REO simply stands for “Real Estate Owned”. It is a term used for real estate that is owned by a bank or investor who made or secured loans against the property. In most cases it means a foreclosure has occurred and the property was not sold at auction and the bank or investor kept the property. There are other ways REO’s can come into a bank’s ownership but from the point of view of the buyer that is not very important.
When an REO is being sold the bank is the seller. You will have all the same kinds of due diligence you need to do with any “normal” sale, inspections, review of the title, appraisal if you are getting a loan, checking public records, etc. But in most cases there will be almost little or no disclosure from the selling bank. In addition, most if not all banks selling REO properties insist on contract language that tries to eliminate any liability of any kind for anything that might be wrong with the property. It is often the case that the bank will wait to collect offers and often there are two or more competing offers.
In some cases banks respond only verbally and may not sign agreements until late in the process. They may not agree to sign all the documents a buyer asks them to. In my experience these transactions still go through but it greatly increases the risk to a buyer. Since only written agreements are binding, verbal promises by selling banks are not enforceable. For example, a buyer may spend money on inspections and the bank could change its offer or withdraw if they have not signed the purchase agreement and only gave a verbal approval.
This does not always occur but is something you should discuss with a real estate broker that is representing you.
Overall buying REO properties sometimes can mean getting a “good deal” but there is more risk and it means you need to be extra diligent with inspections, investigations and paperwork. The REO (Real Estate Owned) Advisory is a form that the Realtor Association created to advise buyers on many of the issues with REO properties. I would encourage you to read it.
One thing I see that is generally thought by the public is REO's and foreclosure distress properties are always somehow a good deal, "below market" and that smart buyers go for them. While they often can be excellent buys they also have risks. In addition, a "non-distressed" property can also be as good or better purchase. The devil, as always, is in the details.
In almost all REO contracts the bank selling the property demands buyers agree to fairly onerous contract terms in the form of addenda that the bank, or bank's legal advisors, created to remove some of the buyer protections in standard contracts. This is not illegal and all terms are negotiable. However, banks generally insist that the purchase is completely "as is"; and the buyer takes on all risk including, but not limited to, anything that might be discovered at any time in the future. There are almost no disclosures. So with REO properties the chances of buying a “money pit” are higher and you must do very thorough investigations to be sure you know what you are getting. Also selling banks often insist on very tight timeframes. All of this is risk that should be reflected in a lower price.
Because foreclosures are on the market, sellers who are not in foreclosure who want to sell must still compete with the distressed property prices and often offer their properties at comparable values.
Regardless of who is selling a property and the circumstances, I always advise my clients compare features, condition and price. We do a comparative market analysis so that we are comfortable that the purchase is a value. Sometimes that is an REO and sometimes not.