REO is more than just a speedwagon—it's a low-barrier entry point to residential real estate investment for inexperienced and experienced investors alike
by William Freedman
The real estate owned (REO) market is the “rock bottom path” to homeownership and residential real estate investment.
These are properties on which the occupant could no longer pay the note, a short sale could not be arranged, and nobody was willing to buy it at a foreclosure auction. So, the lender that got stuck with it has withdrawn its liens and reduced the terms and conditions of sale to two short words: “as is”.
Just like any piece of real estate, however, there is a price at which both a buyer and a seller can shake hands. Today, that price might be heading lower as the number of handshakes starts to rise.
The evolution of REOs
Let’s roll the tape back a decade. The current economic expansion has continued for so long that even real estate investors with a decade’s worth of experience never experienced the Great Recession.
As the crisis unfolded in 2009, Georgia Institute of Technology’s Dan Immergluck, then a visiting scholar at the Federal Reserve Bank of Atlanta, summarized the situation, noting that as long as REOs could be chalked up to urban blight, then the “destabilizing impacts on neighborhoods and communities” wasn’t a problem. But when this class of real estate started to pop up in more upscale communities, suddenly there it was a calamity.
Through 2009 and 2010, it wasn’t unusual to have 80,000 properties per month entering the REO market, in addition to about 250,000 per month that were auctioned off or fell into default. According to the HSH real estate portal, REOs comprised almost half of all transactions during that time.
Today, the volume for each of those situations is roughly one-seventh what it was when the economy was at its worst.
Foreclosures are trending downward, but ATTOM Data Solutions reports that that is not the case for repossessions, as REOs are otherwise known.
“There were 49,898 U.S. properties with foreclosure filings in November 2019, down 10% from October 2019 and down six percent from a year ago,” according to ATTOM, which then points out that REOs are heading the other direction. “Lenders repossessed 13,996 U.S. properties in November 2019 (REOs), up four percent from the previous month and up 22% from a year ago.”
While that doesn’t mean another recession — or even another nationwide real estate bust — is coming, that’s still a troubling statistic.
Securing funding for REOs
Ten years ago, the internet was alight with stories — some real, some apocryphal — of homebuyers targeting REOs in distressed communities and putting entire transactions on their credit cards. And why not? There was so much inventory, banks were willing to accept pretty much any offer that covered closing costs.
Supply is more constrained now so the price per unit has gone up, and people generally aren’t buying REOs strictly on price anymore. There may be a few bucks to be saved, but that’s now around the margins; an REO now goes for pretty much the same price as any other fixer-upper in the neighborhood. Both types of property can all be found via the same websites, listing services, and neighborhood real estate agents. Essentially, the main distinction between an REO and a starter home is that the seller is a bank rather than a family that outgrew it.
That said, there’s no shortage of professional flippers looking to acquire cheap properties to rehab, and they can often pay cash. People looking to buy their starter homes — as well as those looking to enter the REO market for the first time to make a profit — probably don’t. Retail banks and other mortgage lenders generally don’t stick their noses up at REOs, so conventional mortgages are one way to go. But In order for an investor to remain nimble, however, it’s more typical to get the funds through a hard-money loan then refinance later, according to FitSmallBusiness.
Making an REO a home
Ultimately, the whole purpose of the REO market is to get units off the bank’s balance sheet. For anyone who doesn’t work at the bank, though, the most obvious sign of a successful REO transaction is that the creepy house with the plywood windows is now actually inhabited.
But what’s the fastest way to get that done? Here’s where the data conflicts with the received wisdom.
“Conventional wisdom in the mortgage servicing industry has traditionally defaulted to …: a neighborhood is better stabilized when a distressed property reverts back to the foreclosing lender [which] is more likely to get the property back into the hands of an owner-occupant, and owner-occupants have a more vested interest in neighborhood quality and stability than do real estate investors,” according to Auction.com economist Daren Blomquist. “But a thorough analysis of data … shows that properties sold to real estate investors at foreclosure auction more quickly convert to owner-occupancy than those that revert to lenders at the auction.”
Even so, Blomquist’s June 2019 article noted his surprise that more than 40% of the REO properties sold through his portal’s “Day 1” program were soon-to-be owner-occupants rather than investors. Of course, that also means that the majority were sold to investors, suggesting that there is more than enough demand to make REO management and resale a profitable endeavor.
Sharestates is an online marketplace lending and investing platform. To access investors, investors or borrowers can create an account and present their project for review. Using a 34-point underwriting process, the project will be vetted to see if it meets investor expectations, and can be funded from more than one source.
