Short Sale vs. REO: Which Gives You Greater Profits?
by David Lindahl Blog Posted on September 20, 2010
Before the residential real estate meltdown of 2008 you would have been hard-pressed to find a “For Sale” sign that teased passers-by with a dangling “Bank Owned” or “Short Sale” plaque. But today these two terms are common advertising bait Realtors use to hook investors hoping to land the deal of a lifetime.
Neither term is good news for the property owner because homeowners don’t end up in this boat unless they are in default on their mortgage. REO represents the worst-case scenario for the homeowner. It means the bank has repossessed the property and the homeowner is out. They no longer own the house. Any equity they had is forfeited. And their credit is as scarred as a gladiator who has lost a long and arduous battle.
REO stands for “Real Estate Owned” which is another way of saying “bank owned.” The property was collateral for a loan. The borrower defaulted. The lender now owns the property.
In contrast, a short sale occurs before the REO ax falls. The property is in default, but the homeowner still owns it. If they can sell the property, they may still be able to escape with their credit reasonably intact. In a short sale, the property is sold for less than the total mortgage due, thus the bank is coming up on the short end.
Why would a bank agree to a short sale and take less money than what is owed? Because it’s the best offer they’re going to get. Short sale properties generally have a first and second mortgage. The holder of the second mortgage takes the biggest hit because the first mortgage must be satisfied before the second mortgage is addressed. The holder of the second mortgage likely ends up with nothing if the house is foreclosed.
Nobody likes to feel they are being taken advantage of or getting the short end of the stick. So perhaps it isn’t all that surprising that the lien holder in the second position may turn down a short sale offer that gets them a few thousand dollars, and instead force the property into foreclosure where they receive nothing. CNBC reported that some lenders in the second position have fraudulently demanded kickbacks from buyers.
Resentment and tensions can run high among homeowners and lenders. And when emotions get involved, people don’t always act in their best interest. One measure of protection you have with a short sale is that standard disclosures apply because the homeowner is involved. However, with a REO property, the bank has never technically lived in the property and thus is exempt from standard disclosures.
- Occurs during foreclosure.
- Homeowner is in default, but still owns the property.
- Buyer is negotiating with homeowner plus two or more lenders.
- Relatively complex and can take months to get an offer accepted.
- Deals have a high failure rate.
- Occurs post foreclosure.
- Lender owns the property. Homeowner is out of the picture.
- Buyer is negotiating with one party. Generally shorter timeframe.
- Banks often opt not to advertise REO properties and instead offer them to preferred clients.
Neither short sales nor REOs have an unbeatable advantage over the other that guarantees the best profits for investors. In either instance you can get a great property. This is a complicated area and it is wise to seek the services and counsel of experts in the field. A good starting point are Realtors and agents that specialize in foreclosures. Don’t be put off if the parties involved don’t call you back. You’ll likely need to be assertive to persevere.
Reprinted by Permission. The author has been successfully investing in single family homes and apartments for the last ten years. David was a featured MREIA speaker in Jan 2008. He can be reached at firstname.lastname@example.org and www.rementor.com.