Finding Real Estate Deals: REO

I am a private mortgage lender and as such I’ve seen successful investors draw on different types of skills. Some are handy and can build sweat equity by doing parts of their rehab themselves. Others are negotiators and managers extraordinaire. They are the ones who squeeze every penny, negotiate for every nail and breathe down the neck of their contractors every day. Working with them is not a picnic for contractors, but those investors do make money when their softer competitors don’t. Still, regardless of their skills, all of those investors share a single strength in common: an ability to find real estate investment opportunities. Identifying properties with money-making potential and putting them under contract is at the heart of real estate investing.

This article is a continuation of our series on this topic. For more information see our previously-published Introduction and our article on Finding Real Estate Deals at Foreclosure Auctions.

When a property fails to sell at a Foreclosure Auction, it goes back to the bank that holds the nonperforming mortgage. The bank becomes its owner (thus Real Estate Owned or “REO”) and the previous owner, the one who was not paying the mortgage, is taken off the title. As the owner, the bank can do anything it wants with the property. Since they are not in the property management business, the majority of banks choose to sell them off.

REOs are frequently touted as a holy grail of real estate investing. They are also often equated with “distressed” properties. There are good reasons for it. First of all, REOs by their nature are non-owner occupied. The owner (aka bank) is clearly a motivated seller with a vacant property on its hands. That property incurs taxes, property insurance and needs to be maintained. REOs are also typically sold in AS-IS condition, which turns off a whole segment of buyers who are not looking for a fixer-upper. However, as a private mortgage lender I cringe every time I hear that banks will sell their REOs for pennies on the dollar.

Banks might be motivated sellers, but they are not naïve. Their REO-disposition departments are tasked with researching the market values and pricing their properties accordingly. REOs are typically listed in MLS, which means you are not the only one seeing it. The better the deal, the higher the chances you will encounter stiff competition. The bottom line is that being an REO is by far not a guarantee of a bargain. Making money buying REOs is not easy. However, as a private mortgage lender I’ve seen it done many times. You need experience, perseverance and craftiness. Here are few suggestions:

Cash rules.

Just like any other seller of vacant property, banks want to sell fast. They know that obtaining financing is a long and complicated process with no guarantee of approval at the end. For these reasons, they prefer to work with all-cash buyers. A private mortgage lender like us can issue you a proof of funds letter that is equivalent to a cash offer and will allow you to stand out from the crowd.

Look for REOs that’s been sitting on the market.

Now that you got your private mortgage lender proof-of-funds letter in your pocket, it’s time to get more nuanced. One of the best ways to get an REO bargain is to identify properties that are not selling quickly. It’s safe to assume two things about those properties. First, for one reason or another there are not a lot of buyers knocking at their doors – perhaps the bank priced the property too high so it just sat on the market, so competition might be light. Second, the bank must be getting anxious to sell. It all means that you have a decent leverage to negotiate a lower price and should not be shy to doing it.

A pre-approval with a private mortgage lender should already give you a leg up on your competition, but there are additional things that can strengthen your chances.

Justify the lower price.

When negotiating a lower price don’t just say that the current price is “too high for a property in a given condition” – document it. Give the bank a compelling reason to lower it by listing all that’s wrong with the property and the amount of money required to fix it. Without being rude or condescending, help them see that the current price is unrealistic and they would be better off selling it to a well-heeled investor like you.

Choose your timing wisely.

In my 11 years as a private mortgage lender, I’ve seen many tricks of the trade and I love this one. Make your REO offers between Thanksgiving and Christmas. It is typically a dead season with many buyers going dormant until the beginning of the year. At the same time, banks are under pressure to get rid of the properties before the end of the year and make their annual goals. Play your cards correctly and who knows? With some good luck and perseverance, Santa might bring a nice real estate deal for you.

Now let’s talk shift the conversation from the properties that are languishing on the market to those that are hot, hot, hot. If you want to increase the chances for your offer to be accepted, it’s time to step it up. This is how you do it:

Offer to close quickly.

Let them know that you are a serious buyer pre-approved with a private mortgage lender and can close in a week or so. I doubt that a bank selling your REO can move that fast, but this isn’t your issue. Your goal is stand out from the competition and present yourself as a strong well-capitalized buyer that means business.

Make an oddball offer.

Most people submit a round number offers: $105,000, $250,000, etc. Mix things up and make a different offer. Incorporate your birthday or your lucky number. The reason behind this idea is that if someone else is bidding $105,000 you would be the highest bidder if your offer is $105,317. Not a bad return for an additional $317. Also, the bank might think you have a solid reason behind your odd number offer.

Offer a larger deposit.

Another way to stand out is to offer a larger deposit. Not only does it demonstrates your financial strength, it also weeds out a portion of the competition who cannot afford to match you. For example, wholesalers that might be competing with you typically offer small deposits of as little as a couple of thousands of dollars. When competition is tough and you need to come out with all guns a-blasting, aim to offer at least 10% of the property value.

Waive Inspections

As a private mortgage lender, I can’t warn you enough: this option is not for novices. Banks love to see the inspections waived and for obvious reasons. If you later discover a major defect, the only way you can walk away is by forfeiting your deposit. A reasonable alternative for waiving the inspection is decreasing the normal inspection period to 3-5 days. It both protects you from the unnecessary risk and shows the bank that you are serious.

Be ready to walk away.

Regardless of the source of your potential investment, always be ready to walk away. Do not get emotionally involved with the property. A sign of a mature investor is an ability to disengage and let someone else make a mistake. See our previous blog on the 5 signs of immature investors.

New Funding Resources LLC is a private mortgage lender doing business in Maryland, DC and Virginia. We offer private loans that help you compete against cash offers and make money in real estate. Click here to learn more or apply here.