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How REOs and Short Sales Have Impacted the Market
REOs and foreclosed homes have flooded the real estate market within the last two years. A short sale occurs when the proceeds of a sale fall short of what the owner still owes on the mortgage. In a short sale, the bank agrees to forgive the rest of what is owed on the mortgage to avoid a lengthy and costly foreclosure. If the bank cannot find a buyer or is not willing to proceed with a short sale, then the bank must foreclose and a REO may result. An REO is a term to describe a home that has been foreclosed by the bank that the bank now owns.
In both cases of a short sale and an REO, banks are eager to unload these properties because they are non-performing assets that represent costly liabilities. Therefore, the bank will sell the property for much less than what the property is worth, and in some cases, the difference in price can amount to a discount between 50-70%.
The obvious problem with having too many REOs and short sales is that the average seller (who is not a bank) must price down their home in order to compete with the REOs. An even larger problem exists with regards to financing purchases and the declining valuation of comparable properties due to REOs. Most of these REOs and short sales are major fixers since most people who are losing their homes through foreclosure typically do not maintain their homes. Thus, comparing the value of a recently sold or listed REO to a nicely kept property being sold by a private seller can be very deceiving since the two properties can be in very similar areas with very similar property characteristics (such as bedrooms, bathrooms and square footage), but the values can be significantly different. The problem is that when a bank whom finances a purchase is appraising the property’s value, the bank will take into consideration the major fixer REOs that are substantially discounted. The result is that the bank will have a difficult if not impossible task of meeting appraised value guidelines and originating a loan for the purchase of a non-REO property when REOs are selling for 50-70% less.
Despite the deep discounts offered by purchasing an REO or short sale, still many of these properties clutter the market unable to be sold. Since these REOs are major fixers, many banks will not offer a loan to a buyer for a home that is not inhabitable. In addition, the condition of these REOs is often so poor that many owner-occupied buyers are scared off. As such, the only buyers purchasing REOs are typically real estate investors who make all cash offers without the need for any lending from banks.
The Credit Crunch and Lending Crisis
With the meltdown of the mortgage industry due to irresponsible subprime lending, banks have tightened up their lending criteria, and in many cases, have stopped lending all together. This has been another major contributing factor that explains why there are so many properties on the market that cannot be sold.
As a response to the problems caused by the irresponsible lending practices, banks are requiring that buyers put 20% down, have excellent credit and have eliminated most stated loan programs. This is an effort by the banks to overcompensate while they try to shake out all of the bad loans, but ironically, this strategy has created a severe backlash. With less sales being made due to this new rigid credit standard, the inventory of properties has increased, thereby creating a “buyer’s market”, and causing property values to continue their decline in value. An economic recession and rising unemployment may force many existing homeowners who normally would be able to just sell their homes in a normal lending market to become foreclosure risks since their home values have substantially declined leaving them with little to no equity coupled with the fact that banks have simply made it too difficult to borrow. |
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