By RYAN TAYLOR

In this two part series, Cirios’ Valuation Guru Ryan Taylor offers an insider’s look into the nuances of investing in foreclosed homes. Please click here for Part 2.

From Beverly Hills to Detroit, the term REO is quickly becoming part of our country’s vocabulary.

REO, or Real Estate Owned, refers to a property that has already been through the foreclosure process, was unable to be sold at a public auction and has reverted back to the bank. For most of us, the previous sentence is a gross over-simplification and requires more explanation.

Similar to many aspects of life, we are skeptical of things we don’t understand. Since most potential home buyers are unsure of what an REO is, they tend to shy away from even considering REO properties that are for sale. More often than not, this “fear” is unjustified because an REO property does have value, and can prove to be a great investment for those willing to do their research.

Foreclosures, while an unpleasant part of the real estate and mortgage business, have jumped to the forefront of the country’s current economic predicament.

After a bank determines they can no longer depend on a borrower to make their mortgage payments, it begins the legal proceedings necessary to repossess the house. In California and other states where trust deeds are the preferred instrument for securing home loans, the foreclosure process usually culminates with a Trustee sale, where a lender-appointed representative puts the home up for public auction. These sales take place at the local court house, which is why you sometimes hear foreclosure sales described as occurring “on the courthouse steps.”

The lender will typically provide the trustee a minimum bid amount, and if no buyer shows up with the requisite cash, the home reverts to the bank and becomes REO.

Tight credit markets and falling stock prices over the past 15 months have created an environment where the vast majority of properties that enter the foreclosure process eventually end up REO. Even savvy investors, burned by the steep home price declines of recent years, are reticent to bid aggressively for distressed properties. As a result, banks are inundated with these homes, most of which are in extreme levels of disrepair. Banks have never had to deal with so many REO properties at one time and are ill equipped to manage their growing inventory of homes.

The supply of REO properties greatly outweighs the demand, and banks often can only sell them at fire sale prices. Their reluctance to realize further losses leaves these homes neglected, clogging up the real estate market with unsold and unattractive inventory. As long as economic conditions continue to deteriorate for banks, the number of REOs will remain high.

For prospective buyers — and indeed anyone who owns a home — it is essential to become educated on how to understand the current and potential value of an REO property.

The fact of the matter is that recessions create opportunities for those willing to do the work and research. Purchasing an REO property as either a home or income producing property can be a great investment. However, there are numerous pitfalls and market timing continues to be important as home prices continue their slide.

In the second article in this two part series, we will examine the risks involved in purchasing an REO property either an owner or investor.

Tags: bank owned, foreclosure, Housing, property, REO, trustee sale

This entry was posted on Friday, January 16th, 2009 at 5:35 pm and is filed under Foreclosures/REOs, Property Valuations, Real Estate. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.