If you are thinking about buying or investing in a property, you may have run across mentions of real estate owned properties. At first glance, these properties may seem like easy investment choices since they are often sold at a discount relative.
However, REO properties come with a unique set of circumstances, potential advantages, and potential issues. You may want to learn about the pros and cons of REO properties so you can make a more informed investment decision.
What Does it Mean When a Property is Real Estate Owned (REO)?
Real estate owned (REO) property is property that is owned by a lender (such as a bank, Fannie Mae, or Freddie Mac) and was not successfully sold in a foreclosure auction. REO properties are often in some level of disrepair due to damage from vandals, the elements, or other circumstances, though not always.
When a borrower defaults on their mortgage, there is a pre-foreclosure period that usually involves either a public auction or a real estate short sale. If neither of these processes goes through successfully, the foreclosure process often ends with the lender taking ownership of the property, which means the property is considered REO.
After a property becomes REO, the loan servicer secures the property, rekeys the locks, and may make needed emergency repairs. The servicer will generally have ordered periodic drive-by property inspections throughout the foreclosure process, so by this point, they will have a sense of the property’s condition.
Many banks try to sell REOs through a real estate agent or by listing the property online. These properties are generally sold “as is” at a discount. While they can be a good deal for investors, it may be difficult to realize the potential financial rewards before a significant amount of hard work.
Some loan servicers facilitate the disposition of an REO property by hiring an REO management company, which will help with:
- Eviction services
- Debris removal
- Landscape services
- Other necessary property maintenance
- Redemption (when a foreclosed homeowner repurchases a property after a foreclosure during a “redemption period”, which is permitted only in some states)
- Title services
- Marketing services
- Closing services
If an REO property is still occupied by a bona fide tenant, they are permitted to remain through the end of their lease unless the lease is terminable at will or month to month.
The Difference Between Real Estate Owned and Foreclosure
The short answer: A property in foreclosure is in the process of being taken back by the lender, while an REO property has already been through that process. REO means the property failed to sell in an auction and has been taken back by the mortgage lender.
Foreclosure is the legal process where a mortgaged property is sold to satisfy a debt when a borrower defaults. The foreclosure can be judicial or nonjudicial, but either way, the process ends with selling the property so the lender can recoup the money loaned to the borrower.
During a foreclosure sale, the borrower can make a credit bid up to the total amount of the debt plus foreclosure-related costs. Any other interested parties must bid in either cash or a cash equivalent. If the bank is the winning bidder in the sale, the property becomes REO.
REO status can also come from a home being given back to the lender at the end of a reverse mortgage, which is when a homeowner converts a portion of their home equity to cash, often to supplement retirement funds. This situation generally occurs when the previous owner moves out or passes away. If the heirs cannot pay off the mortgage, refinance the home, or sell the home themselves, they can give the property back to the lender.
How to Look at Real Estate Owned Properties as an Investor
REO properties are sometimes attractive to investors because they are sold at a discount. Since selling these properties is usually not the lender’s primary business line, the investor may be able to get a good deal on these properties.
If you are investing with a lower budget and willing to make more repairs than the average property buyer, an REO property could be an excellent option. Be sure to do your research before purchasing a property, regardless of whether it has REO status or not.
Before purchasing an REO property, you will likely want to have a thorough property inspection done. Property inspections are generally recommended when buying non-REO properties as well, but they may be extra important for properties with this status. REO properties are often in disrepair and sold “as is”, so investors should be prepared to pay for significant renovations.
You may also want to consider buying an owner’s title policy if you purchase an REO property. Since REO properties are often properties that were foreclosed on, there’s a high chance the previous owners had financial trouble, which means there may be tax liens or judgments on the property to worry about.
You will likely be required to get a lender’s title policy, which protects the lender’s investment if there is another ownership claim against your home. Unfortunately, lender’s title policies do little to protect your own claim. Taking the additional step of getting an owner’s title policy will protect your investment if anything comes up.
If you are primarily looking at an REO property as a way to invest at a low cost relative to typical property prices, you may want to consider other strategies. For example, real estate funds allow you to invest in properties together with other people, which means you do not have to cover the full cost of the property. These funds also make it easy to invest passively and diversify your holdings.
Learn More About Real Estate Investing From CEP
The CEP team has successfully invested in commercial real estate through multiple cycles spanning four decades. We regularly share articles about common investing terms, practices, strategies, and trends on our blog and in our newsletter.