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 1.

As potential buyers embark on their search for a new home or a prospective investment, they are very likely to see at least one REO property. These buyers need to educate themselves on what an REO property has in store for them because avoiding an REO is often times unwarranted.

One of the first things a prospective buyer needs when looking at a property is imagination. In the case of owner-occupied sales, most buyers can visualize themselves in the property because someone lives in the home. Homebuilders like Centex, Lennar, Toll Brothers and KB Home have made their fortunes by staging homes with swanky furniture so it’s easy to envision life in their new home.

On the opposite end of the spectrum, REO properties are often times neglected by the bank that owns them and they are not nearly as welcoming.

Do not let weeds and trash in the yard, the lack of furniture or a pink bedroom distract you from seeing the property as your potential home.

Another attractive aspect of purchasing an REO is the ability to negotiate with the bank. This fact has become, and will continue to be, a big part of any REO transaction. In the early part of 2008, most banks were unwilling to negotiate for a variety of reasons, but as losses have continued to mount, the fear of the housing market falling further have forced banks to the negotiating table.

Any prospective buyer should ask to be compensated for closing costs and request money for needed repairs. While banks may not give you everything you ask for, with a little negotiating and the recognition that you, the buyer, are in the position of power, buying an REO can save you thousands of dollars.

Probably the most beneficial aspect of purchasing an REO is that the buyer has an opportunity to buy a home that they can turn into their perfect home. Adding your personal touch will not only add personal value to the property, but also monetary value.

In a market where there are very few willing and qualified buyers, most homes that are purchased are turnkey or move-in ready. The majority of buyers are not interested and/or do not have the time to work on a “project”. While these people are getting a very nice home, they could have saved money by seriously looking at an REO property. The money they saved on the purchase price could have helped them upgrade the home to their own taste. Let’s face it – everyone has their own taste and would like nothing more than to have a home that has their own personal touches.

One of the biggest deterrents from an REO purchase is the potential work that needs to be done on the property. You name it and it could be broken, destroyed or missing. REOs come in all levels of disrepair, which makes having a trusted inspector (and a contractor in most cases) go through the home with you crucial to knowing that you are getting what you paid for. There is nothing like saving a few thousand dollars at the closing table and then having to turn around and pay for a new roof and new plumbing system. It can almost always be assumed that the property has been neglected by the bank so be sure all aspects of property repair have been thoroughly reviewed and included in any offer.

The other big risk is the supply of REOs in the property’s immediate neighborhood. The general rule is the more REOs, the worse the potential value declines could be in the near (if not long) term. As unsold homes sit on the market, buyers demand lower prices and neighborhoods become less desirable.

Just because you have found an REO that is in good shape and priced at or around your budget doesn’t mean it is a good buy right now. As you have read numerous times on this site, the real estate market is in for more pain. One of the main reasons for this is that banks are facing increased pressure to liquidate these properties and raise cash, so they are listing their REOs for less than anything else on the market.

This practice is one of the biggest drivers of the declines infecting most of the country, and the primary reason foreclosure prevention efforts are such a high priority in Washington.

Buying a home in a declining market can be a very risky financial decision and everyone needs to be aware that property values could decline by another 25%, if not more, depending on the area. At the very least, prospective buyers have to see themselves living in the home for 5 years. Even though living in the same house for a long time sounds like a great idea now, if you have a 5 year old and a 7 year old and are considering a one bathroom house, do you really to want to share a bathroom with them when they are 10 and 12? And maybe more importantly, are they really going to want to share that bathroom with you?

The final piece of advice I will offer regarding an REO purchase is you should always have an understanding of the true value the home. This is of course, no easy task to figure out.

If there are quite a few REOs on the market listed at $100,000 above their real value, even receiving a discount of $30,000 on the list price means you could still be overpaying by $70,000. List prices are simply what a seller wants, and often bears little resemblance to the actual market price.

On the flip-side of that coin, many banks will drop the list price of their REOs dramatically after they have been on the market for 30 or more days. If you see a home listed for $500,000 and your property valuation provider tells you it is worth $450,000, you should not be afraid to offer $450,000 for the property. If you wait for the list price to come closer to $450,000, you may miss out on the opportunity. When sellers drop their list price, the home immediately jumps on the radar screens of Realtors and investors — this can often create a bidding war that may drive the price up above your target. In addition, it’s hard to argue for closing cost incentives if you’re willing to pay more than the list price.

The supply of REOs is only increasing so do your homework and do not be afraid to make an offer on one of these homes. You never know when you could get a great deal.

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.