What Are REO Properties? Pros, Cons, and More

When we say a property is “going under foreclosure,” it means the lender is selling it to fulfill a mortgage debt after the borrower has defaulted. The home will be sold at a public auction once the foreclosure is complete. However, in many cases, the lender is the sole bidder, which means the lender eventually becomes the new owner. Once sold, the property is called an REO property: real estate owned. The lender can sell the property at a reduced price later.

Real Estate Owned (REO)
Describes a type of residential property that becomes owned by the lender after foreclosure. As a homebuyer, you might see properties listed as real estate owned, REO, or bank-owned, which all mean the same thing.

How Can a Property Become REO?

The property can potentially become REO when the borrower misses mortgage payments. Eventually, the lender can foreclose per the deal's circumstances and state law.

The lender makes a credit bid that includes the debt amount, along with foreclosure charges and costs to recoup damages. Other bidders have to bid in cash or a cashier's check. This requirement increases the chance of the lender getting the property.

A bank-owned property that failed to sell at auction post-foreclosure is also known as an REO property. While a property is typically considered REO after it goes through the whole foreclosure process (which includes pre-foreclosure), the term also applies to lender-owned properties that are owned as a result of deeds in lieu of foreclosure.

What Happens to REO Properties?

The servicers can evaluate an REO property to determine its state and occupancy status. These inspections are conducted periodically once the borrower defaults and the property is foreclosed. The server may change the locks once the property is empty and make quick repairs before the auction.

However, the lender has a lot to lose if it holds onto the REO property. The lender must pay for maintenance, HOA fees, property taxes, and more. Plus, it is not financially wise for a lender to keep the property on the books—foreclosed vacant properties can get vandalized, attract squatters, or be subjected to other types of crime, which can reduce their value.

So it is in the lender's best interests to acquire an REO property that is sale-worthy, or one that can be made ready for sale shortly. The rush to unload these properties is why lenders often list them for less than market value.

Related
Buying a foreclosed home

How Banks Sell REO Properties

Like lenders, most banks prefer to avoid holding onto REO properties since doing so increases risk. If they cannot find suitable buyers for the foreclosed properties, the real estate market may suffer. This is why these homes are usually sold at steep discounts.

The bank’s aim is to recover the money the borrower defaulted on in the past. If the properties don’t sell, their value drops further. This is why most banks sell foreclosed properties in bulk, for even a larger discount. They want to make REO properties irresistible. Selling in bulk brings the bank more money at once than if they sold the homes individually.

With an eye to making fast money, some lenders put REO homes up for rent. This happened in the U.S. when government-sponsored mortgage businesses allowed investors to buy REO properties in bulk and put them on the rental market. The scheme was introduced in areas hit hard by poor real estate speculation, such as Atlanta and Chicago.

Pros and Cons of an REO Property

Like any other investment, REO properties have upsides and downsides, and it is up to the buyer to investigate those to make an informed decision.

Pros of REO Houses

Lower price. REO homes are more cost-efficient than other properties on sale, an attractive characteristic for buyers and investors. Most banks sell them at generous discounts so they can get them off the books as soon as possible, lest they take on costly risks.

No liens. Most REO properties have outstanding debts and other defaulted payments, such as property taxes. But when the homes undergo foreclosure, the liens are removed, so you don't take on additional charges.

Quick sale. Remember that most lenders will try to sell off these properties quickly so they don't lose money on upkeep and taxes. This means they will be more willing to negotiate.

Cons of REO Houses

Sold as-is. Most REP properties are sold as they are. The lender may make minor emergency repairs, but the rest falls on the next owner. The properties are usually in a state of disrepair, so make sure you know how much you will ultimately pay for it. Factor in the repair costs with the purchasing price. A home inspector can determine a ballpark figure for the repairs, upgrades, and renovations.

Steep repair costs. Please remember that a neglected property may require extensive repairs and upgrades to make it livable or sellable. Plus, some foreclosed and REO multifamily homes may be occupied on purchase, so buyers automatically become landlords whether they want to or not.

Requires research. As a buyer, you should be careful before purchasing this property by ensuring that the sale is legal and leases are honored.

How to Buy REO Properties, Step by Step

Buying an REO property could be one of the best investments you make. Follow these steps to avoid pitfalls.

Step 1: Search for eligible properties.

Search for REO properties within your required price range and area. You can get listings from lenders and banks.

Step 2: Find financing options.

Once you have chosen the REO property, you like to discuss your financing options with the lender. Most lenders want to sell as quickly as possible, so if you already have financing options in place, they will be more willing to sell quickly. Prequalifying for a home loan will also work in your favor. The more financially qualified you are, the more likely the lender will accept your offer.

Step 4: Find an agent experienced in REO properties.

If you can find a buyer's agent with REO experience, hold onto them. They will be able to guide you through the purchase and explain additional requirements you may need. For example, you may have to hire an attorney and inspector for the property.

Step 5: Narrow down your list.

After you get a list of REO properties from the lender, consider the following to narrow down your choice.

• The neighborhood
• Purchasing price
• Repairs
• Location
• Number of rooms
• Community resources
• Lender requirements.

Step 6: Get a home appraisal.

Once you choose an REO property, get an appraisal and compare that price to the asking price. While these properties are generally cheaper than regular homes in the same market, ensure that you’re getting a good deal. It will also help you determine why the property is selling for less and whether it needs expensive repairs. An appraiser can determine if you are getting a fair price.

Step 7: Make an offer.

The agent will take your offer to the lender/bank who owns the home. You may have to fill out paperwork and deposit money until the purchase is made.

Step 8: Get a home inspection.

As mentioned, REO properties are sold as-is, meaning any repairs fall on the buyer. An inspection will let you know how much you will pay later in maintenance, beyond the purchasing price. The owner may have already completed an inspection, so ask them about it before hiring your own inspector. Ask for a copy of the inspection report as proof and go through it before finalizing the purchase. By making the inspection part of the deal, you can ensure that no hidden repairs are missed. Note any damage so you can negotiate a better price.

Step 9: Negotiate a price.

While they may look the same, negotiating a price for an REO property is different than a regular home. The lender or bank will try to make a profit. In some cases, the firm will need to get corporate approval before agreeing to the lower price a buyer wants (like a car salesman saying he has to check with his manager). Review each document you receive carefully, and also send it to your lawyer for a once-over to ensure that you don't miss anything, like hidden charges.

Step 10: Finalize the loan.

This isn’t the last step. During the finalizing process, you work with the lender to get the best loan for the property value. Check the title status during this time to determine whether it is pending. Conduct a full title search before closing.

Step 11: Close the deal.

Closing on an REO property is basically the same as closing on a regular property, but you could incur extra charges if you fail to close on time. Get prequalified for a home loan so you don't have to wait. Sign the documents only after getting them reviewed by your attorney. Now you own the home!

Final Words on REO Property

An REO property's price can look tempting compared to other homes in the neighborhood, but make sure it’s truly a good deal given any repairs or upgrades you would need to make. If the home requires extensive repairs, has a weak foundation, or has plumbing or electrical problems, make sure that you budget not only for a monthly mortgage payment but also for a small army of handymen and professionals. When buying an REO property, always consult a reliable real estate agent and lender so you don’t buy a money pit.