The economic downturn, rise in unemployment to nearly two-decade highs, and tightening of lending standards have forced many American families to default on their mortgages and to lose their homes. As a result, the total number of foreclosures has surged to record highs in recent years. In 2008 alone, some 2.2 million homes were in foreclosure and another 3 million homes are expected to enter the process this year.
These staggering statistics describe the collapse of the housing market, which, for many homebuyers and investors ready to take advantage of sharply reduced prices and historically low rates, may represent an excellent investment opportunity. One category of foreclosed properties—bank repossessed properties or real estate owned (REO) properties—stands out as an excellent investment choice.
Real estate owned properties are those types of homes that were auctioned at a foreclosure sale but remained unsold. Banks or mortgage lenders repossess these properties and become their owners. Given that banks are not landlords, they are eager to sell these properties, often at discounts of up to 30% compared to predominant market prices for comparable properties. Banks do this in order to recover their capital and to cut expenses related to holding the properties in bank possession. In the current environment, banks may be especially motivated to sell these homes as soon as possible in order to limit potential losses due to extended declines in home prices.
Given that most homes reported as foreclosed this year are in the early stage of the process, due to various moratoria on bank repossessions imposed by state laws, the number of real estate owned homes on the market will increase sharply in the months ahead, adding more pressure on home prices and urging banks to sell their properties.
In addition to prices below market rates, real estate owned properties may offer several advantages over other types of real estate investments. Investors in this type of housing are buying property that is free from all liens and other outstanding claims. Therefore, title on the REO properties is free from liens such as second or third mortgages and from any unpaid taxes.
Another advantage of buying these properties is a possibility to obtain financing deals that are more favorable than financing terms on mortgages offered for traditional properties. Even though REO purchases are most often cash-only deals, given a continuously rising supply of these properties on the market, lenders may be more willing to negotiate payment terms and offer deals that are below current market rates. Moreover, there is a possibility to bypass agent commissions if the process of purchasing the property can be initiated early, dealing directly with the bank, before it enlists the services of REO property sales agents.
As owners of the properties, banks also handle the eviction process. This means that investors are buying vacant property, which, relative to buying other foreclosed homes, means that investors can save on expenses and can avoid various inconveniences associated with the eviction process.
Buying real estate owned properties allows for additional cost savings when compared to buying other foreclosed properties. In order to secure a price that recovers as much bank capital in the home as possible, banks often make repairs or improvements on the property or offer allowances for repairs. This increases the value of the investment and therefore provides a potentially higher return when compared to investments in other types of foreclosed properties. Moreover, using the same title company that the selling bank used during foreclosure can reduce the cost of title search.
Buying REO properties is fairly competitive and simple as these properties are listed on the multiple listing services. Therefore, except for some deals that are reserved for wholesale investors, REO properties are generally available to the public. Recent evidence shows that states currently offering most opportunities for making a good REO deal include Michigan, Arizona, Washington, Nevada, Oregon, and New York.
With home prices down substantially from their peaks, inventories of REO properties surging to record highs, and low mortgage rates hovering around historic lows, now may be the time to invest in real estate owned homes. Given that the housing market seems to be close to bottoming, home prices are likely to start recovering soon. Therefore, investments in discounted real estate owned properties may yield fast and potentially sizable returns for savvy real estate investors.