Real Estate Owned (REO) properties are properties that end up in the bank's or lender's possession because a buyer could not be found during the foreclosure sale (i.e. auction). REO's and foreclosures should not be used interchangeably.
In other words, if a home cannot be sold by the homebuyer at a price that can cover the amount that is owed during the pre-foreclosure stage, it is put up for bids at a public auction, which is the actual day the home is foreclosed. At the auction, the lender will make a bid that includes the loan balance as well as other costs that were incurred due to the default. The highest bidders at these auctions are usually the lending companies because the sum of what is owed to them is often more than what the property is worth. Thus, REO's are properties that have been taken by the bank after they could not be sold during the process of the foreclosure.
The current owner of the property may have obtained a mortgage in the amount of $400,000 in order to pay for the house. Due to continual defaults on mortgage payments in a span of several months, the lender is forced to foreclose the home and try to resell it at a foreclosure auction. However, the market value of the home may only be $375,000 at the time of the auction, while the borrower owes $425,000, which includes processing fees, attorney's fees, etc. The lender will make a bid in the amount that is owed to them (i.e. $425,000), and in the case that the lender is the highest bidder, the title of the home reverts back to the lending company that is holding a lien on the property. Subsequently, the lending company will take possession of the home, and the mortgage will no longer exist. Generally, this is how a home ends up in the possession of a bank as an REO property.
The purchase/sale process for REOs
Although the foreclosure market offers great investment opportunities, the home sale process of bank owned properties can be complicated. When undergoing a purchase agreement for an REO property, it is important to keep in mind that you are not dealing with a typical homeowner and his real estate agent. Many banks and mortgage lenders are huge corporations that have entire departments dedicated to selling REO homes. There's a number of people who are involved in the decision making process such as the bank's attorneys and shareholders, which means that, realistically, it may be difficult to get a home price that is far below the market value. Granted, there are occasions, where investors that do get lucky and make incredible deals with banks, but for the most part you are looking at perhaps get 10-15% off of the market value. This not bad considering you might save $30,000 to $45,000 on a $300,000 single family home.
The sale process begins when a buyer makes an offer to the bank or lender who is now the owner of the property. Larger banks have a separate department dedicated to managing and selling REO properties. The offer is reviewed by this department. The person looking over the offer will have to answer to shareholders, auditors, etc. They will need to show that they had made diligent efforts to get the highest price possible. Thus, a counter-offer (i.e. a response to your offer with their own offer) asking for a higher price should be expected. Even if a buyer accepts the bank's counter-offer, he or she may find that the sale will not be completed until the bank grants a corporate approval for your acceptance. Nonetheless, REO properties, in comparison to other foreclosures, are the ones that come with the least amount of risk (reasons for this are explained under "Investment Possibilities with REO Homes.