Those readers of this blog who may be new to real estate and the real estate market have often heard the term “foreclosure” and have come to believe it represents a special category of property that magically transforms every potential transaction that carries the label automatically into a great deal. For those readers, let’s get back to some basics. What is a “foreclosure?”
Most
real property is purchased using money borrowed from a lender. That lender secures its right to repayment of
the loan by way of a legal document called a mortgage—or a “deed of trust” in
North Carolina, which is essentially the same thing. In the event the buyer/owner of that property
fails to repay the loan as promised (a situation called a “default”), the
lender has the right to enforce its right to repayment according to the terms
of the mortgage. This legal enforcement
process is called “foreclosure.” It
forecloses the borrower/owner’s right to the property and establishes the
lender’s right to take title to the property in its own name and resell the
property to satisfy the borrower/former owner’s debt. When the foreclosure process has been
completed and title is vested in the lender (usually a bank), the property is
considered an “REO” or “real estate owned” by the
lender.
At
the depths of the “Great Recession” in 2009 through about 2012 or 2013, the
overall economy was in such precarious condition that the real estate market
was flooded with foreclosed properties—REO’s.
Property values collapsed in most regions of the country—some, like
Florida and Nevada—more than others. Due to lenders’ much more rigid
underwriting of mortgage applications, many people who would have easily
qualified for a loan to buy a home in 2006 found it impossible to secure loan
approval in 2010. This also drove market
values down.
Many
people who had bought homes during the boom years immediately before the Great
Recession (also sometimes called the “real estate
bubble”)
found that they owed far more in mortgage debt on their homes than they were
worth at the time. Many of these people
had also lost their jobs or businesses in the economic downturn, and many
homeowners decided it made more sense to simply walk away from their homes than
to continue to pay on mortgage loans that far exceeded what the homes were now
worth. The result of this was a flood of
foreclosures and a huge inventory of REO properties entering the market for
resale.
All
of this put great downward pressure on property values. It was at this time—roughly between 2010 and
2014—that “foreclosures” or REO’s really were generally synonymous with good
deals. Mortgage underwriting standards
had become much more strict, and this further restricted the number of
potential buyers who could take advantage of these generally good deals. This assured that there were many more
properties for sale than there were qualified buyers to purchase them. It was a “buyer’s market.” At that time, a buyer could pull up a list of
REO’s on the HUD Homestore web site (HUD liquidates homes on which an FHA
mortgage has been foreclosed) or the Fannie Mae site and find dozens of homes
in any given city being held by these entities for resale.
Fast
forward to our current market. In 2024, foreclosures completed during the
Great Recession have long been resold and absorbed back into the real estate
market. Searching www.HUDHomestore.com or www.Homepath.com for Charlotte,
NC, reveals only a small handful of properties currently being held in
inventory for resale. Further, loan
underwriting standards have again been relaxed somewhat, allowing more
potential buyers to purchase homes again.
The overall economy has stabilized.
Many who lost jobs or businesses in 2009 or so have moved on, gotten new
jobs or started new businesses; and put their lives back in order. For some people, the Great Recession was a
truly terrible time. But most people
have been able to move on in one way or another.
It
is undeniable that there are far fewer REO’s and short sales (see the January
2019 edition of this blog for a discussion of short sales) in the current real
estate market than there were between 2010 and 2014 or so. Indeed, there are fewer homes for sale in general now than there were at that
time. There are also more qualified
buyers in the market now than there were at that time. Like the economy in general, the real estate
market has largely stabilized away from the turmoil that characterized the Great
Recession.
So
can we assume in 2024 that a foreclosed property up for resale (an REO) is
automatically likely to be a better value than a similar or equivalent property
that is not a distress sale? The simple answer
is ‘NO.” Banks and other sellers of REO
properties are also well aware that the real estate market has recovered. They are also aware that there are far fewer
homes in the market for resale than there were during the Great Recession. So
they price their REO resales accordingly to market. In the current market, a seller who is simply
motivated to sell and not necessarily under any distress may agree to a price
that is actually a better value than a comparable REO property would be at its
listing price.
The
other issue with REO’s is the seller (the bank) is exempt by NC law from
certain condition disclosures that other sellers are required to make. The reason for this is the seller of an REO
may honestly not know much about the condition of the home because they
acquired it in foreclosure. So they are
quite unlikely to agree to any repairs.
The buyer in search of a bargain needs to be very careful about buying
an REO property for these reasons. What
they think may be something of a bargain may be a money pit. It doesn’t have to be, but a thorough home
inspection during the due diligence period under the contract is an absolute
must. (A thorough home inspection by
qualified inspectors is really a must in any purchase, but it is even more so
when the seller is exempt from mandatory property condition disclosures by
law.)
Are
there fewer REO’s or “foreclosures” in the current real estate market than
there were several years ago? Yes. Is an REO automatically a good value? The answer is “no.” Like any other home, an REO can be a good
value, but the perception that it somehow magically represents good value
simply because it is the result of mortgage foreclosure is most often a fallacy
in the current real estate market.
