REO REINVENTED.

Who's got a hot site on the Internet for selling foreclosed properties?

Not one of those leading e-commerce firms--nope, it's a government agency.

Read about what FHA, VA, Freddie Mac and Fannie Mae are doing to unload their hefty inventories of REO.

WHEN IT COMES TO SELLING REAL ESTATE OWNED (REO), EVERYBODY'S GOT AN ANGLE THESE DAYS--whether it's privatization, standardization, e-mailing listing updates to potential buyers or Internet auctions. Long gone are the days when secondary market players simply turned over houses to Realtors, who then sold them through their local multiple listing service (MLS).

* Today, the four biggest players--the Department of Housing and Urban Development (HUD), Fannie Mae, Freddie Mac and the Veterans Administration (VA)--come at the REO task in very different ways. Each has a unique strategy for turning collateral back into liquid assets. And, by looking at each of their operations, you might pick up a few tricks and techniques that could apply in your shop.

Guess again

If we asked you to guess which of the four biggest players in the REO business has a snappy online bidding program that has brokers raving, which would you pick? Most mortgage bankers probably wouldn't guess that it's a pilot program started last October in Florida by the VA.

Ed Hotz, broker/owner of Hotz Realty in St. Petersburg, Florida, has been using the Internet system to submit about 125 bids every three weeks, primarily for investors. "We like everything about the VA operation," says Hotz. "You don't have to wait a week or two weeks for the results of who won the bid. They set parameters so we know who can qualify and who can't. They're a little more lax with their guidelines than Fannie and Freddie. And it [the system] won't let us input incorrect information, so the bottom line is always correct."

The program seems to have caught on with other bidders, too. The VA field office running the Internet site says it's getting offers on about 85 percent of its online listings. At headquarters, officials believe that figure will go even higher as the program heads into a new phase.

"The current system won't consider anything below the sales price. That is going to change, and we hope to see an increase in the offers," says William Lutes, VA assistant director for property management.

Why is the program working? "People like the fact that they can access this on the weekend. They can complete an offer on the Internet and submit the offer electronically," Lutes says.

While the Los Angeles field station is using a similar program, the rest of the field stations across the country are waiting and watching for results. "The exclusive Internet bidding process is an innovation that other offices are exploring," Lutes adds.

In the meantime, those other field stations follow a more traditional route of accepting offers by fax, mail and courier during a bidding period and then announcing a winner. And, given the costs of operating an online REO sales program, the field stations with the smallest inventories are unlikely to head into cyberspace anytime soon.

"Pittsburgh has 28 properties, so they're just plugging along the old way," says Lutes.

Another VA pilot is testing the use of exclusive real estate listings in San Diego, Michigan and two parts of Texas. In that program, the real estate agent who lists the property splits the commission if another agent brings the buyer to the table. That's different from the current practice, in which the agent who brings the buyer to VA keeps the full commission. "The preliminary results [of that pilot] are good, but we're not in a position to make a final conclusion on it," says Lutes.

What's on the shelf?

At any point in time, the Veterans Administration pipeline is filled with about 20,000 properties. "It's a long pipeline. It runs about nine months from the time we initially get custody [of the property] and assign it to someone to manage until we sell it. Of course, some places in the country are much faster than that and others are not as fast," Lutes says.

By the end of its 1999 fiscal year last September, the agency had acquired 24,219 properties and sold just a few more--24,758 (see Figure 1). "We had on hand at the end [of the fiscal year] 12,044 properties and another 9,022, which we call pending acquisition (we had custody but not clear title)," says Lutes.

Lutes thinks the agency is seeing a decent return on those sales. VA's average appraised value at foreclosure is $81,730, and the average sales price is $80,367. "We had an average acquisition cost of $11,103--that's commissions, repairs, taxes, special assessments such as school taxes or homeowner's association dues and our management costs," he says.

In today's market, the VA is accepting conveyance of the property in most cases. "We have a partial guarantee that can be $30,000, and the law requires us to do an analysis of the total indebtedness and the appraised value at foreclosure minus anticipated expenses--and in most cases, it ends up resulting in VA accepting conveyance of the property," says Lutes.

To manage its portfolio, the VA uses about 250 people in 46 regional offices, says VA Realty Specialist Richard Lewis. After acquisition, the VA orders a liquidation appraisal and assigns the property to a management broker. That person then prepares a broker's price opinion and a marketing analysis that includes advice on repairs as well as enhancements that might help the property sell faster or for a better price. "Some stations will do very minor repairs because that's what their market can take. In other markets, more repairs are necessary," says Lewis.

"We measure both holding time and what we're getting in return on price. The objective is to sell as quickly as possible at the highest price," says Lutes. "If you're selling very quickly but you're getting poor returns, that's not good. If you're waiting around for the absolute best price and your holding time is too long, that's not good either. We're measuring on the balance of those two."

In addition to looking at return on investment, the VA carefully watches holding times--especially the number of properties that remain in inventory for more than 12 months. It also tracks sales-to-acquisition ratios for its field offices. "If you're constantly acquiring more than you're selling, you're going to get a buildup of inventory and you've got a serious problem--you're not holding your own," says Lutes.

In the future, the VA's disposition program may look entirely different. That's because the agency is undergoing what's called an "A-76 study"--a not-so-catchy title related to an Office of Management and Budget (0MB) circular. "We're reviewing our in-house procedures and processes to come up with what we think is a better way for VA to handle [REOs] and to compare that with what the private sector could provide for us," explains Lutes.

"A decision will be made next summer as to whether [the REO programj should be bid out to one or more contractors or kept in-house," he says. "That study is going on right now, so we won't know how that's going to play out until next August or so.

Ask HUD, it knows

If VA wanted to see what privatization could do for its REO operations, it could look right across town at the Department of Housing and Urban Development. Last year, HUD turned over its real estate disposition activities to a handful of private contractors, and it has reportedly seen disparate results, depending on who you talk to. HUD statistics, on the other hand, suggest in some significant ways that it's been positive.

In Florida, Rick Harper, broker/owner of Harper Realty Inc., Tampa--who has sold REOs in three states over the past 15 years--thinks the shift at HUD has been a disappointment, and says properties are no longer being maintained.

"We've seen druggies, street people in there ... one disgusting incident after another. At the beginning we called [the private contractor] and told them about it. They said they don't have the manpower and the money to do anything about it," Harper says. "There's rats . . . the trash of the people who are evicted isn't hauled off and prices are suffering."

Harper certainly does not speak for everyone monitoring results from the HUD REO privatization. There are some who enthusiastically support the switch. Still, the differing views signal that the change has not been an unqualified success--at least not yet.

Although a staunch supporter of the privatization of government, Harper longs for the old days when HUD officials answered the phones, and he wonders if the program is really saving tax dollars. "Now not only do you have HUD and all their employees, but you have another company that's sending out substandard properties, and the ability to communicate with them is nonexistent," he says.

The problem, Harper believes, is that the regional real estate management companies that replaced the hundreds of real estate brokers who used to maintain the agency's inventory bid too low. "[In Florida] their average commission is $200 a deal, and the work they have to do for that isn't worth it," says Harper.

But if you talk about HUD REOs with Cyrus Mehta, an agent with Long & Foster Realtors in Washington, D.C.'s Woodley Park neighborhood, you'd swear he was talking about a completely different program. Like Harper, Mehta is a foreclosure specialist, having settled about 85 homes last year--90 percent of which were REOs.

According to Mehta, HUD's Internet system is working fine. "You get to see the history of the bids and whether or not you won. You don't necessarily see it live, but once a week it's updated. The properties are being maintained. The services here are pretty decent," he says.

Matt Franklin, HUD deputy assistant secretary for housing, also takes exception to Harper's viewpoint. Properties are being maintained, prices are higher and REO dispositions at HUD are in the best shape they've ever been, he says. And some statistics back him up.

The sales timeline has shortened from 180 days to 130 days since the contractors took over, says Franklin. The average gross sales price is up 20 percent. "We measure [outcomes] a number of other ways. As a percent of appraised value we were at 96 percent and the contractors were at 98 percent. They, of course, order the appraisal and manage the appraisal subcontractors, so maybe they're doing a better job managing the appraisals," he adds.

On recovery of claim (the claim amount plus out-of-pocket expenses), the contractors have bested HUD by an average of $5,700 per property. Multiply that by the 40,000 homes the contractors have sold, and you've saved $230 million. On a proportional basis, HUD is now recovering about 67 percent of its costs--versus 6o percent when the agency handled REO in-house, says Franklin.

In the first three months of fiscal year 2000, HUD's contractors sold 20,000 properties, making it the biggest quarter ever in its history. By comparison, HUD sold 63,000 homes in each of the last two years. It's a good thing the contractors are moving properties out, because business is coming in fast on the front end. Fiscal year 1998 was HUD's third-best year ever for originators.

The agency insured 1.3 million loans. And given that kind of portfolio growth, the absolute number of properties on the back end is growing. Not every contractor HUD originally picked has worked out. In September, HUD terminated six marketing contracts with In Town Management Group, Hatboro, Pennsylvania, because the firm was doing a "poor job" and "failed to maintain homes in good condition." In Town had sold only 2,261 of the 25,000 homes HUD gave it to manage, the agency reported in a news release.

Innovations

The use of private contractors is just part of the new REO picture at HUD. Other innovations include offering properties via the Internet and through local multiple listing services. "That has greatly enhanced the market and demand for our properties. We used to have a sealed bid process. Brokers had to come into the office for the opening of the sealed bids. It was so complicated and difficult that only a small cadre of brokers and agents understood the process," Franklin says.

Staffing levels of those over REQ management at HUD headquarters are down, according to Franklin, and HUD has reassigned staff to other areas. Those who remain are no longer part-time contract managers, part-time property managers and part-time listing managers. "Now our full-time job is to manage and monitor our contractors' performance," says Franklin.

HUD has a new management and control system that provides detailed monthly and daily reports on the number of properties listed, under contract and sold, as well as details on property condition. Each month, Franklin adds, HUD officials are inspecting one-tenth of each of the contractors' inventory. The agency would know, he says, if properties weren't being cared for properly.

With about 48,000 properties in inventory, what's HUD's current policy on selling as-is versus doing repairs? The general policy calls for contractors to do repairs only when health and safety issues arise, such as broken steps or a loose handrail.

"Our goal is to focus on how quickly we can sell the home. The best outcome is to get the home back into the hands of owners," says Franklin. HUD also wants its appraisals to be as clean as possible. When you start trying to estimate as-repaired values, Franklin argues, you run the risk that subjectivity will color your work.

"We think the simplest instructions are: Leave the property as is and let them [the buyer] come in and see it. I'm not saying another approach is wrong. Both have their pluses and minuses," Franklin says.

Outside the core

At the same time that HUD is privatizing and getting out of the REO business, there are some forces that would apparently like to see Freddie Mac follow suit. Right now, Freddie Mac manages its REQ dispositions through its HomeSteps unit, based in Dallas. One of the unit's projects, a California real estate storefront that's selling a cluster of REOs in San Marino County, has come under fire.

In January, HUD Assistant Secretary for Housing and FHA Commissioner William C. Apgar sent a letter to Freddie Mac questioning whether opening the HomeSteps Home Buying Center in California moved Freddie Mac beyond the role lawmakers envisioned for the congressionally chartered secondary market enterprise. At issue is whether the program might be a real estate brokerage operation or even a new program, in which case Freddie Mac should have asked permission from HUD before the program was started.

"We are in the process of crafting out a response and are completely confident that we can demonstrate that it's not a new program," says Freddie Mac spokesperson Sharon McHale. "The Home Center is run by an independent real estate brokerage. They are not Freddie Mac employees. We have always used real estate brokers [to sell our REOs]. That's still what we do today."

Is Freddie Mac licensed as a real estate broker in any states? Nope. "We don't operate as a broker in any state. Freddie Mac employees are not selling Freddie Mac properties," McHale says.

Central control

You may find regional differences in the way Freddie Mac manages its 5,800-home REO portfolio, but they tend to be differences of the how-should-we-sell-it variety. That's because all the corporation's properties are managed on a central basis out of Dallas. And unlike HUD, Freddie Mac's strategy is to sell properties for their highest value, even if that means property rehabilitation. It's a strategy that requires Freddie Mac REO specialists to really know the local markets and to rely on real estate brokers and appraisers for advice on just what will make a home sell.

On the selling side, Freddie Mac has created an incentive program for real estate agents who bring buyers to the closing table. If you sell three properties for Freddie Mac, you're eligible for additional commissions on your next three properties.

"One of the keys to this is being able to manage suppliers," says Thomas J. Walsh, Freddie Mac's vice president for HomeSteps Asset Services. The corporation has a tracking and monitoring system that measures and reports on the Realtors who list Freddie Mac properties. The system also tracks the other suppliers Freddie Mac uses when it buys everything from carpet and paint to appraisals.

At the same time, Freddie Mac is targeting buyers, too, by reaching out to first-time, low-to-moderate income buyers through nonprofit organizations.

One of those nonprofits, the Citizens Housing and Planning Association in Boston, was selling 50 to 6o properties a year for Freddie Mac. While that volume has slowed to 10 homes a year, it's the lack of inventory and not demand that's restricting sales, says Walsh.

Of course, you don't have to be a low-mod buyer to purchase a Freddie Mac home. Any buyers who visit Freddie Mac's Web site can sign up for e-mailed updates that alert them to new properties added in a chosen ZIP code. And there are still plenty of potential buyers who aren't traveling in cyberspace. Freddie Mac answers about 100,000 phone calls a year and is happy to use the U.S. mail to send property lists.

Sounds like a race

What's Freddie Mac's theory of REO? "At Freddie Mac, we're very focused on recovery and speed. You've got to view it as a scale, and bring the two sides into balance," says Walsh. Of course, regional differences also weigh in on the fix-it-or-sell-it scale, since flooring, paint and kitchen appliance hot buttons differ in New York City and Des Moines, Iowa.

To help it decide what repairs will pay off, Freddie Mac uses a computer model to estimate as-is and as-repaired values, taking into account resale data it has collected for years. When the right amount of repairs and refurbishing is done, everyone benefits. "We get a recovery on our repairs, and it's a win for the community," Walsh says.

Homes in the program are selling quickly, too (see Figure 2). On average, Freddie Mac is moving its properties from the listed to the sold category within 100 days. Wish you moved houses that quickly? Walsh shared three things he thinks any servicer could do to improve its portfolio's sales speed and boost returns.

First, evaluate your portfolio and come up with different strategies for different regions and different properties. "What we [as an industry] tend to do is come up with a formula that's applied to all properties," he says. If you know you have a lot of properties in California, for instance, you could work with a nonprofit there, host an event for California brokers or try something that makes your properties stand out in comparison to other properties in the area--perhaps special financing.

Second, focus on your supplier network--those who supply your real estate services and the vendors from whom you purchase repairs, carpet and other supplies--and, if you don't have a network, outsource your operations to someone who does so you can take advantage of their buying power. Third, be creative and efficient and respond quickly to offers. Lessen your response time and you'll do better with Realtors, Walsh says.

Fannie Mae Beige

Fannie Mae has purchased so much carpet, the rumor goes, that there's actually a color called Fannie Mae Beige. In fact, Fannie Mae does have a national contract for carpeting, and if a Realtor recommends recarpeting a property, Fannie Mae will tell the Realtor where to buy it.

It's a trick anyone can use, says Mike Quinn, Fannie Mae senior vice president for single-family mortgage business. A servicer that isn't doing Fannie Mae's volume isn't going to be able to negotiate a nationwide carpet deal, but you might be able to get a bulk deal from a local carpet supplier.

However, when you sit down to talk REOs with Fannie Mae staff, they really don't want to talk about carpet colors--they want to talk about workouts. For the past six years, Fannie Mae's big REO strategy has been to use loan modifications, repayment plans and preforeclosure sales to avoid having any REOs at all.

Back in the Oil Patch days, when Fannie Mae had about 7,500 REOs from among its 2.7 million loans outstanding (or 0.27 percent), its lenders managed to do one or two workouts for every 10 REOs, recalls Quinn. Today's lenders are doing more than one workout for every foreclosure. And while Fannie Mae's REO inventory was still around 7,000 homes last year, the outstandings leapt to 9.5 million loans, (or 0.07 percent).(See Figure 3.) Of course, some of that improved performance is due to the economy. "If people can sell their houses, they do. If people can get another job, they do," says Quinn.

When it comes time to sell those homes, Fannie Mae is mindful of the influence that REO sales have on communities. Its average sales time is about 150 days, about half of which are needed to evict the occupants.

"We're happy with that time. A foreclosed property can have a tremendous effect on the neighborhood," says Quinn. "We don't want to do quick sales, to lower property values."

Fannie Mae tracks how long it takes to complete each of the tasks involved in disposition--eviction, property marketing plan, appraisals. And if the house doesn't sell within 6o days of listing, the agency does a market review. At any point along the way, a sales agent or an appraiser who's behind schedule can expect to get a tickler from Fannie Mae asking why his or her work isn't done.

On the selling side, Fannie Mae also has a Web site where potential homebuyers can shop around. And while Fannie Mae has every reason to think its Web site is popular, it has been hard to capture information because when buyers are ready to buy, they go to a Realtor and not to Fannie Mae to close the deal.

As you look at the different tactics and techniques Fannie Mae, Freddie Mac, the FHA and VA use to dispose of their REOs, it's clear that they each approach the challenge from a different angle. In part, their strategies are different because their books of business are different. One of the reasons that FHA REOs are sometimes in bad shape is that FHA lends in neighborhoods where the residents sometimes can't afford to make needed repairs, Franklin points out.

That said, the one common piece of advice from the four agencies was similar to what the pre-Socratic philosopher Thales of Miletus said back around 600 B.C.: Know thyself. Advice that, in mortgage banking, translates as: Lender, know thy portfolio.

Dona DeZube is a freelance writer based in Columbia, Maryland.