Whether you're looking for your next home or your next investment, real estate owned (REO) properties are worth looking into. Often referred to as "bank-owned" or "distressed" properties, REO properties can typically be purchased at a discount compared to the retail market. That's a great opportunity to buy a home or investment property at a lower price.
While they can be a worthwhile investment, there's a lot to know about buying a real estate owned property. Learn what REO properties are, where to find them, and important things to know about buying them in this guide.
What are REO properties?
REO properties are properties owned by a bank or other institution after going through foreclosure. REO stands for "real estate owned." If a property doesn't sell at a foreclosure auction, it becomes an REO property and can often be purchased at a discount.
Banks create mortgage loans using two documents -- a note and mortgage. The note outlines the terms of the loan, such as interest rate, payment amount, and length of the loan.
The mortgage is a security instrument used to protect the bank in the event the buyer doesn't pay according to the terms of the note. If the buyer defaults, the bank can foreclose on the property in order to recoup their initial investment.
When a foreclosure property becomes an REO
The foreclosure process requires that the property is sold at a public auction. Most auctions have a minimum bid amount, meaning the property won't be sold until the minimum bid amount is met. Banks strategically set the minimum bid. Some keep it low, offering a large discount compared to the current market value to increase the likelihood of the property selling at auction. Other times, the bid is set to the full amount owed to the bank, even if it exceeds the worth of the home. If the minimum bid is too high, the property may not sell at the public foreclosure auction. That's when the property is deeded to the bank through a certificate of title.
Most lenders don't want too many REO properties on their books because it increases the bank's risk and creates additional costs to maintain and secure the properties. This is why most banks work with property owners to negotiate short sales and prevent the property from becoming a bank REO. If it becomes an REO, most lenders are motivated to sell.
Where to find REO properties
The most common way to find REO properties is through the multiple listing service (MLS), which can be accessed for free on real estate industry websites like Zillow or Realtor.com.
You can also find REO properties for sale by contacting a real estate agent that specializes in distressed sales. Working directly with an REO agent means they'll receive commissions for both sides of the transaction. This can motivate the agent to send you pocket listings of bank-owned homes that haven't been placed on the MLS yet, giving you the first chance to make an offer on the property.
The last way to find REO properties is by contacting banks directly. Most banks prefer to sell their distressed assets, such as non-performing mortgages or REOs, in pools. These are large groups of assets sold as a package. Banks often sell these pools for a steep discount because selling multiple assets at one time saves the bank time and money.
While this method of real estate investing can be lucrative, it's typically for large real estate investors who have hundreds of thousands or millions of dollars available to purchase dozens of properties at once.
How to buy an REO property
Some REO properties are in very poor condition and require a cash-only sale. Others in decent or good condition allow the property to be financed. In most cases, the faster the buyer can close, the more likely the bank will be to accept the offer. It's not uncommon for an offer with a short inspection period and cash closing to be accepted over an offer with financing and a standard closing timeline of 30 to 45 days, even if the cash offer is less than the financed offer.
If the REO property is a cash-only sale, the bank or agent may request proof of funds (POF) when the offer is submitted. This is a letter from your bank showing you have the cash available to close. If cash is required, the buyer can get a hard money loan, but these loans often have high interest rates and loan periods of two years or less. Some hard money lenders provide proof of funds to help you submit an offer. While hard money loans don't make sense for everyone, they can be a good option for a real estate investor whose goal is to flip the house or refinance after improvements are done.
Being a good negotiator is helpful when buying REO properties. The property could be overpriced, there could be multiple offers on it, or it could be in worse condition than you expected. You need to set your offer apart from the rest and be able to show why your offer, even if it's lower than the listing price, should be accepted.
Things to know before buying an REO property
While some REO properties are listed for a low price, many aren't great buys as-is. Most banks list the property with an REO agent who researches the market and suggests a listing price that reflects the condition in relation to the market and neighborhood. The bank's goal is to recoup as much money as possible from the loss of the loan, and while they're motivated to sell, they're also numbers-driven.
It's common to see REOs sit on the market for several months because the bank is asking too much. If your offer is declined, make another offer each month. The longer the bank holds the property, the more motivated they'll be to sell. They may eventually accept your offer after the property sits on the MLS unsold.
Most bank REOs are sold as-is with no warranties. The bank can only tell you what they know about the property. For most REOs, that's very little. It's unlikely the bank will do any repairs even if issues come up during the inspection period, and there aren't any transferable home warranties that come with the property.
Always read the fine print of the contract, including what fees and closings cost each party is responsible for. Some banks won't pay the traditional seller's closing costs and will place certain fees on the buyer.
Most REOs are distressed. While some may be in good condition, plan on getting a house in poor condition that requires substantial work. While the discounted asking price may seem enticing, it's important to consider the condition of the home, the amount of work that's needed, and how that relates to the property's value after it's repaired.
Always have an inspection done and confirm the current market value and after-repair value so you can make an informed decision before buying an REO.
REO properties can provide great value
Remember, REO properties can be a good investment, but not all REOs are a steal. Speak with a professional who has expertise and experience dealing with bank-owned homes and continue to do your due diligence on the process of buying an REO.