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October 31, 2014

How to Make REOs Work for You

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How to Make REOs Work for You

A foreclosure specialist shares his business strategy for making a go in this part of the distressed property market.

When one of the lenders Leo Pareja worked with in 2007 asked him to conduct a broker price opinion for a foreclosed property he wanted to sell, the Keller Williams sales associate couldn’t have realized he was being offered a career-changing opportunity. That request soon led to dozens more BPO offers as housing markets began to shift and distressed property listings became more visible parts of the landscape. Pareja’s burgeoning career as an REO specialist essentially found him.

“I literally stumbled upon this market,” says Pareja, who entered the business in 2002 and today holds broker licenses in Virginia, Maryland, and Washington, D.C. “That BPO turned into about 100 others, and then 100 BPOs later I had eight REO listings.”

He now oversees an 18-person REO team at his Reston, Va., office, which handles between 200 and 300 listings at any given time on behalf of lenders, investors, hedge funds, credit unions, and other institutional owners of foreclosed real estate. His team includes administrative assistants to handle accounting and to track receivables, field inspectors to conduct spot checks of properties, asset managers to work with sellers and vendors working on property repairs, and licensees to work with buyers.

REOs are a volume business that require practitioners to be even more task- and technology-oriented than what’s needed in conventional home sales, Pareja says. That’s because properties have to be inspected weekly to keep tabs on their condition and make sure any work being done is progressing as planned. Virtually all interaction with clients—meaning the banks, hedge funds, and other investors—is done digitally, mainly on clients’ proprietary intranet platforms. That makes it impractical to succeed in this sector if you’re operating alone and have limited technology.

“It’s just a very work-intensive business, and it’s easy to appreciate why clients are so technology driven,” he says. “In order to manage the amount of data and inventory they have, technology has to be a big piece of how they operate.”

Accepting the Assignment

Typically, once you enter into an agreement with a client, REO assignments arrive electronically, by either e-mail or the client’s Internet portal.

This is the case whether the agreement is with the clients themselves or with a third-party outsourcer through which a large percentage of institutional foreclosure business is channeled. Third-party outsourcers enter into agreements with banks and other owners of foreclosed properties and, much like appraisal management companies in the appraisal industry, act as intermediaries between the clients and the brokers who manage the sale.

Among the key issues you must consider before accepting assignments is how any repair or upgrade work will be handled. Not all properties that are put up for sale as REOs will have work done; depending on the market and the goals of the client, properties might be sold as is. But when upgrades make financial sense—such as in neighborhoods likely to attract owner-occupant buyers—the way REO clients handle cost issues varies considerably. It’s not uncommon for large banks to pay for maintenance, repair, and upgrade costs and to use their own network of contractors for the work. Others, including third-party outsourcers and owners that don’t have the resources of the larger banks, expect you to pay for utilities, repairs, and upgrades up front and submit your expenses for reimbursement after the property has sold. That can be a large burden to shoulder.

“It’s very resource-intensive,” Pareja says. “As an agent, you’re spending money to secure, maintain, and repair the property. There’s a billing cycle that these properties go through, so you have to carry those receivables.” You may wait 90 days or even 120 days before you're reimbursed.

Relocating the Occupant

Once you accept an assignment, the first step is to take control of the asset. That’s a straightforward task when the property is vacant, but when it’s occupied and the client wants the property to be vacated, your priority is to relocate the occupant. In most cases, there’s little pushback from occupants; coming up with the money to relocate is often their biggest hurdle, says Pareja. To that end, clients often make assistance available through programs referred to as “cash for keys” or "relocation assistance." In Pareja’s experience, REO clients typically step up with between $500 and $5,000, depending on the neighborhood, the condition and price point of the property, and how long the occupant has been there.

“Any [agent] getting into this business needs to approach relocation with empathy,” he says. “People are never in this situation because they want to be. Some people feel cheated by the bank, whether it was because a loan modification didn’t go through or something else. There’s always a back story. And although our client is typically the financial institution, the occupants live in your community. They could be buyers in three or four years, and they need to be treated with dignity. We try to help them with their needs, whether that means giving them another three weeks to stay in the property or getting them the amount they need to get into their next house. When it does go to eviction, it’s usually because they don’t have the money to move.”

Local laws differ, but Pareja says tenants can remain in the property for a reasonable period of time, typically 90 days, while notice is served and other requirements are met. The entire process can take months—sometimes as much as a year when the tenant forces a legal eviction. “Today, people are more educated about the process and know what their rights are,” he says, “especially if they’ve had a family member or friend already go through this.”

Preparing the Property for Market

Once the unit has been vacated, you or your field staff conduct a site assessment and get back to the client with recommendations. Pareja says this is where your market knowledge is critical. For most clients, the property is less a bricks-and-mortar asset than a file on someone’s desk. “Your sellers never see this asset,” he says.

The property’s condition and that of the surrounding neighborhood, whether investors or owner-occupants are buying nearby properties, and whether other properties in the area are converting to rentals are the kinds of considerations you have to bring to the client.

Pareja says he’s seen an increase over the past two years in clients’ willingness to invest money in properties before putting them on the market. “It’s an effort to stabilize neighborhoods,” he says. “They’re more willing to put in curb appeal, like mulch and flowers. For a lot of these clients it’s a mantra that they want their properties to be indistinguishable from others on the block. That means they want a fresh coat of paint and new carpeting, and they want the utilities on.”

Have big-ticket items like HVAC systems and the roof checked out to minimize the chance of a sale falling through before closing because of an undiscovered problem. “It makes sense to spend $100 or $150 on an HVAC inspection and roof certification and to make sure the plumbing and electrical are working. What you don’t want to do is spend $15,000 of a client’s money to renovate the bathroom and kitchen, accept an offer, and then find out that the HVAC is on its last leg or the roof is shot,” he says.

Properties that have been positioned for owner-occupant buyers typically move quickly, often within a month, Pareja says.

In low-price-point neighborhoods, however, properties often won’t command enough in the market to recoup fix-up costs. In these cases, the properties are typically sold as is. From the neighborhood perspective, that’s not all bad; giving investors an attractive entry point is better than leaving a property vacant. Even for properties that sell as is, if buyers are using federally backed financing through the FHA or VA, there needs to be enough of an investment to make sure they pass the agencies’ minimum appraisal requirements. That means the utilities must be turned on, and big components such as heating and air conditioning need to be in working order.

“If you know it’s not going to pass the FHA, it’s your job to advise your client of that,” Pareja says. “Otherwise, you need to negotiate what’s expected up front, because if these repairs come up and your client’s not going to pay for them, the buyer’s going to have to pay for them. You need to have that fiduciary view of the transaction.”

Structuring Compensation

The compensation arrangement for Pareja’s team has evolved over the years. When he first started, most of the team members were on a salary plus bonus structure, but as REO inventories started dropping in 2010, largely because of the moratoriums banks imposed after widespread “robo-signing” and other problems disclosed during the process, he changed his team’s compensation to a percentage commission basis. This was preferable to continuing to pay salaries amid greatly reduced volume.

“Paying salary with some performance bonuses is a great business model when there’s a plethora of inventory, but the last couple of years have taught us that inventories can fluctuate tremendously,” he says, “so I’ve gone to very few salaried support staff while everyone else is on a percentage of revenue, just as if they were buyer’s agents.”

Accounting staff continue to receive a salary. For others, Pareja wouldn’t disclose the split, but he said it’s common in this niche for splits to be lower than on the conventional side for two reasons: It’s a volume business, so team members accept a smaller percentage in exchange for higher volume, and brokers often have to carry the utility and repair costs. “That’s a big difference with the retail space,” he says. For that reason, 70–30 commission splits are not uncommon in the sector, he says.

The commission rates he negotiates with his clients vary widely. “We typically get a percentage-based compensation, usually with a minimum, built into the listing agreement, like minimum commissions of $1,000 or $2,000,” he says, “because in REOs you end up selling houses for $10,000, $20,000, $30,000, or $40,000, depending on where they’re located. Some clients pay 6 percent; some pay 5.5 percent and expect you to keep 2.5 percent and pay out 3 percent to the selling agent. Some pay 5 percent and ask you to split it.”

Making the Move into REOs

For practitioners looking to get into REOs, look first at whether you or your broker has the financial wherewithal to carry the utilities and repair costs for clients on an ongoing basis. Then evaluate your technology and staffing structures. Since most of your interaction with clients is via technology, you need to have dependable mobile computing capabilities and up-to-date hardware, including scanners, to digitize documents. Regarding staffing, an accounting specialist is indispensable, Pareja says, and you need at a minimum a licensee who can work with buyers, conduct valuations, and make recommendations on property needs.

To get into the field, Pareja recommends you start with education: The Five Star Institute, REOMAC, REO Expo, and Vendor Resource Management University are industry programs that recognize program graduates with certifications and provide networking opportunities with institutional investors and third-party outsourcers. “It’s no different than in the retail space, where you develop a reputation and get referrals,” he says. Pareja now teaches classes for VRM University.

Pareja says it’s not too late to get into REOs, even though the market is maturing, because institutional investors and third-party outsourcers are always looking for sales partners who can demonstrate capacity and market knowledge.

There’s also a change in business practices among clients that’s working in agents’ favor, and that’s a move toward requiring practitioners to work in smaller geographic areas. “They’re putting proximity requirements into their agreements, and that really shrinks down the radius that an agent can work in,” he says. With tight geographic restrictions, even well-established REO brokers can’t work outside certain areas, opening the door for brokers new to REOs in those areas to fill the void.

REOs will be a major part of home sales for the foreseeable future, so it may make sense for you to learn more about the niche and position yourself as an REO broker. But, as Pareja’s experience shows, you have to be prepared to hire team members and set up systems that enable you to achieve the sales volume necessary to make REOs a profitable move for you.

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