Buying REO’s 2

I’ve had several calls lately from people wanting to buy “foreclosures”.  Many of them have seen or heard commercials that tell them they can “buy foreclosures for pennies on the dollar, with no money down”.  I’ve been in this business a long time, and I wish it was so easy!  Yes, the lenders do have a lot of bank owned properties (REO’s), but they are generally not going to give them away.  The banks have a fiduciary obligation to market and sell these properties, making a good faith effort to maximize their return.  As an investor, I sure wish they would just give them away.  For the average homebuyer, a bank owned property is not realistic.  Most of the homes are not in good repair, with many of them needing major renovation.  No lender will consider a house that has had the plumbing lines and A/C condensor unit stripped of copper as habitable.  The owner banks will not make repairs.  I have seen banks offer a credit at closing for repairs.  Unfortunately, a low downpayment buyer will not be able to have a credit at closing.  This effectively shuts the average first time homebuyer out of the REO market.  With less potential buyers, the value of these properties diminishes.  This leaves this section of the market only to investors who know their neighborhoods, can accurately estimate repair costs, and have cash or credit lines to buy these homes.  And for many investors- the homes aren’t priced low enough for the risk in a down market.  It’s hard to pay top dollar for a home that you may have to carry for months, or even a year or more, waiting for a buyer after rehab.  Remember, investors are looking for a return on investment, and need to be very conservative.  You only need one costly mistake to ruin your year.

Buying REOs

OK, now that you’ve learned how to find the bank owned properties, and your best method may be a patient REALTOR who knows how to work the system, it’s time to write the offer.  Rule number 1- inspect the property before hand.  Take a handyperson type friend with you to look.  Look for major issues.  Remember, the lender-owner is selling it “as is”.  Rule number 2-decide what your strategy is for the property and figure out the cost of repairs.  You must decide your strategy up front because a home to be resold to an owner occupant needs more detail than a home you are going to hold for rentals.  Once you’ve estimated the cost of repairs and know after repair market value, decide how much you are willing to pay.  Rule number 3-make sure your offer is complete.  It will not be submitted without a loan approval or verification of funds letter and the minimum required good faith check.  Rule number 4-the lender owner runs the show!  This means you must use their forms, agree to their addendums, and usually close with their title company.

Have we hit bottom yet?

The Federal Reserve cut the “discount rate” on Friday by a half percent.  The “discount rate” is the rate the banks pay to the Federal Reserve to borrow money.   Is the the perception in the real estate world that home loan rates are tied to the “discount rate”.  This is inaccurate.  The home loan rate is more closely tied to bonds, as most home loans are “packaged” and sold to investors.  It’s actually this packaging that has fueled the sub  prime loan mess, but that’s a story for another day.  Today we speak of the housing market, which I fear has not yet hit bottom.  The first quarter of 2005 was the peak for adjustable rate loan originations.  That means that the the first quarter of 2008 is the peak for adjustments on the 3-1 ARMS.  Agora Financial’s Strategic Investment newsletter has an article with a table showing that March 2008 will be the peak month for adjustables with $110 Billion dollars in home loans scheduled to reset that month.  This does not bode well for the average homebuyer.  I predict that we will go from seeing almost anyone who could conjure up income statements getting a loan, to a massive swing with FHA being the only option for the first time homebuyer.  This is not a bad thing, but will require significant retraining for buyers.  Many first time homebuyers will need to be helped through the process of cleaning up credit and saving a 3% down payment.  This alone will further slow down the real estate market.  What does this mean for the investor- stayed tuned as we explore the world of foreclosures and REO’s.