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Dangers of Buying REO's Just Out of Foreclosure

Aug 18, 2008
Banks and lending institutions that own real estate that was acquired through foreclosure call these properties real estate owned or REO;s. REO's represent a liability to lenders because of the required accounting that literally "sucks" away assets of the lenders by the requirement they have substantial cash reserves to offset any potential loss when the properties are sold.

This cash requirement substantially depletes the leveraged lending ability of that specific institution so REO's are not what any lender wants. In addition, the lender faces capital loss due to a declining real estate market.

REO's are a fact-of-life for lenders, so much so that they have extensive infra-structure to deal with these properties and have developed ways to sell them that whips investors into a buying frenzy.

As always the REO is placed on the Multiple Listing Service (MLS) at what is assumed to be fair market value (FMV) and allowed to stay at this price for 30 to 60 days. The price is next reduced by about 10% and the results are carefully watched.

If there is no action, the price will be reduced at least once more by roughly 15% - 20%. Because of the data sorting capabilities of the MLS every time the price is reduced, investors and realtors see the price changes and look more carefully at the property.

After two price reductions, if no firm acceptable offers have been tendered, the lender will "free-fall" the price as much as 30% to 40% below what it was originally offered. This pricing will almost always get plenty of interest and contracts.

However, the lender and his agent stall taking an offer and tell perspective buyers to "Give us your best and final offer". The reality is the lender is trying to play each investor/buyer against the next to get the highest bid possible.

In many cases the final sales price is well over what the lender would have taken without the bidding process.

The lender will give priority to cash offers because of the speed in closing the sale, but often they will accept conventional financing if the buyer looks good credit wise and has a substantial down payment.

If there is a cash offer versus a financing offer and there is less than $5,000 difference, the lender will take the cash offer. What an investor needs to know, to get his offer accepted, is to only deal directly with the listing broker.

If a buyer's agent is used representing the investor, the commission will be split between the lender's agent and the investor's agent.

I have personally made higher offers through a buyer's agent who originally showed me the property and had them declined for a lower offer that was submitted directly to the lender's agent.

Simple mathematics, the lender's agent got twice the commission taking the direct offer. Don't let this happen to you, go t o the REO agent to begin and pay your agent separate if he brings you the deal.

Another huge issue not often mentioned in REO sales is illegal structures added without permitting. These are not title issues because they are not covered by title insurance unless the code violations are open and in the public record.

So a buyer of an REO can get title insurance, but actually purchase an illegally added bedroom, bathroom, etc. and have problems when he resells the property. Some counties and cities required a "re-inspection" before title can be transferred, and these issues would become apparent to a buyer. However, the vast majority do not require re-occupancy inspections and the problem may be passed on to the buyer.

Lenders do not give a warranty deed but offer a buyer a limited warranty deed which only covers the period when the lender actually owned the property further reducing the lender's liability for deficiencies in the property.

Buying REO's is truly the best example of "buyer beware" and the solution is to have a certified inspector look for structural problems, permit issues and illegal additions.

If the buyer does his homework and is willing to assume the risks of the unknown, unseen problems, REO's can be rewarding purchases. The best way to acquire the properties is to decide on the highest bid you are willing to pay and not to exceed this offer despite what the "friendly" agent is telling you. Even more importantly, the actual price the lender is offering is always negotiable.

If the lender says "No" to your offer, just say "What will you take?" and you will almost always save yourself thousands of dollars!
About the Author
Dave Dinkel
has over 33 years experience in real estate investing which has given him a
unique perspective into the real estate market. Dave is the author of the
best-selling e-courses http://www.FSBOAutoPilot.com
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