Since the full blown onset of the nationwide foreclosure crisis in 2006, mortgage defaults and property foreclosures have steadily increased to dramatically put downward pressure on most housing prices nationwide. These numbers grew largely due to the resetting of sub-prime loans to higher interest rates (most of these loans were obtained during the height of the housing market bubble when all you needed was a pulse to get a mortgage) coupled with a struggling economy that was shedding jobs faster than we could get a grip on thus impacting families ability to afford their mortgage payments which has led to many losing their homes. This environment led to a nationwide plummeting of home values even though some markets were already so overpriced that a significant correction would have been inevitable. Throughout nearly every community we are faced with the reality of properties being sold at the foreclosure auction and Banks putting inventory they have purchased back on the market at dramatically reduced prices and in very poor condition. Because these properties, called REOs (Real Estate Owned), are priced lower than similar non-REO properties on the market, they generally sell faster and have a "price-depressing" effect on the overall market.
According to a October 1st, 2010 report by RealtyTrac, through the 2nd Quarter of 2010 REOs and Foreclosures accounted for nearly 25% of all sales completed. That means one out of four deals getting completed in today's market environment are either completed at the foreclosure auction or owned by the Bank and sold against other available competing inventory. Some markets such as California, Nevada and Arizona have percentages of Foreclosure and REO home sales ranging from 40-55% of total sales completed. When you add in short sale transactions to the nationwide figures, nearly one-third of all transactions being completed are from some sort of distressed transaction.
RealtyTrac, a foreclosure marketing service, recently stated that it would be then end of 2013 before the housing market worked its way through the foreclosure inventory. As long as Foreclosures and REOs will continue to be a fact of life in our real estate market for the foreseeable future, continued downward price pressure on non-distressed inventory will be commonplace. A normalized market should have roughly 5% of the sales coming from this distressed area of the market.
In order to keep housing prices from plummeting further, I believe that many Banks have sought alternatives to stem the tide of the amount of REO properties actually hitting the market. Initially, at the start of the housing crisis, most Banks were quick to pull the trigger to start the foreclosure process and now many have softened their stances and are now looking to alternatives like short sales or loan modifications to avoid going the route of a costly foreclosure and risk destabilizing the housing market further. The numbers of new loans going into some form of default or foreclosure process continues to rise, therefore eventually this will likely lead to a continued increase of foreclosure and REO inventory. According to a 2009 report by Amherst Mortgage Insight/Amherst Securities Group regarding the "Housing Overhang and Shadow Inventory", the overhang of potential additions to the inventory of REO properties is estimated to be as high as 7 million properties worldwide. This become even more likely if demand remains unstable, many loan workouts such as modifications default and the problem of millions of underwater borrowers in homes continues to be unresolved.
Where there is distress, there is opportunity. I believe that this will be one of the greatest markets in history to build and grow wealth in real estate because I believe 2011 will signify the official bottom of the downturn in our real estate market. With housing prices down, interest rates at historical lows and with very few people having the "capacity" to be active Buyers in this market, those with "capital" and the right plan will prosper. I think there are four distinct categories of properties that today's investor has to evaluate when determining what to purchase: Traditional Non-Distressed Inventory, Short Sales, Foreclosures and REOs.
Your traditional non-distressed inventory are properties that generally are move-in ready, available for use with traditional financing vehicles (FHA, VA, USDA, Conventional and Jumbo mortgages) but subject to continued downward price pressure when competing against increasing numbers of distressed properties. Short Sales generally have been maintained to some degree depending on when the homeowners have moved out or if they are still occupying the property, they are generally at a discount to non-distressed properties, traditional mortgage financing options can be used to acquire the properties but are subject to extremely long processes while working with the respective Banks to approve a deal.
Foreclosures present different challenges, generally properties are in some state of disrepair due to the home being abandoned by the previous homeowner, they are generally at a steep discount to Non-Distressed and Short Sale inventory (though this trend seems to be changing somewhat as many Banks have been raising the prices at auction causing many potential homes to not sell during this process) but require the capital necessary to close on hand since conventional financing is not available and the ability to close quickly on a transaction. The capital requirement is generally the biggest hindrance to more foreclosure transactions from being completed at Auction.
REOs, I believe, offer the greatest opportunity for today's investor. The condition of the home is generally similar to that of a foreclosure though some of the property preservation work has been completed by the Bank to get it into sale condition, though oftentimes a budget needs to be established to complete some property renovations. Conventional financing can be used to acquire the property which makes it more advantageous to more potential investors including FHA 203k loans or property rehab loans. The prices are generally at a level deeply discounted below Non-Distressed inventory, Short Sale and Foreclosure inventory. Much of the potential downside risk has been taken out of these properties due to the fact the Bank is committed to getting the non-performing asset off of its books. Negotiating on price is also still possible even though you are working with a Bank that is selling an already depressed asset. Finally, there will be abundant amounts of quality inventory to choose from for the foreseeable future in communities where there are still a steady stream of non-distressed sales successfully being closed to support the resale of your property after renovations have been completed. Additionally, according to recent data provided by RealtyTrac, prices of foreclosures and bank owned homes rose 1.6% in the 2nd Quarter and are up 6.1% year over year and have now appeared to stabilize which provides more evidence to support that this is where you want to put your investment dollars. Simply put, this investment vehicle should provide investors the highest amount of return with the least amount of risk to capital so long as you have great representation that can help you screen the properties to identify the best REO investments that fit into your portfolio.
Look out for more upcoming blog posts and upcoming seminars that we will hold on investing in REO properties. Please feel free to contact me at any time to learn how you can get started investing in REOs at 206-300-2693 or contact me via email at terryj@jamesregroup.com to get on a sheet for our weekly hot list of REO properties. All information is private and confidential.
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