First, an explanation of the term “REO”: it stands for “Real Estate Owned.” This term is used in a bank’s balance sheet to identify properties owned by the bank other than properties it actually uses (like a branch office). Typically, the bank becomes the owner of such a property when the bank forecloses after an owner/borrower stopped paying the mortgage. At the foreclosure auction, the bank usually bids the amount owed. If somebody bids higher, then that bidder buys the property and the bank is repaid in full. If nobody bids higher, then the bank is the winning bidder and becomes the owner.

Note also that the term “bank” isn’t really accurate. Over the last ten years, more and more mortgages have been sold to Fannie Mae or Freddie Mac, government-owned businesses that buy mortgages originally issued by private lenders. By purchasing these mortgages, the federal government makes it easier and more profitable for banks to lend money. This is one of the reasons why we experienced the housing bubble – lots of easy credit meant lots of buyers, which in turn led to rapidly increasing prices, which led to more buyers who had easy access to credit, etc. In any event, an REO property is more likely to be owned by Fannie Mae or Freddie Mac than any particular bank. But the same rules apply.

Once a bank owns a property following foreclosure, it will usually list the property for sale on the MLS. But right now there are thousands of bank-owned properties on the market. This is a problem as far as banks are concerned for two reasons. First, it’s a basic economic principle that an increase in supply will drive down prices (the ol’ “supply and demand curve” that we would have learned in college if we hadn’t skipped class that morning), and no seller, whether a bank or otherwise, wants to see prices drop. Second, bank-owned homes are generally sold for something less than full market value because the bank would prefer to sell the home quickly and recover as much of its principal as possible. Banks are in the business of lending money, not selling homes. But because of the sheer number of these properties on the market, it is not uncommon for a property to sit off the market for several months after the bank has purchased it.

Eventually, though, the bank will put the property on the market for sale. When that happens, the property will probably be listed at the low end of the market range, again because banks want to sell. Thus, for buyers, REO properties can present excellent buying opportunities.

But like most of the time in life, there is a down side to this otherwise too-good-to-be-true situation. Because banks are not in the home-selling business, but do have a lot of good lawyers, banks will only enter into a contract for the sale of a home if the contract fully protects the bank well beyond the protections of an MLS form contract (the forms used by real estate brokers). And where one side gets additional protection in a contract, it comes at the expense of the other side, i.e. the buyer.

Banks get this added protection by requiring that the contract include a bank-specific addendum. This addendum is generally non-negotiable. While the terms of these addendums can vary significantly, they all achieve the same general result: It is more difficult for a buyer to get out of the contract with a return of the earnest money.

So if you’re thinking of making an offer on an REO property, recognize that you will have fewer opportunities to get out of the contract unscathed. For example, many bank addendums require the financing contingency to expire before closing. In contrast, the standard form contract allows this contingency to remain open until closing. So if you’re buying an REO home and your financing fails on the eve of closing (say, for example, you lost your job unexpectedly), you will probably lose your earnest money, while you would have gotten the earnest money back in a “traditional” transaction without a bank addendum.

What can a buyer do to protect herself if she is thinking of buying an REO property? Well, first and foremost, read the bank addendum carefully. Make sure you know your rights under the contract and when they expire. In addition, you can hire a lawyer, who will at a minimum make sure you understand the risks you are taking. If the bank is willing to modify the terms of the addendum, a lawyer will negotiate those changes.

If you’re considering buying REO (short for Real Estate Owned — the term used to describe the asset on the bank’s general ledger) you should seriously consider hiring an attorney. First, some background.

An REO house is a property that has been taken back by the bank. In other words, its a bank owned property. Banks acquire these properties most commonly either through a deed in lieu of foreclosure (where the owner/debtor agrees to deed the property back to the bank instead of going through the foreclosure process) or at foreclosure (where nobody bids more than the amount owed). Once the bank acquires the property, the bank wants to sell it ASAP. Banks are in the money business, not the real estate business.

As a general matter, a bank is willing to sell for a lower price than a typical homeowner. Accordingly, REO properties offer the opportunity for good bargains. The listing price may be lower, or the bank may be more willing to entertain a lower offer.

But there are downsides. The bank will probably have its own addendums to the PSA, which will almost certainly protect the bank at your expense. The bank will not convey title by a standard Statutory Warranty Deed, which will reduce or eliminate your ability to go after the bank if there is a title issue down the road. Similarly, the bank probably will not purchase title insurance on your behalf, again increasing your exposure if a title problem develops in the future.

So how can you get a good deal while still protecting yourself? That’s easy — hire a lawyer to assist you in the transaction. Unlike an agent, a lawyer can practice law. This means that the lawyer can review the contract to assure it sufficiently protects you. The lawyer see to it that title is ordered (even if at the buyer’s cost) and review the title report to identify any possible issues.

But what about cost — won’t a lawyer set you back and cut into your savings? Nope, not if you use us. We will assist you throughout the process, and we can address those issues unique to REO sales. We do so for a flat fee (a total of $3195.00) and then rebate to you the commission that is paid to us as your agent. That can be up to 3% of the purchase price! Comprehensive legal counsel to protect your interests, and you save money too? Now THAT’S a good idea…