REO stands for Real Estate Owned and refers to properties that have been foreclosed on, and currently for sale by the bank. They can generally be a good value, since they may be somewhat in disrepair. Sometimes this means they just need cosmetic work, sometimes they need more work. Depending on how hot your local real estate market is, they may also sell for less since they are not staged and generally don't show well. However, in a sellers market, they still go quick!
Some Tips for buying an REO home:
1. Schedule to go see them ASAP.
Don't wait for the weekend, go now! New listings pop up every day, so sign up for email notifications from Redfin.com or another reliable website that shows updated MLS info.
2. Get Pre-approved
In order to put in an offer or even get a showing, many banks require that you get pre-qualified or even pre-approved. Sometimes they require that you get pre-approved by their specific lender, but you are not obligated to get the loan through them (should your offer get accepted). No worries about your credit report - all inquiries within 45 days count as one inquiry.
3. Gather Your Paperwork
Get the last 2 months of bank statements, pay stubs and the last 2 years of W2s ready. Also get your credit report yourself from the internets and keep a copy on file (annualcreditreport.com).
Negotiate that your closing costs are paid by the bank - at least 3-6%. This is commonly agreed to by banks.
5. Research Rehab loans
Look into FHA 203k streamline rehab loan (FHA 203k Limited) for house. If it requires structural repairs, you would apply for the regular FHA 203k rehab loan. However, this one is much more complicated and has many more hoops to jump through.
6. Line up a contractor
Have both a trusted contractor (and an inspector, see below) look at the house to estimate repair costs. Attempt to negotiate price lower with bank based on those costs and area comparable sales. This may or may not work - banks generally will only negotiate the price down a max of 10%. Generally this is done after the offer is accepted and within your inspection contingency period. Some investors advice to get that house under contract with a contingency and then do your due diligence in order to ensure that you get the house, not someone else.
7. Line up an inspector
Always get an inspection and make the sale contingent on an inspection (done within the first 14 days, check the offer paperwork for details). The inspectors we've used range from $350 to $395. Get the inspection within 5 days of making an offer. Review your offer paperwork, it may require an even faster timeline. Also consider getting a sewer and plumbing inspection. Mold if necessary. This may need to be arranged with a separate inspector.
8. Add a loan contingency
Make your offer contingent up getting a loan at the current prevailing interest rates (make sure there's no expiry of this condition). This is called a loan contingency clause or financing contingency clause. This will cover you if there's anything wrong with the house or if you have trouble getting a loan (common right now).
8. Set aside more money than you think you need.
Budget another 2-3% of the final price for closing costs on top of the other closing costs paid by the bank. This was a big surprise, as it was not included on the Good Faith Estimate nor the HUD-1 statement. As of October 3, 2015, the HUD-1 and the Good Faith Estimate went away and were replaced with the Closing Disclosure and the Loan Estimate.
9. Approach the selling agent.
Not all selling agents are ethical or fair, and real estate is Los Angeles is extremely competitive. Many local real estate investors advise buyers to approach the selling agent to represent them. That double commission seems to be motivating to close that deal. Scrolling through sold properties, you frequently see the selling and buying agent from the same agency. We've called to see properties and never received responses, only to see that property magically go under contract the next day. Determine if you feel comfortable with this strategy, and back yourself up with expert real estate advice outside of the selling agency if you do go this route.
Some cons to making an offer on an REO property:
1. Banks move so incredibly slow.
We counteroffered 5 times - over 2 weeks. A friend making an offer on an REO at another bank did it all in one day - 4 counters - so it really depends on the bank, mine was Freddie Mac. Then it took 2 1/2 weeks for them to sign the final offer - in which they ignored my 40 day closing request. I should be moved in by then. As well, they had yet to fix the sewer issue they promised to. Part of this issue was the borderline incompetent selling agent they had hired to sell the house.
2. Plan on little wiggle room on the negotiation.
Sometimes the bank will not pay for repairs found in the inspection report. Many REO properties are offered AS IS, so make sure you are comfortable with the price you offered or are comfortable walking away during the inspection contingency period. However, do make sure to get an inspection as soon as possible and list the results clearly. Attempt to negotiate based on the results. Do your due diligence and check all permits with the city. I had an inspection before I even got an acceptance by the bank, checked permits and was able to use some of those results to push them for credits.
3. The agents may lie to you.
If you find a house that's been on the market for 300 days - there will sometimes MAGICALLY be another offer the same day as yours. This happened to numerous people (check the Redfin.com forums), including my best friend. This may not happen if the listing agent is also your agent. Be patient and be willing to walk away if you're uncomfortable with the negotiation process.
4. Some houses are barely livable.
Make sure you're ready for a project. My best friend and I were both in the market and looked at probably 10-15 houses together. Some we were scared to even go in the door (and we're both pretty handy and practical). Shoddy construction, a ton of illegal additions, etc. I checked the permits on my house before even putting in an offer. You would check permits at the Department of Building and Safety office. The one in Van Nuys and one downtown on Figueroa allow you to check permits. If you go when it opens, you may have your info in 20 minutes. Otherwise plan to be there a couple hours. Parking is hefty at the downtown location. Definitely get a relationship with a contractor prior to putting any offers in - because it'll come in handy to have them advise you if it's worth it.
5. You will need to be patient.
While not as slow as the short sale process, the REO process may be held up at multiple points. While technically the bank owns the house and has accepted your offer, the company that held the PMI policy also had to approve of the sale since they were paying out the bank or their loss. By my calculations, the bank was losing about $140,000 on my house. I bought in the thick of the real estate downturn and it had been purchased by the previous owner at the peak of the bubble.
As well, my rate lock expired multiple times during the 4 month escrow period (I had negotiated a 40 day closing) so my final mortgage rate ended up a half percent higher than I had initially agreed to. I did refinance within a couple years, but incurred some costs to do so.
Pros to REO Homes:
1. They are generally priced well.
You will usually have equity within months, since they are generally priced below market and need work. Once you put in that work, the value of your home goes up and you have instant equity (assuming you didn't overspend on improvements). As well, buying a lower priced home may allow you to move into a better neighborhood than you can normally afford. We bought the lowest price house in the neighborhood, though we also bought one of the scariest looking! Once we spruced this place up, it's one of the spiffiest on the block.
2. They usually need cosmetic updates.
You get to choose the finish you like, instead of whatever finish a flipper or previous homeowner got cheap at the local big box store.
3. You get a better view of the house.
An REO house is usually empty, having been cleaned out by the bank. This allows you to see both what needs work and what looks great. In regular homes, curtains can cover cracks in the walls, rugs can cover issues with flooring and furniture may throw you off from any other potential issues.
Look at the pros and cons and decide if an REO home is for you. They certainly are not for everyone! If they are, they are a great opportunity to gain equity quickly and personalize your home with renovations.
Disclaimer: this was my personal experience with purchasing an REO home in Los Angeles. Your mileage may vary. Do your own research and contact a reputable real estate agent in your own local area for more information.