Buying Distressed Properties at "Bargain" Prices

There is a lot of talk in the media about foreclosures, Short Sales, Notices of Default, Bank Owned/REO's, Public Auctions, Private Auctions, etc. This has created high interest in these so called "distressed" properties these days. A lot of information, some good and some bad, is floating around about the subject. Often the information offered is for sale, with the promise that you can make a lot of money with little effort once you know “the secret formula”.  The fact is that there are no secrets or shortcuts. To make money in the distressed property market requires a lot of effort and can be tricky business. There is also considerable risk associated with buying these properties. Joanne and I decided to post this information to our web site due to all the calls we have been getting from past, present, and new clients regarding this subject. 

What is a Distressed Property?

Generally speaking any property that must be sold due to the owners inability to meet the mortgage obligation can be considered, in my opinion, a distressed property. Unfortunately many home owners are in denial about their true situation and do not act early enough to avoid having a bad situation get much worse.

What is a REO?

REO stands for “Real Estate Owned”.  These are properties that have gone through the formal foreclosure process (i.e. being delinquent on mortgage payments for a number of months, did not do a "work-out" with their lender, had a Notice Of Default filed on the property, did not cure the default within about 95 days of the NOD filing or did not get some form of extension, was foreclosed on, went to public auction, and did not sell at the auction) and are now owned by the bank or mortgage company. 

When buying a property at a public auction (or foreclosure sale), you must pay at least the loan balance plus any interest, back taxes, HOA Dues, and possibly other fees accumulated during the foreclosure process.  You must also be prepared to pay with cash in hand at the time of sale. The sale is final. And on top of all that, you’ll receive the property 100% “As Is” usually without the benefits of Physical Inspections, formal disclosures from the occupants, Natural Hazard Disclosures, etc.  "As-Is" could include existing liens and even current occupants that need to be evicted. In California evictions can take months and be legally expensive. Evicted occupants can sometimes be vindictively destructive. We had an experience in which the occupants took all the built-in gourmet kitchen appliances.

A REO, by contrast, is a much “cleaner” and attractive transaction.  The REO property did not find a buyer during foreclosure auction.  The bank now owns it and is marketing it for sale.  The bank will see to the removal of tax liens, evict occupants if needed and generally prepare for the issuance of a title insurance policy to the buyer at closing.  Do be aware that REO’s may be exempt from normal disclosure requirements.  In California, for example, banks are exempt from giving a Transfer Disclosure Statement, a document that normally requires sellers to tell you about any defects they are aware of.

Is it a bargain?

It’s commonly assumed that any REO must be a bargain and an opportunity for easy money.  This simply isn’t true.  You have to be very careful about buying a REO if your intent is to make money off of it by fixing and flipping or by fixing and renting.  While it’s true that the bank is typically anxious to sell it quickly, they are also strongly motivated to get as much as they can for it.  When considering the value of a REO, you need to look closely at comparable sales in the neighborhood and be sure to take into account the time and cost of any repairs or remodeling needed to prepare the house for resale/rental.  The bargains with money making potential exist, and many people do very well buying foreclosures (REO's).  But there are also many REO’s that are not good buys and not likely to turn a profit. It would be a wise move to enlist the services of a local Realtor. It costs the buyer nothing to have professional representation and the opinion of a local Realtor who is very familiar with the comps is also of value. 

Ready to make an offer?

Most banks have a REO department that you’ll work with in buying a REO property from them.  Typically the REO department will use a listing agent who specializes in REO resales to list their properties on the local MLS.  Before making your offer, your agent will want to contact either the listing agent or REO department at the bank and find out as much as possible about what they know about the condition of the property and what their process is for receiving offers.  Since banks almost always sell REO properties “As-Is Where-Is”, you’ll want to be sure and include an inspection contingency in your offer that gives you time to check for hidden damage and terminate the offer if you find it.  In the case of bidding on REO's you must include documentation of your ability to pay, such as a pre-approval letter from a lender, proof of down payment, etc.  After you’ve made your offer, you can expect the bank to make a counter offer.  Then it will be up to you to decide whether to accept their counter, or offer a counter to the counter offer.  Realize, you’ll be dealing with a process that probably involves multiple people at the bank, and they don’t work evenings or weekends.  It’s not unusual for the process of offers and counter offers to take several weeks or even months.

In summary, buying distressed properties can be very profitable but may not be for the faint of heart or for conservative, risk averse buyers.