The REO Formula - Real Estate Owned

For clarification let’s describe what Real Estate Owned or “REO” is. Real Estate that is foreclosed on by an Institutional Lender (primarily banks, mortgage companies, insurance companies, etc.) and is now owned by that Lender is REO property. Most lenders have within their company an REO department usually managed by an REO officer, employee of the bank, or other lender. Lenders definitely do not want to own property they have had to foreclose on. They are under pressure from Federal and/or other banking regulators to dispose of these properties. This also lessens their ability to make new loans.

Today, the Short Sale is a very popular method of buying these foreclosed (or about to be foreclosed on) properties from the banks. There is another method or technique that has been used by Real Estate Investors for many years that has become known as the “REO Formula”.
Let’s look at an example for the use of the REO Formula.

Let’s say you are a Real Estate Agent with a very active & wealthy investor client who owns several properties and is always looking for a way to acquire more properties and/or raise cash. It seems like many investors are always in need of cash to make another “deal”.

Let’s say that your client owns several parcels of good development land. He would like to acquire more income producing properties. You find out from one of your REO officer contacts about a small apartment complex that the bank would take $250,000 for. You know that the fair market value of the units should be around $350,000.
After conferring with your client, you come up with the following proposal to the bank:

1) Your client will exchange development land valued at $250,000 to the bank for the apartments provided the bank will loan your client $175,000 (70% LTV) cash back on the apartments.
2) Your client then will buy back the land from the bank with $87,500 cash down and the bank loaning the balance of $162,500 (65% LTV).

Let’s look at the benefits to both parties:
A. YOUR CLIENT
1. Has completed a tax deferred exchange of his development land for the apartments.
2. Has $87,500 cash which is also tax deferred.
3. Has exchanged dormant land for income producing property.

B. THE BANK
1. Has exchanged an unwanted REO property (a bad loan) for two good loans from a capable borrower.

Another way this could be structured could be to have the bank make the loan on your client’s land. Then your client could buy the apartments with cash down and a loan from the bank. However, using this method would not have the same tax benefits.
Please be aware that I am not giving tax advice here. Before structuring any transaction that might have tax ramifications, you or any person should consult a CPA or tax professional.

These posts are the opinion of the author who is not engaged in rendering legal, accounting, or investment advice. If such advice is required or desired, the services of competent professional persons should be sought.