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The World of REO

March 5th, 2012 | Category: Blog

forclosure bank owned propertyWhen lenders foreclose on real estate loans, they get the property back, and become the owners of the real estate which secured the loan. They have various acronyms they use for these assets. The most common term is REO.

REO stands for “real estate owned”. Some lenders call it ORE, which means “owned real estate’. Still others confuse the matter further by calling it OREO, or “other real estate owned”.  But they all mean the same thing: real estate assets taken back by the lender because the loan went bad.

REO is an undesirable asset for banks to have in their portfolio, for several reasons. First, banks make their money by lending money. When the borrowers stop making payments, the banks are not making money anymore. The banks foreclose when it becomes clear that the only way they can hope to get their money back is to take the asset back and re-sell it.

Foreclosures are very costly for the bank, by some estimates as high as 45% of the original loan amount (Bloomberg Business Week, May 8th, 2008). This is due to a variety of factors, including loss of value due to the foreclosure process, legal fees, deferred maintenance, taxes, vandalism, etc.

Lenders are not in the property management business. Departments have to be created, and people with skills other than those in the bank’s core business have to be hired. Banks sell REO for less than private sellers can afford to, often 20% to 30% less.

Banks want to sell their REO, so they can get the idle money back into circulation as loans. They are required to have a certain amount of liquidity, and nonproductive assets really hurt their profitability, so they are under pressure from regulators to make it go away.

All of these factors add up to why banks do not want REO- it cuts way down on their ability to make profits, and when they have too much it threatens their very solvency and might result in a forced shut down by regulators.

So why cant the banks just quickly cut their losses and get rid of their REO? Why do they maintain unproductive assets in their portfolio that are expensive to maintain, manage, and pay taxes and assessments, that represent no income or profits to the banks?

In the present 2012 environment, where average real estate values in most markets have plummeted by 30% to 80% or more since the peaks in 2008, banks often cannot sell these nonproductive REO assets because once they sell them, they are forced to recognize a loss. This situation is a real double edged sword for the banks. They are receiving no income on the loans they made and in fact are losing money for their shareholders with these nonproductive assets. However, if they try to sell them and receive current market prices, the situation changes from a loss of income to actual losses once they sell them.

The banks want to sell their REO for market prices, but when they have too much of it, they are often forced to sell for the lowest prices the regulations will allow. In these circumstances, when they can find a way to take a significant write off, they will pursue an auction or a bulk sale to lighten their portfolio of these nonproductive assets.

When banks sell REO, and particularly when they auction it, their terms are as-is, with no warranties as to property condition. Because it was a loan-gone bad which resulted in them having to own the asset, they are not likely to offer any financing on the sale of the asset, so any buyers must have access to whatever cash they might need to close the sale and perform any necessary repairs.

It is important to do your homework before buying REO at auction. Know what present values are for that property type in that area. If you cannot access the property sufficiently to get clear estimates of repair or cure, you should assume the worst and factor that cost in before you bid. And above all, do not get carried away in the competitive fever and bid more then your analysis indicated.

We think an informed bidder is a better bidder! We will attempt to make any and all relevant information available to bidders so that they can do their due diligence before the auction.