How To Buy Foreclosures And REOs (Part I)

HOW TO BUY FORECLOSURES and REOs/bank owned property is a hot topic today. Dozens of online websites offer, for a charge or monthly fee, foreclosure buying systems, foreclosure tracking systems, and foreclosure information.  I have purchased at trustee sales both residential and commercial properties for myself and clients. I can write with some authority on this subject for California buyers.

Newcomers to foreclosure buying and online information must be reminded this process is governed by California law. Foreclosure systems, procedures, or laws in other states now found online are not applicable in California.

This is a series of articles, Part I is buying bank owned property, real estate owned by a lender following a trustee’s sale foreclosure. Parts II-V will cover specific details of equity purchase agreements buying out the seller-in-foreclosure, tracking Notices of Default and Notice of Trustee Sale, investigation of property pending trustee sale, preparing for and bidding at the trustee sale, and post sale problem areas.

Normally, when someone says “I bought a foreclosure” they mean they purchased a property from a bank.  Bank owned properties acquired at trustee sale are called ‘real estate owned’, or REOs.  Lenders typically bid the full amount of the loan at trustee sale where the lender is the beneficiary of a deed of trust. The trustee named in the Deed of Trust sells the property at public auction for the benefit of the lender. Generally, if there are no public bids over the amount due the lender, the lender “buys in” for the full loan balance due and the trustee then gives the lender, or the buyer at the sale, a “Trustee’s Deed” to the property.

California lenders do not secure loans with mortgages.   California is one of five states that use Deeds of Trust to secure loans made to borrowers to purchase real property.  Lenders rights and remedies, borrowers rights,  foreclosure law and procedure, and rights of junior lien-holders are radically different in California as a result.

Between the time a Notice of Default is recorded and the date of the trustee’s sale there are many investors who want to “slip in there” and buy the property directly from the seller-in-foreclosure. These are called Equity Purchase Agreements. These will be covered in Part II of this series.

After taking title to the property by Trustee’s Deed, a lender then owns the real estate.

Savvy investors contact bank real estate owned departments BEFORE foreclosed properties are listed with a real estate broker. Each lender has a different procedure for selling REOs, and most maintain only one corporate REO office in California.  Real estate agents also contact REO departments to get foreclosure listings.   Knowledgeable real estate agents and investors contact the corporate office of the lender (banks don’t always name it the ‘real estate owned department’) and find out what they have coming up for sale they might purchase directly. This can save the lender the real estate commission, management costs and expenses.  Further, it can speed up a sale for the lender.

Banks often have investors standing in line to buy REO properties.  If you call, just don’t expect to be the only one inquiring about buying bank owned property.

Buying property directly from a lender has major advantages.  First, the investor does not have to pay all cash as required at a trustee sale.  Second, there are not all the lien priority risks the trustee sale buyer has, among many other risk factors.  Third, tracking foreclosures and going to Trustee Sales is a nearly full-time job if done prudently.   I know.  I’ve spent full time buying foreclosures.  From my experience, buying directly from a bank is by far the easiest, most risk free, and net most profitable, way to buy foreclosed real estate.

These are the steps investors should follow in buying bank owned property:

1. First, the investor or agent should contact all the lenders in the geographic area the investor-buyer is interested in.  The optimum way to do this is to call a title company and ask for the last two or three months Notices of Default each Notice contains the name of the lender.  Call the local county office of the lender, and ask them the number and email address of the corporate office managing foreclosed property for the bank/lender.

Questions to ask each lender REO office should include a) what properties are owned by the bank, addresses, and specifics; b) what properties are MLS listed by agents; c) whether it is possible to ‘buy direct’ before property is listed, and d) what additional properties the bank expects to have for sale in the future. This first step insures the investor will discover all the REOs available from all lenders in the market area.

Always ask if there are special contract requirements/conditions the lender has (there always are!). And ask if the lender is willing to finance the property. The bargain is often in the financing offered by the lender-seller!  If the lender is willing to finance the purchase feel free to low ball the interest rate and loan terms.

Investors will discover that each lender will be somewhat different.  Some will prefer not to MLS list their properties, but to sell directly to investors. They may have a ready list of bank owned real estate for sale. The first step, calling all over California to corporate real estate owned departments, is time consuming and sometimes frustrating, but it is by far the most important step.

Realtors soliciting listing from lenders will make the same contacts.  However, they should be very knowledgeable regarding lender sale conditions, and be ready to advance costs to secure the property, change locks, do emergency maintenance, and even deal with hold over owners.

Investors buying REO property will need to search through all the bank owned properties in the area for the best buys.

2. Investigate the bank owned real estate discovered in contacting REO departments.  Of course, it is possible to just look through MLS listings for REOs.  However, in looking at only listed bank owned properties the investor may give up 10%+ of the bargain price to be had dealing direct.

Next, investors need to know they are NOT going to receive all the information and detailed disclosures customarily given by a seller. Don’t expect the lender to be highly cooperative in supplying information.  It is up to the buyer to determine the physical condition.

3. If buying direct from the bank rather than listed REOs don’t use the CAR or PRDS residential purchase agreement form.  REO purchases are practically speaking commercial transactions. Due diligence is required by the buyer, not the seller. If the investor is unfamiliar with due diligence, an experienced buyers agent is highly recommended. Offers should contain the condition of the property terms required by the lender-seller. A custom drafted purchase form is best, not the CAR form.

It is important to note here, that the reason many lenders prefer not to MLS list foreclosures with Realtors and instead deal directly with sophisticated investors is the bank does not care so much about price/economic terms, as they do liability and risk factors.  Banks are trying to minimize loses, not maximize profits on a sale.  They like buyers who know what condition of the property and related contract terms the bank can live with. Making a purchase simple for the bank’s management is a contract advantage. Another way of finding out the seller-lender contract requirements is to contact a title company.

Agents and investors who understand the Federal Reserve bank board regulations have a big advantage.  Licensed banks must deduct the full amount of the loan from shareholders equity within 90 days of taking title.  Bank board regulations require minimum shareholder equity percentages for a bank to remain solvent and avoid being taken over by the Fed.  Once the banks solvency is threatened they’re desperate to sell REOs that are at or over this 90 day period.  This is when the Golden Angle Bear REO buyer comes in an saves the bank by making an offer the bank can’t refuse!

To get the best buy, expect to make at lest a 20% down payment, with sold gold loan pre-approval.  If the seller-lender is financing the purchase, have credit and loan application instantly available or submitted them with the offer.

4. Low price offers are expected by lenders. No one is offended by a low offer.  Be a Low Ball Louie! This includes both price and loan terms. Generally, depending on market conditions, REO properties purchased direct should sell 20%+ below the current fair market value.  If listed on the MLS, homes should sell between 5% and 15% below fair value.  Expect them to be in terrible physical condition.

Sophisticated buyers of REO property will focus on property still on the market 90 days after the date of the trustee sale. Discounts over 20%, 30% and more can frequently be had on these REOs.

Because of the risk, title risks, and dumping the physical condition risk on the buyer, REO properties should sell for less than market value!

Buying bank owned property is the primary way investors find bargain real estate buys.  Buying at Trustee Sale is vastly more complex and risky, as will be apparent in Parts II-V of this series.

Remember McMurdie’s Real Estate Rule No. 7: never let greed cloud logical and rational assessment of facts and risk in buying, managing, lending on, or selling real estate.