REO stands for "real estate owned," which happens when a bank forecloses on a home and now owns it. An REO occupied home is one the bank foreclosed on, and the former owner or renter is still living there.
REO occupied homes could make an interesting, lucrative investing niche for the right type of investor; like most foreclosures, they're often cheaper than market value. But because the former owner or renter is still living in the property, there are some challenges involved.
How a property becomes REO occupied
There are several reasons people remain in a home after it's been foreclosed on, both legal and illegal, as outlined below.
Illegal: The former owner simply doesn't move out
This happens often enough to warrant its own term: "vampire foreclosure." Here, the bank forecloses, but the owner, like a visitor to the "Hotel California," never leaves.
Vampire foreclosure situations happen more often with a nonjudicial foreclosure (only available in certain states) because with this type of foreclosure, the process is typically quick -- a few months -- compared with a judicial foreclosure that could take a year or more. (Don't confuse a vampire foreclosure with a "zombie foreclosure," which is a home where the owner does leave during the foreclosure process, but the foreclosure never completes, leaving a vacancy.)
Legal: The former owner lives in a right of redemption state
About half of states allow a statutory right of redemption, meaning the mortgagor has the right to redeem the property after the foreclosure takes place, typically between a month and a year after.
Of the states that allow a statutory right of redemption, some also allow the mortgagor to remain in the home throughout the redemption period. So even though the bank now owns the home, in some situations the mortgagor has the right to stay in the home until the redemption period ends. (Of course, if they buy the home back, they will also be allowed to remain).
Illegal: A renter simply doesn't leave
Even with homes that have not been foreclosed on, some renters just won't vacate when their lease term ends. This can also happen during a foreclosure. Tenants do have certain rights if they are renting a place that has been foreclosed on, but they don't have the right to live in the property indefinitely. If they are past the period allowed (see below), they are there illegally.
Legal: Renters can stay awhile
Renters don't need to leave a rental property the minute it's been foreclosed on anymore, as used to be the case. Thanks to the Protecting Tenants at Foreclosure Act (PTFA) of 2009 through 2014 and the Economic Growth, Regulatory Relief, and Consumer Protection Act of 2018, tenants are allowed to stay in the rental property until the end of their lease, or if they are month-to-month tenants, they are entitled to a 90-day notice to vacate.
There is one exception to this law: if the buyer intends to live in the property. In that case, if there is a lease, the new owner can give the tenant a 90-day notice to vacate.
Are REO occupied homes good investment opportunities?
Buying a foreclosed home with occupants could work out well for a real estate investor. But, as with any investment property, you need to crunch the numbers and determine whether the deal makes sense. Follow the normal procedure you use before you buy any flip or rental property, namely:
- Figure the total cost of the property: the property itself, repairs and renovations, holding costs, taxes, and insurance.
- Determine whether the value exceeds the costs by looking at what other similarly priced homes are selling or renting for.
- Assess whether the neighborhood is on the upswing, downswing, or holding its value. Look at employment figures, crime statistics, and school ratings.
The extra step you'll add when buying an REO occupied property: Have a plan regarding the occupants.
Of course, if your goal is to use the property as a rental and there are already good tenants in it, you don't need to do anything except get the renters to sign a new lease once theirs is up. You are now on your way to making money on this investment.
If you don't intend to use this property as a rental or if you want the old renters out for any reason, you will need a plan if they don't want to leave. You'll need to either evict them or possibly pay them to leave if they won't go on their own.
How to evict
You can find out how to evict tenants from a phone call or visit to your local courthouse, which will let you know all the steps you'll need to take to file an eviction notice and what to do after that to prepare for court. You could also hire a real estate attorney or property manager to do this for you.
Offer cash for keys
Before you go through a formal eviction, you might want to offer to pay the renters to leave. That might rub you the wrong way, but if cash for keys turns out to be the more time- and cost-effective solution, it might not be so distasteful after all.
When you offer to pay renters to leave, they don't have to take your offer. In that case, you would evict, as outlined above. But if the offer is attractive enough, many renters take the cash, which is usually between a few hundred and a few thousand dollars. Make sure there is a stipulation that you get to conduct a final inspection before you pay out. The property must be returned to you in good condition. In other words, if the tenant vandalizes the property as a parting gift, they get no cash.
What's the risk in investing in an REO occupied property?
Let's face it: Buying an REO occupied property is risky, no matter how you slice it. The odds of getting to view the property are slim anyway with a regular foreclosure, but when people are still living there, the property is most likely selling "as is."
Plus, because it's occupied, you now are dealing with complete strangers living in a property you just purchased. What could go wrong? Well, lots. Because you did not get a chance to screen these people, you have no idea whether they'll be vindictive and either ruin the property or make life difficult for you by not leaving when they're supposed to.
Knowing the risks going in, however, puts you somewhat in the driver's seat in the sense that you can forge a plan.
Tips on buying an REO occupied property
Probably the biggest risk to buying an REO property, whether it's occupied or not, is not knowing the condition of the property. But with an REO occupied property, there is a way you can check: Offer to pay the occupants to let you inspect it.
You could ring the doorbell and ask if they'd let you look around for $50 (more or less). If they are receptive and you want even more information, you could ask if you can come back one more time with a professional home inspector. You would likely need to offer additional money for the tenants to agree to that one.
This suggestion falls into the "it doesn't hurt to ask" category. If the tenant allows you or a pro to inspect, you should then have a good idea of whether the property will make a good investment. And if the tenants have been keeping the place in good shape, you might want to continue renting to them after you buy it.
The bottom line
The REO occupied market could prove to be a great investment opportunity once you understand the ins and outs. Treat it as you would any other possible investment. Since you'll be dealing with occupants in the property, however, if you have any doubts about how to proceed, you might want to contact an attorney who specializes in real estate or landlord-tenant issues.