You might not have heard of the real estate owned (REO) market. That’s all right; neither has the secretary of Housing and Urban Development.
If you have, though, then you know that this is the rock-bottom path to homeownership or residential real estate investment. These are properties on which the occupant could no longer pay the note. Then a short sale could not be arranged. Then nobody was willing to buy it at a foreclosure auction. So the lender that got stuck with it has withdrawn its liens and boiled down the terms and conditions of sale to two short words: “as is”. Essentially, even the banks have walked away from these distressed properties.
And yet, just like any piece of real estate, there is such a thing as a price at which both a buyer and a seller can shake hands. Today, that price might be heading lower as the number of handshakes starts to rise.
Where we are, and Where we Were
Let’s roll the tape back a decade. The current economic expansion has been going on long enough that real estate investors with a decade’s experience entirely missed the Great Recession.
As the crisis dawned in 2009, Georgia Institute of Technology’s Dan Immergluck — then a visiting scholar at the Federal Reserve Bank of Atlanta — took a snapshot of the situation. As long as REOs could be chalked up to urban blight, then the “destabilizing impacts on neighborhoods and communities” wasn’t a problem. But when this class of real estate started to pop up on Forsythia Lane or Warbler Crescent, suddenly there it was a calamity.
“In general, in traditionally weak-market metros — many of which had substantial REO levels before the advent of the national mortgage crisis — REO tend to be relatively concentrated in central cities. Conversely, in regions where REO accumulated more recently and in those with high central-city housing prices, REO tend to be somewhat more suburbanized,” Immergluck found. “In particular, in the formerly ‘hot-market’ regions where home values have declined rapidly, a large majority of ZIP codes with ‘severe’ REO levels are suburban.”
Through 2009 and 2010, it wasn’t unusual to have 80,000 properties per month entering the REO market. That’s on top of about 250,000 per month that were auctioned off or fell into default. According to the HSH real estate portal, REOs comprised almost half of all transactions during that time.
Today, the volume for each of those situations is roughly one-seventh what it was when the economy was at its worst.
ATTOM Data Solutions reports that, while foreclosures are still trending downward, that is not the case for repossessions, as REOs are otherwise known.
“There were 49,898 U.S. properties with foreclosure filings in November 2019, down 10 percent from October 2019 and down 6 percent from a year ago,” according to ATTOM, which then points out that REOs are heading the other direction. “Lenders repossessed 13,996 U.S. properties in November 2019 (REOs), up 4 percent from the previous month and up 22 percent from a year ago.”
While that doesn’t mean another recession — or even another nationwide real estate bust — is coming, that’s still a troubling statistic.
Hunting Houses, Finding Funding
Ten years ago, the internet was alight with stories — some real, some apocryphal — of homebuyers targeting such distressed communities as Cape Coral, Fla., or Detroit’s “greyfield” neighborhoods, putting the whole transaction on their credit cards. And why not? There was so much inventory, banks were willing to accept pretty much any offer that covered closing costs.
Supply is more constrained now, so the price per unit has gone up. Generally speaking, people aren’t buying REOs strictly on price anymore. An REO now goes for pretty much the same price as any other fixer-upper in the neighborhood.
There may be a few bucks to be saved, but that’s around the margins now. Essentially, the main distinction between an REO and a starter home is that the seller is a bank rather than a family that got too big for it. They can all be found via the same websites, listing services, and neighborhood real estate agents.
That said, there’s no shortage of professional flippers looking to acquire cheap properties to rehab, and they can often pay cash. People looking to buy their starter homes — as well as those looking to enter the REO market for the first time to make a profit — probably don’t. Retail banks and other mortgage lenders generally don’t stick their noses up at REOs, so conventional mortgages are one way to go. But it’s more typical, according to FitSmallBusiness, to keep up with the nimbleness of the cash-on-the-barrel investor, to get the funds through a hard-money loan then refinance later.
From House to Home – REO Style
Ultimately, the whole purpose of the REO market is to get units off the bank’s balance sheet. For anyone who doesn’t work at the bank, though, the most obvious sign of a successful REO transaction is that the creepy house with the plywood windows and the Jumanji lawn is now the abode of human souls still attached to their bodies.
But what’s the fastest way to get that done? Here’s where the data conflicts with the received wisdom.
“Conventional wisdom in the mortgage servicing industry has traditionally defaulted to …: a neighborhood is better stabilized when a distressed property reverts back to the foreclosing lender [which] is more likely to get the property back into the hands of an owner-occupant, and owner-occupants have a more vested interest in neighborhood quality and stability than do real estate investors,” according to Auction.com economist Daren Blomquist. “But a thorough analysis of data … shows that properties sold to real estate investors at foreclosure auction more quickly convert to owner-occupancy than those that revert to lenders at the auction.”
Even so, Blomquist’s June 2019 article noted his surprise that more than 40% of the REO properties sold through his portal’s “Day 1” program were soon-to-be owner-occupants rather than investors. Of course, that also means that the majority were sold to investors, suggesting that there is more than enough demand to make REO management and resale a profitable endeavor.