What are bank owned homes (REOs) and should I invest in them?

What are bank owned homes (REOs) and should I invest in them?
by Brad Cartier, posted in Investment Strategy

A bank owned home is a property that has been taken back by the lender. Bank owned homes typically start as foreclosures, but not all foreclosures end up as bank owned property.

The foreclosure process that banks follow to repossess a home generally consists of four steps:

  • Homeowner falls behind in their payments
  • Lender sends a default notice
  • Lender sends a notice of sale to sell at an auction
  • Foreclosure auction takes place

When the house goes through the foreclosure process, but nobody makes a winning bid at the foreclosure auction, title to the property passes to the bank and the asset officially becomes bank-owned. The key question for real estate investors is, do these distressed properties make good investments? As usual, the answer is: it depends. Let’s take a closer look to find out how to find bank-owned investment property and how to give yourself the best shot at acquiring them at the right price.

Is there a difference between an REO and a bank-owned home?

REO – or “real estate owned” – and bank owned homes are the same thing. In most cases, the home went through the foreclosure process and was taken back by the lender. Banks usually have a “Real Estate Owned” department and REO is an abbreviation for the name of the department.

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How to find a bank owned home

Real estate investors employ a variety of techniques to locate and purchase REO property. Three of the most popular methods for finding a bank owned home are:

MLS — Many lenders have relationships with real estate agents to list and sell REO property on the multiple listing service. When bank owned properties are listed on the MLS investors can work directly with the bank’s realtor or use a buyer’s agent to represent them in the purchase.

Bank websites — Banks have REO departments that are responsible for getting the home off of the bank’s balance sheet as quickly as possible. That’s because banks aren’t real estate investors, so the sooner they sell the home the better. To find the REO section for a specific bank, search for “Bank name + REO”.

Foreclosure listings — Foreclosure, REO, and distressed property listing services and websites are another great way to find bank-owned homes for sale. Some services are completely free, while others offer a free trial followed by a monthly or annual subscription.

Real estate investors thinking about adding an REO property to their rental property portfolio will find that subscribing to the various listing websites will yield more timely and relevant information. Some of the most popular foreclosure and REO listing services include RealtyTracForeclosure ListingsForeclosure.com, and Equator.

Pros and cons of buying a bank-owned home

Not all bank-owned homes are created equal. Banks are in business to make money, even when they sell their REO property. Some of the pros and cons to consider when buying a bank owned home are:

Pros

  • Compared to buying a foreclosure property at auction, bank owned homes are easier to access and inspect, and are usually vacant
  • You may be able to negotiate concessions such as a home warranty, points, or other buyer benefits
  • Your sweat equity can quickly add value to an REO property as they are frequently discounted due to deferred maintenance and/or other shortcomings

Cons

  • The extra cost of needed renovations may be greater than what even the best homes is the neighborhood sell for
  • REO bank departments may not be willing to negotiate on the asking price and/or it may be hard to get a hold of someone with the authority to make a deal
  • Bank-owned homes do not provide seller disclosures, so getting accurate information on the current status of the property might be difficult

How to buy a bank-owned home

There are 7 main steps involved in buying a bank owned home:

  1. Find an experienced real estate agent who specializes in bank-owned homes
  2. Protect your offer by using contract contingencies that let you back out of the deal if there are problems with the inspection or appraisal
  3. Make your best offer on the REO home, keeping in mind that there may be other investors competing for the same home and that banks often price property they own at market value
  4. Professionally inspect the home for any structural, plumbing, electrical, or environmental issues and needed repairs
  5. At your option, order a professional third-party appraisal to make sure you’re not paying more than what the home is worth
  6. Close with assistance from your lawyer and/or real estate agent and keep in mind that in a bank-owned home sale there is sometimes a lot of extra paperwork
  7. Bonus step: If you’re buying a bank-owned home as an investment get set up with a user-friendly financial management platform like Stessa to track and manage the performance of your rental property

5 advanced tips for buying a bank-owned home

Not all REO homes sold by a bank are good deals. Protect yourself and your investment by following these five advanced tips for buying a bank-owned home:

REO property is sold “as-is”: This means the bank won’t make any repairs, so be sure to accurately estimate the cost of your repair work.

Be patient when buying a bank owned home: It may be several weeks before you hear back from the bank’s REO department.

Always get a home inspection: Banks put very little effort into fixing up their REOs and overlooking a needed repair issue such as a bad sewer connection or major electrical issue can be a costly mistake.

Explore your financing options: Some banks may be willing to lend you the full asking price of an REO home, even including the cost of repairs, while other banks won’t make a mortgage loan at all on homes coming off of their balance sheets.

Do your research and math: Have your real estate agent run comps to make sure your offer price is in line with recent sales in your area, and be sure to factor in the costs of renovations.

FAQs about bank owned homes

Q: Are bank-owned homes short sales?

A: No. An REO, or bank-owned home or foreclosed property, is one that has already been foreclosed on. Short sales occur when the homeowner sells their house for less money than what is owed on the mortgage. The bank typically must sign off on this arrangement in advance.

Q: Do banks negotiate on REO property?

A: It depends on the bank and the market. In a homebuyers market, where there are more properties for sale than buyers, banks may be more motivated to make a deal and sell fast.

Q: Do you have to pay cash for a bank owned home?

A: No. Cash is usually required at a foreclosure auctions, but many lenders will make loans on bank owned homes.

Q: Is it smart to buy a bank-owned home?

A: Many investors like bank-owned property due to a perceived discount versus widely marketed regular offerings. During the last market crash in 2008 real estate investors stepped into the market and scooped up foreclosed homes at big discounts.

Final thoughts: Things to remember about buying a bank owned home

Buying bank-owned homes can be a solid way to grow your portfolio at lower purchase prices and build equity over time. That said, completing proper due diligence on bank-owned homes is critical. New construction often comes with warranties and regular home sales include seller disclosures that are required by law to be complete and truthful. No such safeguards are in place with REO transactions. You need to work with your team—inspectors, contractors, and lawyers —to ensure your “fixer upper” isn’t actually a “tear-down.”

Here are 5 key things to remember when buying a bank owned home:

  • “Bank-owned homes” and “REO property” are two ways of describing the same thing
  • Not all foreclosure homes end up as bank-owned homes
  • Sources for finding bank owned homes include the MLS, bank websites, and online REO listing services
  • Just because a home is bank owned doesn’t mean it’s a good deal
  • Buying bank-owned homes may be a more risk-averse strategy than buying at foreclosure auctions