A smarter approach to REOs: a new approach to the disposition of real estate-owned properties is gaining a following.

DURING THE PAST 15 YEARS, LIKE SO MANY OTHER VETERAN DEFAULT INDUSTRY professionals, we have witnessed countless changes within our dynamic industry. These changes have included growing consolidation of lending and servicing institutions, proliferation of third-party outsource vendors, myriad procedural and investor guideline changes, and shifts in local and federal laws governing the industry. As a result, most within the mortgage servicing arena would agree with this assessment: The only constant has been change itself. [??] A great many of these changes have to do with an increasingly global view of the industry. Another trend reshaping our industry has been the move to centralize more processes within national servicing operations and their service providers. This has given rise to a growing interrelation between different sectors and interests within mortgage servicing. [??] One important change we see beginning to materialize has to do with the relationship between the foreclosure process and real estate-owned (REO) disposition. Today we are observing top-level servicing managers throughout the industry addressing the reality that final disposition of nonperforming real estate assets begins with the first delinquency. [??] These executives are recognizing that the entire default process should be a continuous flow of intertwining and efficient business processes. This approach makes the most of continuous inventory tracking capabilities that are designed to manage and streamline the entire process. [??] With the remarkable technological advances of the past several years, REO managers, their staffs and upper management can find out much more than ever before about the history of an REO property prior to a foreclosure sale. In addition, with vastly expanded contractor networks, national field service providers, with their specialized property preservation (P & P) personnel, have dramatically increased their ability to complete REO services in a timely and consistent manner. This is something that is critical to all REO managers.

These expanded networks enable national property preservation service providers to successfully service the servicers' and investors' properties, whether they be in urban inner cities or ultra-rural localities, and everywhere in between.

This nationwide service capability is further enhanced by the improved quality control and reporting technologies that many national companies have developed over the years. Many tasks, including providing repair and maintenance estimates to filing insurance claims (on damaged properties), are streamlined in the process.

Couple these factors with a few others and one can grasp the appeal of this "cradle-to-grave" approach. Some other benefits include standardized flat-fee pricing structures, greatly simplified bulk-billing capabilities and, most important, the inherent, magnified accountability that a national service provider must have.

For years within many loan-servicing organizations, it was often said that a virtual--and sometimes actual--barrier existed between the foreclosure and REO departments. This seemed to be the case especially in larger servicing shops. This barrier not only impeded cooperation between the foreclosure and REO departments, it also wasted valuable time and contributed to higher losses for the servicer.

Foreclosure specialists work closely with their P & P vendors to ensure that their institution's nonperforming real estate assets are being maintained and protected against deferred maintenance, vandalism, adverse weather conditions and the like. When these properties become vacant and/or abandoned, the vendors are also responsible for securing them. Because the P & P vendors inspect these properties on a regular basis throughout the collection and foreclosure stages of default, they become very familiar with property condition, the surrounding market and property value.

The foreclosure specialists also develop an internal information base about these properties. In the past, this knowledge sometimes stopped at the door (or barrier), between the foreclosure and REO departments. REO specialists took in properties without the benefit of having complete access to information about loan/property history, or even the services that were provided during the foreclosure process. As a result, many preservation services, such as lock changes, winterizations, damage reports, repairs and so forth, were actually performed two or more times on many properties.

Dave Gibson, an independent national loan servicing consultant based in Santa Clarita, California, who has worked for several of the nation's leading mortgage servicers over the past three decades, also knows most of the country's top default managers. He has first-hand knowledge of the "barrier" that existed and may still exist in some servicing institutions.

Gibson says he saw this happen more often in larger organizations. These larger servicing shops have different departments that are sometimes divided into different divisions in an office, but can even be separated geographically.

"Effective communication starts with effective leadership from management," says Gibson. "If management emphasizes close communication, the staff will follow [through]."

Gibson also feels it is important for managers to articulate the common ground and common goals of the overall servicing organization. "If properly aligned, the areas can be of great benefit to each other," he adds. "The REO department can help with [determining property] values, bidding strategies relative to the foreclosure sale, and can even offer advice on challenging properties." The REO department, in turn, can benefit from advice received from the other areas about problem properties before they come under the control of the REO group.

Today nearly all default managers agree that communication, cooperation and a collective singleness of purpose are what is needed to improve efficiencies and lower costs in default management.

Examples help make the critical need for better communication more understandable. If the discovery of mold or conditions that could lead to mold growth is not communicated in a timely manner by the foreclosure department to REO, it can prove even more costly to a servicer. Additional property valuations ordered on new REOs, when multiple valuations were already obtained just prior to the foreclosure sale, also create unnecessary costs. These are only a few examples of circumstances that can contribute to longer holding time and decreased net recovery on assets. What's more, these losses are avoidable.

Over the past several years, several leading P & P service providers have come to the realization that there is a better way for them to offer their services to the industry. They decided that overall field services and property preservation should not end with a successful foreclosure sale. They concluded that it could (and should) be carried through all the way to settlement or the close of escrow on REO properties. In a perfect world, one vendor for pre- and post-sale services could be relied on to ensure cradle-to-grave continuity in the preservation of each asset.

The major benefit of this approach is the ability to eliminate duplicative work and associated costs, the ability to provide better reporting and tracking capabilities, and the acceleration of the entire default process. By centralizing all P & P work, including REO-related services (reporting occupancy status, rekeying locks, securing properties and completing ongoing maintenance and repairs) with a national P & P vendor, quality control is improved and efficiency is increased.

When all of the parties involved in the entire process better understand the roles of each other, and how each division's actions can affect the others, the result is a more cohesive and efficient team-focused environment.

Many benefits can be derived from the fact that national P & P service providers have built large nationwide networks of property inspectors and contractors. These individuals are experienced preservation experts who can act in concert with the REO brokers as the servicers' "eyes and ears" in the field.

A national vendor visiting the properties within the servicers' portfolios on a regular basis before the foreclosure sale can easily continue this monitoring post-sale and through to closing, providing a reliable and consistent history of property condition and preservation activity. In addition, diverting the administrative burden of managing day-to-day preservation activity to third-party outsource partners will help servicing institutions minimize operating expenses. At the same time, this empowers internal staff to focus on their core competencies. This is particularly true relative to the billing process, which can be remarkably burdensome.

Many servicers have already embraced this all-encompassing approach to property preservation, although not everyone in the industry has welcomed the change. For example, some real estate brokers--who traditionally have been called on by REO specialists to provide services such as rekeying properties, securing bids for and supervising trashouts and repairs, performing lawn maintenance, as well as listing, selling and helping to close sales on REO properties--can be resistant to relinquishing control over these services.

To some brokers, this additional work (although outside of their specific area of expertise) can be a means of generating additional income on properties they are listing. These brokers have become attached to this extra income, despite the associated carrying costs of providing these additional services and waiting for reimbursement from their servicer clients.

Yet, according to Ira Mizell, a 17-year veteran REO broker with GoldTree Realty, Skokie, Illinois, most brokers who provide maintenance services on REO properties do not even make money by doing so, but actually are lucky to break even.

"The billing alone is a monster," says Mizell. "We have to cut 300 to 400 checks each month, check the invoices for accuracy, make copies of the checks and account for every penny. It's a monumental task that I'd gladly give up to a national property preservation company that could consistently do this work and be as responsive as we have been to our lender clients."

Mizell manages a rolling inventory of between 30 and 50 REO properties in any given month. His firm has to carry nearly $40,000 worth of maintenance expenses that it has paid out, for which it awaits reimbursement.

"I like having control of these properties, because I'm being held responsible for them," Mizell adds. "But under the right circumstances, I'd give it up if I could."

REO market history

Mortgage servicers' dependence on local REO brokers for providing post-sale property maintenance was brought on by other changes in the real estate market that began to take shape in the last decade of the 20th century.

During the early and mid-1990s, a backlash occurred after the booming second half of the 1980s with respect to property values. Favorable economic conditions fueled increased employment and higher incomes, due to rising wages and from many types of investments--including stocks and real estate. Plus, the advent of a growing number of "creative financing" programs combined with improved economic conditions propelled many more average Americans into the market for homeownership.

As if this weren't enough to drive up demand for real estate, many foreign investors were in the market as well for both commercial and residential properties. As a result of this growing demand, prices could only rise, and rise exponentially is what they did--for a while, at least.

Well, what goes up ... you know the rest. There truly is a ceiling to most every price increase, and the housing market in the early 1990s not only hit that ceiling but broke its neck in the process. This created the downward spiral of real estate values that continued on through most of the last decade of the 20th century.

The resulting severe drop in property values all across the nation fueled an unprecedented increase in loan defaults and foreclosures. This ultimately glutted whole neighborhoods with large inventories of bank-owned homes that were put on the market. Real estate professionals got into the REO business because it offered them an alternate revenue stream that came to many of them unsolicited. There were far more REO properties than experienced REO brokers to list them. For many brokers, during this time, their incomes rose to previously unheard-of levels.

As more and more real estate people entered or tried to enter the REO business, many servicers and investors decided they could reduce the commissions they were paying. "After all," the thinking went, "the brokers will make it up in volume." For many REO brokers, however, volume is a relative term, and lower income is lower income.

To make up for this drop in income from more competition coupled with a smaller inventory of REO properties in the early 21st century, many brokers began to rely more on providing clients with value-added services. Such services included property preservation and maintenance services. Brokers made this move to appear more competitive and to gain more business. In a sense, they got trapped into doing the work because it made life easier for the servicer or investor to deal with as few individuals as possible on a given property.

However, a growing number of REO brokers today recognize that the changing trend toward national P & P service providers doing post-foreclosure work is not only better for their clients, it also yields real benefits for them. Relieved of the responsibility of obtaining bids or contracting for repairs, (not to mention the administrative and financial burdens of carrying and documenting preservation expenses until reimbursement at closing) brokers can devote their time and resources to their primary job: marketing and selling nonperforming real estate assets.

The views of REO brokers

One veteran REO broker we spoke with recently, Faith Rosselle, owner-broker of Rosselle Realty Services Inc., Rockville, Maryland, said that in many ways this new trend is benefiting her.

"While I have always liked having control of the REO maintenance process, I do not miss carrying the expenses until [being] reimbursed," says Rosselle. "Having someone else responsible for the utilities is a big help, and as the national P & P companies get better and better--as they have recently--I'll gladly let loose of the control, too."

Because wanting control of the process was a recurring theme as we talked to REO brokers, we decided to ask another top REO broker, Anngel Benoun, director of REO sales for Dilbeck Gibson Realtors, Encino, California, for her perspective.

"The hardest thing for any real estate agent to do is give up control over their transaction, because we always believe we can do it better than anyone else," says Benoun. "But what a relief not to have to concern ourselves with the property preservation aspect of REO disposition.

"I believe too many times REO agents are reluctant to communicate with either the property preservation vendor or their asset manager for fear that any criticism or complaint will damage their relationship with their lender client," Benoun adds. "With the national P & P vendor I worked with, however, I found that they encouraged our honest dialogue, and that actually helped to make the process a great success."

This latest change in the property preservation arena will bring new opportunities for many. REO brokers will be able to focus on their specific areas of expertise. National P & P service providers will be able to expand the scope of services they provide. Finally, servicers and investors will be able to realize measurable savings in time and expense.

Foreclosure rates are on the rise in some markets, dramatically so in states such as Ohio, Illinois, Michigan, the Carolinas, Alabama and others. Servicers and investors must continue to look for innovative and effective ways to minimize holding time and maximize net recovery on their REO assets. At Servicing Management's December 2004 Professional Development Series 2004 conference, William Garland, senior vice president of San Diego-based Fidelity Hansen Quality, reported that mortgage loan servicing costs actually rose by 4 percent industrywide in 2004, based on the most recent Mortgage Bankers Association (MBA) Cost of Servicing Study. This suggests servicers will be open to embracing cost-saving approaches as they seek to hold down costs in the months ahead.

A change in mindset with regard to nationwide cradle-to-grave property preservation can only serve to benefit America's lenders, servicers and investors. The approach that makes sense is one that allows work performed by national field service providers to continue in a seamless fashion throughout the entire life of a defaulted loan.

Implementing a consistent and properly channeled workflow from first delinquency all the way through to the final disposition of each REO property will result in higher efficiencies. It will enhance overall communication that will facilitate shorter holding times, lower costs and, most important, will yield higher recovery on portfolios of nonperforming real estate assets.

Robert Klein is the founder and chief executive officer of Brooklyn Heights, Ohio-based Safeguard Properties Inc., a privately held mortgage field services company. He can be reached at [e-mail].