclosure process. When a homeowner defaults on their mortgage – fails to make monthly payments – the lender has the right to retake possession of the home and sell it to recoup their losses.
The foreclosure process begins with the lender filing a public default notice and court-ordered auction. If no third-party buyers bid on the home at auction up to the amount owed, then the home becomes known as a foreclosure property owned by the bank. This is an REO.
Banks do not want to own these foreclosed properties. It is not their business model to maintain, manage and sell real estate. So REO properties are essentially distressed assets that they aim to dispose of as soon as possible.
Why Do Lenders End Up With REOs?
There are a few reasons why lenders end up taking ownership of foreclosed properties rather than third-party buyers purchasing them at auction:
- Home Valuations: If the amount of money owed on the mortgage is higher than what the property is actually worth, buyers may be hesitant to bid. They have no incentive to pay more than market value.
- Poor Property Conditions: Similarly, buyers may be turned off from bidding if the home was not properly maintained during the foreclosure process due to issues like overgrowth, vandalism, or squatters.
- Market Declines: Rapid declines or crashes in the real estate market also lead more buyers to stay away from auctions. There is less investor demand overall for properties.
For all of these reasons, auctions can fail to attract bids and lenders to have to take on the property as an REO.
The REO Inventory Process
Banks have entire REO departments dedicated to managing and selling their inventory of foreclosed homes. The process typically involves:
- Taking Possession: Once a property has officially become an REO, the lender files the ownership paperwork and takes possession. A bank representative inspects and secures the home if necessary against damage/squatters.
- Property Preservation: Basic maintenance is done to prevent any more deterioration – things like changing locks, winterizing, cleaning up debris, etc. The property must be stabilized.
- Valuation & Listing: A thorough appraisal is done to establish current valuation. The property is then listed, typically on the Multiple Listing Service (MLS), at a competitive market price.
- Repairs & Enhancements: Depending on the property’s condition, banks may also invest in minor or major repairs to increase salability and value. Cosmetic enhancements also help properties show better to retail buyers.
- Price Drops: If there are no acceptable purchase offers after 2-3 months on the market, gradual price reductions of 5-10% at a time may occur to incentivize buyers.
- Bulk Sales: Large portfolios of REO properties may also be packaged and sold all together to investor groups rather than one-by-one on retail MLS. This speeds up the disposition process when banks own many foreclosures.
The lender’s goal is to sell REOs to new homeowners or real estate investors as quickly as possible to recover losses from the original foreclosed loan. This inventory and liquidation process allows them to remove the distressed asset from their books and also collect cash proceeds from the sale.
Opportunities with REO Properties
REO properties that lenders list for sale present unique opportunities for both individual homebuyers and real estate investors:
- Below-Market Pricing: To attract buyers, REO home prices tend to be well below market value – sometimes up to 30-50% discounts in distressed markets.
- Value Potential: Despite lower asking prices, REOs offer the opportunity to build significant equity. As markets recover, the below-market purchase often leads to above-market property valuations down the road.
- All Cash Deals: Investors with financing contingencies often lose to cash buyers. REOs require swift and secure transactions that cash enables.
However, risks and special considerations come with REO purchases as well:
- Property Conditions: There may be underlying defects or damages not disclosed or readily visible, leading to unexpected repair costs post-purchase.
- Tenant Occupation: Long redemption periods in some states mean tenants can remain in REOs even after foreclosure, delaying purchase.
- Lien & Tax Issues: There may also be hidden liens attached to the property that aren’t resolved until after purchase.
Working with a knowledgeable real estate agent to identify promising REO deals while also carefully evaluating properties for issues are key to success when buying these unique bank-owned homes.
The Takeaway
REO properties come about when lenders take back possession of foreclosed homes that fail to garner buyer interest at auction. Banks must then hold these distressed assets in inventory and undertake preservation and listings efforts to market and sell the properties.
Despite requiring some additional scrutiny, REOs can also present opportunities for buyers willing to do the research – with potential discounts and value upside over time. Understanding the REO process helps both homebuyers as well as real estate investors looking to add bank-owned properties to their portfolios.
FAQs
REO stands for “Real Estate Owned.” It refers to a property that has gone through foreclosure and is owned by the foreclosing lender, typically a bank or mortgage lending company.
A property becomes an REO when it fails to sell at the foreclosure auction after being foreclosed on. With no outside buyers bidding, the mortgage lender takes ownership of the property to sell it themselves later.
Lenders list REO properties for sale in order to recover losses from the defaulted mortgage loan. They want to quickly sell the property and remove it from their books as a distressed asset.
Because lenders want to liquidate REOs quickly, they often list them for below market value pricing, sometimes as much as 30-50% discounts. This pricing incentive helps attract more buyers.
Not always. Some REOs have been poorly maintained, vandalized, or require major repairs. However, lenders often invest in rehabbing and enhancing REOs to increase salability. Still, careful inspections are required when purchasing.
