In Utah where everyone looks for bargains, the lure of buying foreclosed properties is strong. But the business has changed over the last three years and the changes require an adoption of new purchasing strategies in order to realize foreclosure opportunities.
The biggest changes came in the forms of proliferating foreclosure management companies and the increased securitization of mortgage loans. Lenders are no longer limited in the ways they can dispose of foreclosed properties. The current market gives institutions a lot of options.
In the beginning, banks had to unload REOs (REO is an acronym banks use that stands for real estate owned) themselves and most had no system or internal department dedicated to the sale of properties whose loan had gone bad. Loan managers usually had to handle the bank’s recovery program. Loan managers don’t make money selling property; they make money managing new loans. In addition, they had to admit the loan was bad and that put into question the criteria they used to make the loan in the first place. So the goal became “get the REO off the books.” The banks could then get on with the money making side of their business, loaning money. Here is where a vigilant buyer could find a deal that made investment sense.
However, the dramatic increase in foreclosures over the 2002 through 2005 years presented a mounting problem, one that inventive entrepreneurs were quick to capitalize on. Another change occurred when the securities market for mortgage loans also dramatically expanded.
In 1990 there was an estimate $45 billion in securitized mortgage loans. In 2003 that number had grown to an estimated $800 billion. (Some sources say $600 billion, still a significant increase.) Here’s what that means to the average real estate investor. A bank has a certain amount of money to loan. As that fund becomes scarcer, it becomes more valuable. The natural market inclination is to lend what’s left at a higher rate, but competition from other lenders created an uneven market. Larger institutions, the ones with more money, could still lend at a lower rate. They had a competitive advantage. The local savings and loan was at a substantial disadvantage.
Securitization allowed investors to buy pools of loans from several lenders. The local savings and loan can then make a loan, quickly sell it to a market fund and recoup their loan money. That fund may be looking for a long term interest return, the revenue from loan originations fees or other incentives that make the purchase attractive.
Pools of several hundred to several thousand loans are now combined and include varying numbers of risky loans. Adjustable rate loans are also included and given a value. Large institutions such as Cargill, Chase Bank and ABNAmbro can now have purchased thousands of loans that may go into foreclosure.
The point of all of this is that now there are only a few institutions servicing bad loans instead of thousands of small banks, credit unions and savings and loans. In fact, many people still refer to these properties as “bank owned” when actually the bank is far removed. This concentration of foreclosures provided the incentive to deal with defaults in a quicker more organized manner and the asset management company was invented.
Asset management companies are organized on several levels. Some will contract with a large investor and oversee the sales of foreclosed property. Some will actually buy the portfolio of bad loans and take possession of the properties. Some operate in several states and have thousands of repossessions. They employ several property managers to determine the value of each property and mange the sales process. They will contract with local real estate agents to sell each one.
The goal of the asset management company is to sell the property at the maximum market price and pocket the additional money. They are structured for this process and are willing to take more time to sell the property as opposed to the local bank who just wanted to be rid of the bad loan. The resulting change means buyers of REOs must adapt to the changing market if they want to realize profits from these purchases.
The New Buying Strategy
The change in the market requires buyers and their agents to fundamentally change their typical search pattern. Most agents search listings that have been on the market from 1 to 14 days. The current market structure seems to recommend that listing on the market for 80 to 90 days would be better. While an asset management company is willing to wait longer to sell a property, they still have to sell their portfolio to generate revenue. As time goes by an asset’s price will be incrementally lowered. The first price reduction will come somewhere between 14 and 30 days, the second between 45 and 60 days and the third reduction will come between 60 and 90 days. After that time, the banks will request a new price evaluation and will most likely lower the price again. After 120 days the company will seriously consider all offers and at 150 days will often sell to the remaining highest bidder.
Of course the better properties will sell first and many will be gone. Also a buyer has to determine what level of repair they consider acceptable. The longer a property is on the market the more likelihood some substantial repairs will be necessary. But the longer a property is on the market also means the more likelihood the asset management company will deal. To immediately assume the older properties are not worth inspecting could mean some truly good deals will be missed. An asset manager is usually authorized to take an offer once the 150 day mark has been reached.
Additionally, new listings are frequently price high just to see if a buyer will bite. The number of good deals right-out-of-the-chute is dramatically reduced.
For the most part, realtors will hype the financial gains of buying foreclosed properties. Most don’t even know the structure of the industry. Their goal is simply to get buyers to buy.
This strategy actually gives you a reasoned approach to investing in REO properties. With a well reasoned strategy, patience, and a willingness to take on bigger projects, bank owned properties still have great potential.
Gary B. Howard
Gary B. Howard has negotiated the sale of over 200 REO properties and can be reached at 801.706.5866 or by email at gary@garyhowardrealestate.com
