Should I Buy a REO from the Bank?

Reproduced with the permission of Joel Block below: 

There's a common misconception among consumers who want to buy real estate from a bank. Does this provide them with the best deal? Maybe yes, but maybe no. Lets take a look at the reality of the situation.

The common logic is that since the owner's equity has been washed out by the bank’s takeover of the property, the bank owned property must be a good deal. Real estate professionals immediately recognize this is not necessarily true. There are many times when the property is still worth less than the amount of money that's owed to the bank – making the bank’s price the wrong price.

For this reason, buying from the bank is not necessarily a great deal.

But if the bank if feeling distress, it might just go your way. You may recall from previous columns that I have described 3 types of distress. Owner distress occurs when someone has a financial problem in their life. That might mean a divorce, a bankruptcy, a business failure, or some other agonizing circumstance. That pain creates an opportunity for a cash-rich buyer to buy the property at a substantial discount to market.

In a property distress situation, the real estate is generally under-managed or under-optimized. It might have extensive vacancies. It might need some tender loving care, in the form of repairs and maintenance. We never get involved in situations where there's massive distress, such as geological failure, but small repairs and maintenance are very attractive to us.

Finally, there is market distress which is what the entire economy suffers from now - all prices are depressed, but that doesn't necessarily mean that any single property is an especially good deal. Our private equity company, The Bullseye Capital Real Property Opportunity Fund, LLC, for example only buys property distress and owner distress. We never get involved in opportunities that primarily involve market distress – though market distress can sweeten the pot!

Buying from individual people, it is always best to focus on owner distress and property distress. But, when buying from a bank, there really is no owner distress. This is because the government agencies that force banks to move their real estate portfolios are not putting the kind of pressure that creates much distress. Banks don't have owner distress if they don't get forced into selling by the government, which they are not at present.

It doesn't mean, however, that distress doesn't exist at the bank level. What it means is that banks don't respond necessarily the same way that consumers do. Therefore, it is important to find opportunities where the bank feels some amount of distress. That tends to come in a property distress situation. Banks do feel property distress. If a property is under-managed and has assets that are problematic and create liability, the bank may very well feel that they need to abandon that property. The reason is lender liability.

Banks may be very aggressive in dealing with properties that have physical problems because banks are typically big with lots of cash and lots of other assets. They are easy targets for attorneys. Buildings that have under-managed assets, such as empty swimming pools, broken fences, broken glass, and other types of exposures that could harm a passerby, are the type that banks may not want to keep on their books. Even though they try to insure for many of these risks, the exposure is still great for them and they want to move away from those risks. So if you are going to buy properties from banks, buying distressed assets is probably the group that will be the most negotiable.