The ABCs of Buying Financially Distressed Properties

By Matt Fein and Debbie Nagle



Foreclosures, short sales, REOs, pre-foreclosures, auctions, bank owned? These are terminologies used when describing financially distressed properties (a property where the owner is in danger of foreclosure or already has been foreclosed on).

Although financially distressed properties are one way to get a very good deal in today's real estate market, they are not necessarily for everyone. It is important to understand what these terms mean and the pros and cons when buying these properties. When it comes to buying financially distressed properties, there are basically three types of sales: short sales, auctions and REOs (real estate owned).



Short Sales

Until recently many people had never heard of a short sale, but it is a very common term in today's market. Although short sales have been around for a long time, they were a rare occurrence until recently. Now short sales have exploded onto the market and make up a significant percentage of the homes currently for sale.

A short sale is the selling of a house in which the proceeds will fall short of what the owner still owes on the mortgage (and/or other liens on the property). Many lenders will agree to accept the proceeds of a short sale and forgive the remainder of debt owed on the mortgage in order to avoid a lengthy and costly foreclosure.

The most important thing to understand about purchasing a short sale is that you must have patience. If you need to move into a house within a month or two, then a short sale is not a good option for you. Many lenders are inundated with requests to accept a short sale of a property, and it can often take months for a representative from the lender to even respond to an offer.

Although most banks do take two to three months to respond to a short sale, there are steps that can be taken to ensure the offer is reviewed (and hopefully accepted) in a relatively timely manner. For that reason, it is always better when the person(s) communicating with the lender is experienced in negotiating short sales.

Another important factor to know is that short sales are sold in "as-is" condition. The buyer should protect himself by adding verbiage to a contract to the effect that he has the option to perform a home inspection and can declare the contract null and void if the home inspection results are unsatisfactory. With a short sale, closing help is sometimes provided by lender to help with buyer's closing costs.



Auctions

This is the riskiest type of real estate purchase among the three, and anyone purchasing real estate in this manner must be especially cautious.

Usually auction sales are properties that have been through the foreclosure process, and the lender is exercising its right to sell the property to the highest bidder - often at the courthouse steps of the county the property is in. Most of the time there is a minimum bid that must be met, and if it is not, the seller (lender) does not have to sell. If it does not sell for the minimum bid, the lender takes back ownership of the property.

When buying real estate at an auction, the property is sold in "as-is" condition with no contingencies. This means that once you sign the contract, you are legally obligated to purchase that property, provided the lender conveys the property with clear title. If you do not, you will lose your deposit (typically 10% of the sale price) and possibly incur other penalties and fees that can get pretty costly.

So, if you are going to bid on a home at auction, you should be 100% sure you will be going forward with the sale or be prepared to lose up to tens of thousands of dollars. Also, a thorough inspection of the property should be done prior to the auction so you know how much work the property needs. This knowledge will affect your price. If you cannot gain access to the property before the auction, then you should assume the worst case scenario with regards to property condition.



REOs (Real Estate Owned or Bank Owned)

A property that is REO or bank owned has gone through the foreclosure process, went to auction and did not sell, and is now owned by the lender.

Once the property is owned by the bank, the bank usually hires a Realtor to sell it. Sometimes a bank will pay for some improvements or renovations to a property before putting it on the market. But once it is for sale, the property is sold "as-is" (like short sales, the lender will allow the buyer to make the offer contingent on a satisfactory home inspection).

Unlike short sales, though, the bank often will respond within a few days of receiving an offer. So folks who need to settle quickly should consider REO properties. As a matter of fact, the lender prefers a fast settlement.

Another commonality with REO sales is that the utilities are often shut off. On occasion the bank will turn the utilities on for the buyer's home inspection, but sometimes that is the buyer's responsibility.

The bank may request that the buyer use its title company for settlement. Sometimes that will actually save the buyer money, but be sure to get an estimate of the title company's fees before agreeing. It might even be a good idea to get a second estimate from another title company so you can compare accurately. With REOs, closing help is sometimes provided by lender to help with buyer's closing costs.



In general, buying a financially distressed property holds varying degrees of risk (depending on the type of sale), but the main benefit is that the buyer usually can get a bargain.

How much of a discount can one expect? Some buyers have expectations of getting a property at 25-40% discount, but in truth, this kind of discount is not realistic to expect. However, it is common to purchase a finically distressed property anywhere from 5-15% below market value. As a general rule of thumb, the worse the condition of the property, the bigger the discount.

For the more conservative buyer, inventory of residential re-sales is high enough that you can still get a good deal, have the security of performing a home inspection, ask the seller to make repairs and get to settlement in a timely fashion. But if you are a little more of a risk taker, make sure you use a Realtor experienced with financially distressed properties.



Matt Fein and Debbie Nagle are on The Fein Properties Team at Keller Williams Select Realtors in Ellicott City. Matt Fein can be reached at mattfein@kw.com, 410-707-5865, and Debbie Nagle can be reached at debbienagle@kw.com, 443-745-4425.