5 Things to Consider When Searching for REOs or bank-owned properties

Buying real estate at a discount is at the heart of real estate investing. A home well-bought gives investor a head start in the chase for profits and equity, an idea that’s easy to illustrate.

In the third quarter, says research from ATTOM Data Solutions, the typical home sold for $281,438. And the typical bank-owned property? Just $180,250. That’s a discount of more than $100,000. It’s like buying a home today at the typical sales price seen at the end of 1998.

According to Rick Sharga, Executive Vice President with RealtyTrac, a leading source of investor leads and foreclosure data, “to find success with bank-owned properties there have traditionally been five base-line considerations: identification, acquisition, condition and repairs, local market trends, and marketing. However, because of the pandemic one also has to keep an eye on Washington where the decision to continue or discontinue various programs can substantially impact real estate markets across the country.”

Identification

Bank-owned properties  are known as “REOs” or “real estate owned” by lenders, insurance programs, and government agencies. REO are distressed properties that could not be sold on the open market, were foreclosed on, did not sell at a foreclosure auction, and are now owned by creditors.

In theory at least, you can find such properties by calling up banks, private investors, local attorneys, HUD, and the IRS. The easier approach is to use a website like RealtyTrac. It has data regarding more than 120 million properties including foreclosed homes, off-market properties, and homes listed for sale. The important point for investors it that it tracks notices of defaults and lis pendens as well as auction and bank-owned properties by ZIP code. There is a free seven-day trial program for investors.

Acquisition

The reason REOs are available at discount is that they simply cannot be sold for a fair market price in the open market or at auction. In effect, the purchase of REOs is a trade: the buyer gets a discount, but the property may not be in pristine condition, meaning there can be costs for repairs and upgrades.

The big question concerns the appropriate price for a given property. Is it low enough? There has to be enough financial “meat” on the bone to make an investment worthwhile after the cost of acquisition, repairs, upgrades, mortgage costs, marketing expenses, closing to buy and closing to sell, insurance, other costs, and – of course – a profit.

Many investors have the financial ability to buy for cash, a situation that creates two advantages. First, the cash investor can act quickly without waiting for lender approval. Second, costs are lower.

Short-term investment loans are available for those who need financing through private money lenders, also called hard-money lenders. Investors should expect to have 30% up front. The reason? Short-term investor loans — loans that last a year or two – are risky, one reason many traditional lenders stay away.

Modern private money lenders use big data to qualify properties. They’re concerned with the property’s acquisition cost and also the final after repair value (ARV), a projection based on such assumptions as repair costs and market demand. In a sense the ARV shows the numbers investors need to hit for a successful project.

Private lenders can include helpful relatives and friends, but a commercial source for such financing is an industry group, the American Association of Private lenders.

Condition and repairs

At first the term “distressed property” might suggest that a given home or structure is in woeful shape. That may be the case, but “distressed property” really has two meanings. Yes, there’s always the matter of physical condition but in some cases it’s the owners who are distressed.

We’re at the end of 2020, a year that has featured a pandemic, massive unemployment, widespread business closings, and a series of natural disasters. Many people have been terribly hurt and some will lose their homes, not because they have bad credit or have been unwise with their money but because the economy has changed underneath them.

Also, among those who rent there will be evictions. The landlords of those evicted are unlikely to get unpaid rent and in turn some owners will lose their properties.

What this means is that financial circumstances will be responsible for a large number of 2021 foreclosures and REOs. The properties themselves may well be in good physical condition even though they are described as distressed.

Local market trends

Life is much easier when properties are being sold in a rising market. Historically low interest rates coupled with a massive imbalance between supply and demand have created a solid sellers market. The National Association of Realtors (NAR) reports that in October unsold inventory was at an historic low while the typical home sold for $313,000, up 15.5% from October 2019.

“October’s national price increase marks 104 straight months of year-over-year gains,” said NAR.

The odds are good that investors today will be selling into a rising market but – as always – there’s risk. For example, NAR reported that third quarter home values increased in all 181 metro areas surveyed. That’s important, but it does not mean prices rose in all neighborhoods and with all properties within individual metro areas. It also does not tell us what may happen in the future and 2021 could be a very rocky year as we come out of the pandemic and its related financial woes.

Marketing

Once a property has been acquired and prepped for sale or rent it needs to be marketed. Marketing can result in a solid return, however it’s also a cost that needs to be considered when drawing up budgets and projections. With the shortage of homes available for sale,  investors have an advantage in most markets as consumers search for housing options. In many markets that can mean multiple offers, quick sales, and solid returns. Research from ATTOM Data Solutions found that in the second quarter the gross profit on the typical home flip nationwide (the difference between the median sales price and the median paid by investors) amounted to $67,902. That doesn’t mean all investors did so well with each project or that some didn’t have an outright loss, but it surely means many earned as much and better.

The bottom line: The hunt for real estate discounts in 2021 is likely to favor those with the best information, cash, and the ability to move quickly when a prospect property has been identified.