REO is the acronym for “real estate owned.” It is the acronym banks use for real estate the bank forecloses upon, takes in lieu of foreclosure or otherwise owns. Such property is carried on the bank’s books as an asset. The value of the bank’s assets is critical to the operation of the bank because the bank’s balance sheet, and thus its solvency, is linked to the value of its assets. In a market downturn, like the downturn in the real estate market after 2007, real estate assets become less valuable and this can raise very serious solvency issues for banks.
The link between asset value and bank solvency makes the sale of real estate owned critical to bank operations. The link also makes it difficult to predict how a bank will go about selling the real estate it ends up owning. Typically, the sale of real estate owned is handled by the bank’s “loss mitigation” department. Loss mitigation means making losses less severe or painful to the bank. How the loss mitigation department tries to mitigate the loss associated with real estate owned depends on the direction of the market, the rate of market change, market liquidity, the bank’s ratio of liabilities to capital and assets, the number of properties owned and many other factors.
As complicated as the loss mitigation factors may be, the bottom line is that the bank wants to keep losses to a minimum. That means that, contrary to popular belief, REOs are not normally dirt cheap. Banks do discount their property to reduce time on the market and to account for the fact that bank property is typically not occupied, or staged or otherwise groomed to obtain top price. Historically, this discounting has put REO properties on the market at about 95% of true market value.
Beginning in the Spring of 2009, government intervention in financial markets and the glut of REOs resulting from historically high foreclosure rates began forcing banks to consider larger discounts to clear their books of real estate owned. In some markets this has led to REOs being sold at 75% or less of market value. As a result, pre-foreclosure, REO and other foreclosure-driven sales can make up as much as 50% of total sales in some markets. Although the market is “distressed,” sales can be “hot” with multiple offers, escalator clauses and all the other pushing and shoving associated with a hot market. Click here for detailed discussion on multiple offers in a distressed property market. It has, therefore, become increasingly important that real estate professionals understand the operation of the REO market.
Unfortunately, the REO market involves a very odd real estate commodity. Most of the real estate owned market is residential. What is being sold is homes, but not homes in the typical owner-occupied family home sense. To the bank, the home is just an asset with a market value no different than a piece of repossessed farm machinery or the inventory of a failed business or a corporate bond. To the REO buyer, the home may be a home or a rental investment or just real estate with a short-term flip value. Thus, the REO market consists of buyers with different goals competing in a market where sellers are detached business people trying to minimize a loss rather than maximize profit.
Most agents spend their careers helping homeowners and homebuyers get together. Real estate practices and forms are designed for this homeowner/homebuyer market. The vast majority of individual agents’ experience is in the homeowner/homebuyer market. Although the object of the transaction is the same residential property REO transactions have very little in common with homeowner/homebuyer transactions. Whether on the listing side or the selling side, expectations, practices and forms will all change in a REO transaction. That means a steep learning curve for agents who find themselves in the REO market.
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