From Distressed Properties to Distressed Owners

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Back in the day, which was a Wednesday, investing in real estate pretty much meant that you bought a property and rented it out.  Sometimes it was a duplex, sometimes a single-family house, sometimes a 4-unit, and up from there.  The goal became to have as many “doors” as you could get to increase your income.  This worked swimmingly for quite a long time, and then something new appeared – on TV.

Bob Vila and the gang came along with “This Old House” and started the rehabbing revolution.  At the time that he was doing it, the owner of the house was right there playing the game with him.  Then someone else came along and discovered that you could buy so-called “distressed” properties, fix them up, then re-sell them on the open market.  A new practice was born; they called it “fix-and-flip”.

Early on, “distressed” meant houses that were in pretty bad shape that the bank had foreclosed on and taken back into their “Real Estate Owned” (REO) inventory.  The interesting thing was that REO inventory was toxic to a bank – the rules used to be that the bank had to set aside seven (7) times its “non-performing asset” value in liquidity (cash) that it could no longer use for loans.  Consequently, if the bank had, say, $500,000 worth of REO inventory, it had to keep $3.5 million liquid that it could not lend to customers.

This could quickly crater a bank; whose lifeblood is the ability to make loans.  So, it was with little surprise that it was relatively easy to acquire these properties from the bank at severe discounts.  They were grateful to have them gone.  Now, this explanation is a bit trivial and used for illustration purposes only; it does not go into new liquidity coverage requirements (LCR) and all the changes that have occurred since the 2008 crash and the introduction of Dodd-Frank.  And we’re only talking about portfolio loans; those that are held by a bank.

But back then, foreclosure was not common and REO inventories were exceptionally small.  It’s only when banks relaxed lending requirements (some say to the level of the ability to fog a mirror), that loan defaults became rampant.  The resulting explosion of REO inventory was astounding.

Fast-forward to today and this is no longer a good way to acquire property for a real estate investor.  All the banking changes have these non-performing assets (REO inventories) exerting less impact on bank operations, and with the high demand for housing, banks can afford to sit back, put lipstick on a pig, and get retail prices for properties held in REO.  This does not work for real estate investors that need to acquire at a discount.  And banks are also selling off low-performing and non-performing loans to note brokers, getting them off their books without foreclosure at all.

That last piece has the effect of reducing the appearance of housing foreclosures because, while the note may be sold at a loss, the bank skips the whole foreclosure process.  Some say that this may have been engineered to give the appearance of a rebounding economy in the housing market.  And it seems to have worked.

So, where are we today with all this?  Well, a real estate investor that is looking to acquire properties is working directly with the distressed owner to solve his problem on the front-end long before the property ends up as an REO.  And in many cases, “distress” simply means not wanting to list a property with a REALTOR and endure that whole process.  As a result, the marketing practices of a real estate investor have shifted dramatically away from dealing with banks and empty, distressed properties to working directly with distressed owners and active properties.



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