If building a portfolio through REOs (real estate owned) is your goal, then you either need your own money or partners with money looking for long term growth. Besides the passive investors, there is one more category that represent excellent partnership opportunities, and that is the 1031 Tax Free Exchange crowd. These are investors who use the benefits of chapter 1031 of the IRS code which allows investors to keep their capital working while deferring taxes (the government doesn’t lose on this arrangement even though it is an excellent tool for growing wealth). Exchangers have only a limited amount of time between transactions (180 days total) so frequently they represent money in the form of ready cash looking to get into a deal.
In some markets banks are listing these properties at retail prices and above and at deep discounts in other markets. So how can you capitalize on this phenomenon? Planning and execution are the usual keys to success. Here are 5 simple steps to maximizing your opportunities with REOs.
Develop a relationship with a REO broker:
REO properties are listed in the Multiple Listing Service, so why not just use any real estate agent to present your offer? The reason is simple; banks only use a certain number of brokers to list their properties. If you deal with the listing broker they have more flexibility. If their office is getting both sides of the commission, they are more likely to concede a point or two of their commission to make the deal work than if they were only entitled to half. Additionally, by building a relationship with the broker who represents the bank, your offers may be viewed as more credible because many bidders for REOs do not have the ability to close. They prove to be time wasters. In this business, a reputation for integrity is worth its weight in gold!
Don’t jump in right away; wait for the price to drop at least 2 or 3 times before making an offer:
When REOs first come on the market they’re not much different than any other new listing, the seller is usually testing the market. When a property becomes a REO it usually means that the lender wasn’t receptive to any short sale offers which may have been submitted prior to the foreclosure sale, nor were they willing to accept a discount at the foreclosure auction. Perhaps they thought there was sufficient equity for them to recover their investment but the market said, “no.”
Once listed for sale by the lender, the property may sit for a while but reality begins to set in as either low or no offers come in. After about thirty days (sometimes sooner) the lender authorizes a price reduction. Again after another fifteen to thirty days. We like to submit our initial offer once the property has been listed for at least 90 days or two price drops. The current problem is that many national lenders are out of touch with local markets and some brokers are offering to advertise at higher prices in exchange for listings. Because it says “Bank Owned Foreclosure” in the listing, many uninformed buyers may think they are getting a deal when the property is actually listed at or very near retail price.
Be prepared to buy for cash and close quickly:
When presenting offers to purchase REOs, be prepared to provide a ‘proof of funds’ letter (either from a bank, hard money or private lender) or a lender approval. From a lender’s perspective, the best offers will have no financing contingencies so cash or hard money are usually your best options. You will likely be required to sign a number of bank disclosures as well because the lender wants no liability to follow the transaction.
Submit an offer 10% to 15% below asking price and a right of inspection:
Regardless of asking price, always submit a lower bid unless you are completely satisfied with the deal. Note: some brokers may list the property at an artificially low price in order to generate offers and then counter with a request for “Highest and Best Offer.” This is almost a form of silent auction where the hope is that there will be enough low initial offers that someone will make an emotionally high bid to win the property. Don’t be fooled by this action.
Additionally, the right of inspection gives you an opportunity to have the property professionally inspected and if warranted, to renegotiate the price or terminate the deal should your inspector uncover additional defects in the property.
Upon acceptance, inspect the property and modify your offer as necessary:
As soon as your offer is accepted, schedule your inspection quickly, three to five days. If you have to renegotiate your offer because of a previously undetected defect you can do it quickly and either get an acceptance or move on to your next deal.
