The REO Formula – Real Estate
To clarify, let’s describe what Real Estate or “REO” is. Real estate foreclosed by an institutional lender (primarily banks, mortgage companies, insurance companies, etc.) and now owned by that lender is owned by REO. Most lenders have an REO department within their business generally managed by an REO officer, a bank employee, or another lender. Lenders definitely do not want to own property that they have had to foreclose. They are under pressure from federal and / or other banking regulators to dispose of these properties. This also reduces your ability to make new loans.
Today, Short Sale is a very popular method of buying these foreclosed (or about to be foreclosed) properties from banks. There is another method or technique that real estate investors have used for many years and is known as the “REO Formula.”
Let’s look at an example of using the REO formula.
Let’s say you are a real estate agent with a very active and wealthy investor client who owns multiple properties and is always looking for a way to acquire more properties and / or raise cash. It seems that many investors always need cash to make another “deal”.
Let’s say your client owns several parcels of good building land. You would like to acquire more income generating properties. He tells one of his REO officer contacts about a small apartment complex for which the bank would take $ 250,000. You know the fair market value of the units should be around $ 350,000.
After consulting with his client, he presents the following proposal to the bank:
1) Your client will exchange development land valued at $ 250,000 to the bank for the apartments, as long as the bank loans your client $ 175,000 (70% LTV) in cash for the apartments.
2) Then your client will buy back the land from the bank with a down payment of $ 87,500 and the bank will loan the balance of $ 162,500 (65% LTV).
Let’s see the benefits for both parties:
A. YOUR CUSTOMER
1. You have completed a tax-deferred exchange of your development land for the apartments.
2. You have $ 87,500 in cash that is also tax deferred.
3. You have traded idle land for income-generating properties.
B. THE BANK
1. You have traded one unwanted REO property (a bad loan) for two good loans from a capable borrower.
Another way this could be structured could be for the bank to make the loan on your client’s land. Then your client could buy the apartments with an advance and a bank loan. However, using this method would not have the same tax benefits. Please note that I am not giving tax advice here. Before structuring any transaction that may have tax ramifications, you or anyone should consult with a certified public accountant or tax professional.
These publications are the opinion of the author who is not engaged in providing legal, accounting or investment advice. If such advice is required or desired, the services of competent professionals should be sought.