"REO" is an acronym that stands for "Real Estate Owned" properties. A loose definition is: homes that have been foreclosed upon and subsequently become the property of the foreclosing bank or lender. REO properties are also known as bank owned residential property, bank REOs, foreclosure properties, etc.
A New Industry Is Born
Foreclosure has been front page news across America for the past couple of years. And this phenomenon is expected to continue unabated for the next 2-3 years, if not longer. And, as a result, foreclosure property investment has become an industry unto itself.
This article is written to help investors understand the REO properties business and most importantly, the best way to profit from this tremendous opportunity: by investing in "specialized REO companies" .
Specialized REO Companies Emerge
Today, at any point in time, there are several MILLION homes in various stages of foreclosure. As a result, companies that are completely dedicated to the acquisition and resale of REO properties have been springing up in various markets around the United States. These are called "REO companies". (Not to be confused with "Asset Management Companies" who work for the banks at liquidating their REO property inventories for a fee.)
As foreclosures were just beginning to grab headlines, various investors and real estate professionals began to approach banks and lenders for their lists of bank REOs. When the banks supplied these lists (known as "tapes"), they also provided the selling price that they would accept for those REO properties. There was some negotiation room at that time, but the banks weren't really willing to drop their prices too much below the amount of their original loans to the former homeowners. At the time, making a foreclosure property investment was basically an informal process done on a bank-by-bank, house-by-house basis.
However, that changed when foreclosures began to sweep across the U.S. like a tidal wave. Banks and other lenders were literally being inundated with REO properties every week and began to seek means to cut their losses and unload these homes. This is because it costs money to hold onto REO properties with no payments coming in. The banks still have to continue to pay fire insurance, maintenance, utilities and numerous other expenses on every one of their REO properties. As a result, they began to reduce their asking prices and became more willing to negotiate in order to unload their ever-increasing inventories of homes -- thus, an industry was born.
So, in the true American entrepreneurial spirit, specialized new companies began to take shape. These new REO companies deal only with "distressed" real estate, including REO properties plus homes in various stages of foreclosure and homes that are in jeopardy of foreclosure. An over-simplified description of their business model is that they acquire REO properties well below the current market value, repair them to "move-in" condition and resell them as soon as possible at a profit for their investors.
What Successful REO Companies Do
There are a lot of businesses that like to consider themselves REO companies. However, most are not making any money. This is because they lack one or more of the following: experience, strong management, funding/cash flow, relationships with banks and lenders, networks of realtors, contractors and appraisers, etc. However, the most successful REO companies that are profitable have all of these attributes and proven business processes as outlined below:
Successful REO companies request complete lists of all bank owned properties in inventory from their senior bank contacts at the national or regional levels. These are known as "REO tapes". These tapes are often provided to the REO companies before they are released to the general public and smaller investors because they can buy homes in large quantities and quickly reduce the inventory of the bank’s REO properties significantly.
The premier REO Companies have a network of real estate professionals in each market around the country that physically inspects the REO properties on the tapes. They create a separate file for each home, describing its condition, repairs needed, cost estimates, photos, comps and all other pertinent details about the house. These files are then provided to the REO companies.
Next, the REO companies will review all of the information and formulate a purchase price offer that they will submit to the banks for only those REO properties that they believe have good resale and profit potential. These offers will typically be no greater than 50-60% of the property’s current market value. (This is where they make their money.)
Upon bank approval, the REO properties are purchased.
Next, the REO companies send in their network of building contractors and handymen to make any repairs necessary to get the homes into "move-in" condition.
Finally, the REO properties are listed for sale via their network of real estate professionals. The properties are typically priced under the current market value of surrounding neighborhood homes in order to sell very quickly.
And, believe it or not, the top REO Companies are so efficient that they can often buy, repair and resell their REO properties in as little as 4-6 months!
How to Invest with REO Companies
Professional REO companies will set out to acquire what is known as an "investment pool" of REO properties. Initially, they will seek out investors as "silent partners" to raise a certain amount of capital to help fund the investment pool of homes (i.e. To purchase REO properties from the banks).
Silent Partners definition: Business partners who provide capital but do not actively participate in the management or operations of the enterprise or investment. (InvestorWords.com)
Silent partners are not involved in the day-to-day management or operations of the investment pool, nor are they involved in the REO process described in Steps 1-6 above. It is strictly a "passive investment" for them. They simply sit back and let the REO companies do all of the work!
Passive Income definition: Income derived from real estate and business investments in which the individual is not actively involved, such as a limited partnership. (InvestorWords.com)
To exemplify how this works:
Let’s say that an REO company will raise $5,000,000 from silent partner investors like you and me.
Once the $5,000,000 is raised, the REO company will typically go to a lending institution and initiate a short-term "bridge loan" for an additional amount of capital, by leveraging the $5,000,000 they have already raised. Let’s say that this new loan is for an additional $10,000,000.
The REO company now has a total of $15,000,000 in buying power with which to acquire REO properties from the banks and create an investment pool of homes.
Next, the REO company will begin the process described in Steps 1-6 above. They will purchase "the cream of the crop" from the banks’ REO property inventories until they reach their $15,000,000 spending limit. Now they have acquired their "investment pool" of homes. (e.g. 100 homes, averaging $150,000 each = $15,000,000.) * For our example this is 60% of market value - which is conservative.
As a silent partner, you would now be invested in this pool of 100 REO homes. After Steps 1-6 above are executed and all of the 100 homes have been sold, the investment process is completed.
* For this example, 60% of market value acquisition cost on our homes would translate to an average selling price of $250,000 each for a total of $25,000,000.
From the sales proceeds, the REO company pays all business expenses incurred ($3,300,000 or 13% of sales for our example). Then, the REO company will repay the $10,000,000 loan + loan fees of $700,000 to their lender. Next, they will repay the silent partners their original $5,000,000 investment. The remainder is a net profit of $6,000,000 to be shared proportionately with the silent partners.
Here is another way to look at it:
$ 5,000,000 Silent partners' original investment
+ $10,000,000 Bridge loan amount
-------------------- $15,000,000 Total paid for 100 REO homes @ 60% market value
$25,000,000 Total sales of 100 REO homes @ market value
- $ 3,300,000 Expenses (commissions, repairs, marketing, operations, etc.)
- $10,000,000 Repayment of bridge loan principal
- $ 700,000 Loan fees (10% APR, 6 months + 2 points origination)
- $ 5,000,000 Repayment of silent partners’ original investment
-------------------- $ 6,000,000 NET PROFIT (to be shared with the silent partners)
The foreclosure market today is presenting investors with one of the greatest wealth building opportunities of our generation. And best of all, it's passive income - the REO companies do all of the work for you!
The key to success with this method of foreclosure property investment is finding the right REO companies to invest with.
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