Real Estate Owned (REO) Definition, Advantages, and Disadvantages

What Is Real Estate Owned (REO)?

The term real estate owned (REO) refers to a lender-owned property that is not sold at a foreclosure auction. Properties become REO when owners default and the bank repossesses them and tries to sell them. The lender, which is often a bank, takes ownership of a foreclosed property when it fails to sell at the amount sought to cover the loan. These properties generally come at a steep discount but may require extensive repairs.

Understanding Real Estate Owned (REO) Properties

When a borrower defaults on their mortgage, the pre-foreclosure period often involves either a real estate short sale or a public auction. If neither goes through, the foreclosure process can end with the lender taking ownership of the property. Lenders may be banks, non-traditional lenders, quasi-government entities like Fannie Mae and Freddie Mac, or other government entities.

Lenders may attempt to sell REO properties in their portfolios without the help of real estate agents. When this is the case, banks or government agencies often list their REO properties on their websites. A bank's loan officers may also notify customers looking for homes about the REO properties in its portfolio.

REO properties are managed by the lender's REO specialist. Their role includes:

• Marketing the properties
• Reviewing any offers
• Preparing regular reports on the status of properties in the bank's portfolio
• Tracking down deeds

The REO specialist also works closely with the lender's in-house or contracted property manager to ensure properties are secure and winterized or to prepare a property for vacancy. The REO specialist undertakes these job functions to help the bank liquidate its properties quickly and efficiently.

Special Considerations

REO specialists often contract the services of local real estate agents to list the properties in the multiple listing service (MLS) so they get more exposure. Listing properties in the MLS ensures that potential buyers who real estate websites, as well as sites like Zillow, Realtor.com, Redfin, and Trulia, will see the listings. REO listing agents bring any offers they receive to the REO specialist.

How a Property Gains REO Status

So how does a property become real estate owned? There is a process that lenders must adhere to for it to go from the original owner to lender-owned. It starts with the borrower defaulting on their mortgage or home loan. Lenders normally have a cut-off date, generally within a few months. When a mortgage is in default, lenders try to work with the borrower to bring it up to date. If not, it goes to the next stage: foreclosure.

Foreclosure is a legal process. It allows lenders to repossess the property and try to sell it to recoup the outstanding balance of the loan. There are instances when lenders can't sell the property. This is the point at which it becomes real estate owned. The lender manages the property and prepares it for listing on the market.

Advantages and Disadvantages of a REO Property

Advantages

REO properties can be attractive to real estate investors and homebuyers because they're cost-effective investments. Banks may often sell them at a discount to their market value since selling such properties is not typically their primary business line.

Many properties that come through the foreclosure process don't have only outstanding loans; there also may be other defaulted payments on them. This can include property tax payments and other debts. The point of foreclosure is to remove any liens from the property and sell it. Purchasing an REO means they come lien-free, so there are no defective titles and no outstanding debts.

The majority of lenders don't want to hold onto REO properties. Keeping them on the market means they lose money. As such, they're usually more motivated to unload the REO property than a regular seller would their own home. Instead of doing the back-and-forth, lenders may be more willing to negotiate, which means buyers can often walk away paying a lower price than they otherwise would.

Disadvantages

Lenders typically sell REO properties on an as-is basis. This means they will not make any (major) repairs or renovations prior to selling. These properties are often in disrepair, so it's crucial to have a thorough home inspection and be prepared to make (and pay for) renovations that may be needed.

A highly neglected or damaged property may require extensive repairs and upgrades to make it habitable again. The cost of repairs can often negate any savings buyers have on the actual purchase price.

Although single-family home occupants may be evicted prior to listing, multi-family homes may still be occupied by tenants. This means buyers may end up becoming landlords, even if they never intended to take on that role. Buyers will have to take precautions to ensure they are compliant with local and state landlord-tenant laws by honoring existing leases.

The Bottom Line

Real estate can present a lucrative investment opportunity. To save money on the purchase price, many investors find opportunities in real estate owned properties, which are owned by lenders. These properties go through the default and foreclosure process and aren't sold at auction. Because it can be costly to maintain REO properties, lenders are often highly motivated to sell. You can get these properties at a steep discount. But if they are neglected or require extensive repairs, the cost of renovations can cancel out any savings from the lower selling price.