Flipping REOs can be a very profitable endeavor. The key is knowing the process and the ways to do it effectively.
What are REOs?
REOs (Real Estate Owned) are properties owned (or “taken back”) by a lender after the sale at a foreclosure auction did not succeed. Lenders that have REOs include banks, government loan insurers, and government agencies.
Most of these properties had amounts owed that were higher than their market value due to mortgage loans made during a real estate bubble. Nobody was willing to pay the minimum bid for the property (mortgage balance plus legal and auction costs) at the foreclosure auction because this exceeded the current market value. So the bank was forced to take it back and it became “real estate owned”.
REOs Come with Clean Title
REO properties are typically sold on the open market after the lender makes them marketable. This includes fixing issues with the condition of the property that make it uninhabitable, resolving building code violations, and paying off tax liens. Banks will “clean up” the property title to ensure it’s marketable. This is major benefit of flipping REOs.
In most states, when a property goes to foreclosure auction, nobody buys it and the property becomes REO, this eliminates any junior liens. This includes second and third mortgages (if the first mortgage lender foreclosed), as well as contractor liens.
NOTE: In some states, the former owner may still have the right of redemption (can reverse the bank taking the property back) if he or she can pay off the mortgage, plus legal and transaction fees. This is uncommon and redemption rights do not typically last long. Do your research on this as laws vary by state.
Buying REOs from Banks
More Financing Options
You can buy a REO house, condo, land, multi-family building or commercial building just like any other property. This means you can buy it for cash, obtain a mortgage, etc.
Tight foreclosure auction deadlines are no longer effect once a property becomes REO, so there is no need to keep cash on hand or rush to get financing. You definitely have time to shop around for better financing rates when buying REOs.
TIP: If you need a quick loan to close on a REO property consider hard money lenders in your state.
REO Sales May Go Slowly
When you purchase an REO the bank is represented by an agent who must follow REO procedures required by the bank’s Board of Directors. Normally, this entails getting three bids for a property before agreeing to a sale. In a slow market obtaining three bids can take time — weeks or even months. This means you shouldn’t expect to make a quick buy when dealing with REOs.
If three bids are not received by the bank within a month or two, the bank will often loosen up this requirement. You may be the only buyer if the market is slow. Persisting with your bid can pay off in a slow market with a good deal.
If the market is strong, then an REO property will sell quickly just like any other potential house you can flip. It all depends on market conditions.
Offer Cash to Flip REO Properties
One way to get a lower price on an REO property is to make a reasonable cash offer right after the foreclosure auction when the bank has just taken it back. Some banks will allow this — particularly small banks with a glut of REO properties. So it may be worth a try.
The odds are greater if the property has major physical issues, because the bank will be save a lot of money it would otherwise have to spend to bring it back to habitable condition. If you have cash and are willing take the property subject to any title and condition issues, then the bank may sell it to you for a deeply discounted price.
It might take making several cash offers on REOs to convince the bank’s agents that you are a serious buyer. You will need definite access to funds to be able to close fast. Making clean offers with no inspection or financing contingencies also helps.
Remember, if you buy one of these pre-rehab REO properties you’re essentially buying an auction foreclosure house. There will likely be issues, so be ready to rehab the house and clean up the title!
Flipping REO Properties You’ve Bought
So you’ve bought an REO from the bank. Now what?
A lot depends on the condition of the property and the market. Is it better to rehab the house and take it upmarket? Or just fix a few things, clean up the title and sell it quickly? Or rent it for awhile and sell when market conditions get better? Or wholesale the property to another investor?
If you acquired the REO with cash, you could be dealing with liens and building code violations, the same things the bank didn’t want to deal with. The key here is to either resolve the liens or find a way to generate cash flow (e.g. renting) with the liens still on the property.
If you bought the REO from the bank after its title and condition issues were cleaned up, then flipping it could entail a number of options:
- Find a new buyer, whether it be cash or mortgage financed
- Seller finance it to a new buyer
- Lease-to-own it to a tenant
- Rent and hold until the market improves
The main benefit of buying REOs is their clean title and the fact it is habitable. This does not mean there aren’t issues with the property’s condition (there usually are). This gives you opportunity to rehab the house, perhaps add on or up-market it, earn some “sweat equity”, and flip it for a solid profit.
Getting REO Deals Off the MLS
During certain market conditions, there may be a large quantity of REOs available to purchase on the MLS. The key is to make consistent offers and a good deal with show up eventually.
Get Title Insurance to Flip REO Properties
Getting title insurance is essential to reduce any major unforeseen title-related costs. It might seem like a title is clear, when down the line an old issue shows up that no one caught. This is a rare occurrence, but it can happen.
One way to handle “out of the woodwork” title issues and save some money is to get a “hold open title policy”.
A hold open policy is used when an investor intends to buy and sell the home within 18 months. It can save hundreds in title insurance costs. The title company does not issue a final policy to the investor. Instead, the title company “holds open” the policy for the next buyer (the end buyer). Once the investor flips the house to the new buyer, the title company issues a complete title insurance policy.
A hold open title policy lets the REO investor concentrate on rehabbing the house quickly and finding a buyer to flip it to. He can then sell it to the new buyer along with a title insurance policy that’s been prepaid, essentially. This helps grease the wheels on the sale and moves thing along quicker.
Using a Land Trust to Flip REO Properties
Its possible to use a land trust to buy and sell REO’s. To do this, assign your beneficial interest in the land trust to the end buyer at sale who in exchange will pay your fee. You can resign as Trustee once the deal closes. The property then gets recorded as “Stree Name Land Trust” and not in the end buyer’s name.
Flipping Government REO Properties
Many U.S. government websites exist that offer foreclosure listings and REO properties. These include:
- Fannie Mae
- U.S. Marshal Service
- Treasury Department
Most government REO listings require a real estate agent to submit the buyer’s offers. Like many REO properties, these are sold “as is”.
Flipping REO Properties in a Nutshell
Flipping REO properties can be lucrative if done correctly. There are definite ways to do this that require preparation and persistence. But when successful, the efforts can be worth it to determined real estate investors.