What is "REO", and How do They Work?

In today's economic condition, we hear a lot about short sales, foreclosures and REOs. So, just what is an "REO"?

"REO" stands for "real estate owned" and it refers to a property that is now owned by the bank. This usually results from the conclusion of a foreclosure.

Some REO properties are in good condition, while others have been trashed (even to the extent of cupboards and appliances having been removed) - usually by the disgruntled previous owner, the one who lost the property. It's a shame...and a crime...but it happens.

By the time a bank actually regains clear ownership of the property, it (the bank) has already hired one or more professionals to inspect the premises, do a comparison value study, and to provide a written broker professional opinion ("BPO") of the current market value of that property. This valuation could also be a formal appraisal done by an appraiser, but more often, it is a BPO done by an experienced real estate agent. Sometimes banks have multiple BPOs done to get a multiple opinions.

Some BPOs are "drive-by" external-only inspections, where the agent never sees the inside. In such cases, they cannot provide a valuation for repairing or replacing missing items. That is something a prospective buyer must consider.

Most BPO forms ask the agent to indicate what a property will sell for within 30 days and within 90 - 120 days. In setting a price, the bank considers:

* current, local market conditions including active inventory, average days on market, etc.
shape of the property;
* how much of a loss it has already taken on the original mortgage and the foreclosure process;
* amounts paid for trash-out and any work required to make the home safe and secure;
* carrying costs (insurance, taxes, bare-bones maintenance, utilities, etc.) during the time the REO is listed;
* the commission it will pay both agents - usually a fixed percentage.

Based on these factors, the bank also looks at its internal situation. How many REOs are they carrying? How quickly does the bank need to "unload" the property? Remember, most banks are "for profit" organizations; many report to shareholders. Nevertheless, an REO list price (Asking Price in the MLS) is usually a good deal.

The list price is typically a huge bargain, and the bank really DOES know the fair market value based on hard data for local market conditions. The list price already takes the shape of the property into account, so don't expect another discount based on bad condition or missing appliances. The bank will not take lowball offers seriously and may not even counter one.

The bank already knows that most homes in a given area sell for X% of the list price, so don't assume that you are going to negotiate another significant discount. It simply won't happen. For the most part, the price is what the price is...and the bank will only accept an offer close to (usually within 95%) the published asking price.

Your offering price is just one factor that the bank will consider. In addition, they will look at:

* Closing Date. If you want to purchase an REO, offer to close in 30 days. Yes, I realize this is quick but it has a dollar value! Banks want the REO off their books, especially if the closing will be prior to the end of a financial quarter.

* Paperwork. Complete and submit every piece of paper the bank has requested. Most banks have their own forms and want them used. Banks will reject offers that are missing the required paperwork.

* Down payment. Some banks specify a percentage of the price as minimim earnest money. In every case, I suggest the "good faith deposit" be at least 1.5% of your proposed purchase price, but if you want to make a good impression, make it the full 3%. Show the bank you are a serious buyer. A strong second deposit (post-contract, before closing) will also sway the bank in your favor.

* Mortgage. A few banks want a shot at your loan and insist they do your pre-approval, even if you have no intention of using them for the loan. (Remember, it is their property and they can make whatever rules they want.) Even without any imposed requirements, a letter of pre-approval from a "brand name" lender such as HomeServices Lending, Wells Fargo or Bank of America will strengthen your offer. Sure, you can actually then get your loan from "My Cousin Vinnie's Finance Center in Podunk" if you want, but a brand-name lender might just be that little added extra that gets your offer accepted by the bank.

Banks tend to have a very aggressive price-reduction strategy. They want to sell the REO quickly even if they will not consider offers far below the list price. Many banks drop the price almost monthly, assuming no offers are being negotiated. Waiting until the price drops where you want it to be could mean someone comes in ahead of you - DON'T RISK LOSING A PROPERTY YOU REALLY WANT OVER A SMALL DOLLAR AMOUNT.

But in determining what you will offer, you should know WHEN the last price reduction took place, the frequency between all price changes and the percentage of each. If it is a new REO listing, I can often determine a particular bank's reduction pattern by examining another local REO listing owned by the same bank. So, if a bank habitually reduces its list price 5% every 32 days and the current price came about 27 days ago - well, let's just say that bit of information often gives us a useful advantage.