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REO Realities: servicers are dealing with massive inventories of foreclosed properties. New techniques are mixing with old to try to move these properties out the door to make room for new ones coming in.

Any way you spell it--REO or ORE--it's OMG (Oh My God) for some investors who had expected that the mortgage financing they provided would be faithfully repaid by the borrowers, as agreed. That popular texting acronym may be a bit light-hearted for a problem that's plaguing today's housing market but it gives some idea of the massive scope of the issue. * Real estate-owned (REO)--sometimes called owned real estate (ORE), especially in the commercial real estate world--used to be rare in the housing finance business. * But a brew of bad economic conditions over the past two years has driven down household incomes and property valuations, and tightened credit restrictions, producing a swell of properties flowing backward to investors and lending institutions. The trend has left servicers sitting on a huge backlog of distressed properties with little relief in sight.


The growing REO numbers are disquieting. Roughly one in four houses sold nationally in the third quarter of 2010 had to be rescued from a foreclosure-induced REO state, according to a report from Hanley Wood Market Intelligence, Washington, D.C. That number was even higher in the eight most-affected metro areas, led by Modesto, California, where 61 percent of all sales in the quarter were REO properties. This was followed by Las Vegas and Flint, Michigan, in which 60 percent of all sales during that quarter were REOs.

Five other markets where more than half the sales in the third quarter were foreclosures, according to Hanley Wood, were: Detroit, at 57 percent; Phoenix, at 54 percent; Stockton, California, at 53 percent; Bakersfield, California, at 52 percent; and Lakeland, Florida, at 52 percent.

According to a December 2010 report by the Congressional Oversight Panel--created by Congress to "review the current state of financial markets and the regulatory system"--roughly 250,000 new foreclosures are started each month nationwide, while 100,000 are completed. Up to 13 million foreclosures are expected to have occurred between September 2008 and 2012, the panel forecasts.

Nationally the total number of residential, one-to-four-family homes flowing into REO inventories is expected to peak at just under 1 million--971,000 properties in all, according to West Chester, Pennsylvania-based Moody's Analytics Inc., which foresees the number receding later this year, when (and if) overall housing conditions improve.

Along with the rest of the market, the twin government-sponsored enterprises (GSEs), Fannie Mae and Freddie Mac, have experienced their own mounting REO numbers over the past few years. For the nine months ending on Sept. 30, 2010, Fannie acquired a total of 216,116 properties through foreclosure. During that same period, it disposed of 135,484 REO properties. Fannie's total REO inventory more than doubled from Sept. 30, 2009, to Sept. 30, 2010, rising from 72,275 to 166,787 in that year's time.

To move more of these vacated homes off its books, Fannie has begun auctioning off pools of bulk real estate-owned properties and is looking at a new initiative that invites offers from real estate agents for the company's REO properties on behalf of its clients, with the capacity to monitor the bids online. The agency says approximately 10 percent of its REO properties have been sold through auctions for the first nine months of 2010.

Jane Severn, Fannie Mae's director of marketing for the credit loss management division in Washington, D.C., says the agency sells "approximately 90 percent of REO properties through our retail channel using a real estate professional to list and market the property."

This is a preferred method, she explains, because it is "more likely to attract owner-occupiers who will live in that home, sleep there and be part of that community--[thereby] stabilizing that community," she says.

Saying "all real estate is local," Severn reports that Fannie Mae strives to sell these special properties individually, ensuring in advance that "lawns are mowed and repairs are made before we list them." Improvements range from new paint and carpeting "all the way to a kitchen remodeling, new HVAC [heating, ventilation and air conditioning] systems and roofs," she says.

The company also has two other incentives intended to promote more REO sales transactions. According to Janis L. Smith, spokesperson for Fannie Mae, the incentives are "unique from others we offer," and include a 3.5 percent seller incentive for homebuyers to use toward closing costs on an REO property and a $1,500 bonus to the buyer's agent for this same purpose.

Further, under Fannie's HomePath[R] mortgage financing options program--expressly for the GSE's REO properties--there is a reduced down payment, as low as 3 percent, and no mortgage insurance payments. On certain properties, Fannie offers repair financing of up to $30,000. Smith says more than 45 lenders are participating in this program nationwide, offering it through their broker and correspondent networks.

Widening the program's scope at year's end, Fannie expanded HomePath eligibility to include second-home and investor properties.

Freddie Mac offers its own program, called Home-Steps[R], aimed at moving REO properties off its books. As of Sept. 30, 2010, some 26,300 were sold, up 47 percent from a year earlier, according to the company. The GSE held 74,900 REO units as of Sept. 30.

Guesstimates for 2011

Ultimately any guesstimates of REO inventory conditions in 2011 are more guess than estimate, given the many and unpredictable winds of change impacting these statistics.

William Phillips, vice president, REO services, BBVA Compass, Dallas, declares that "an REO explosion is under way," with a flood of foreclosures yet to come. "In some states like Florida," he notes, lenders "were bragging they had just sold over 60,000 foreclosures in a month--but they didn't mention there are still 700,000 in the pipeline."

Exacerbating the problem is the molasses-like pace of resolution of defaults pending foreclosure--a process getting slower by the day as problems, politics and litigation take their toll, especially at the state level.

This troubles Mark Paniccia, group vice president, REO, SunTrust Mortgage, Richmond, Virginia, who compares the process to the workings of a funnel. "It doesn't matter how big the hopper [total inventory] is," Paniccia reasons, "it's how big the pipe at the bottom is"--a reference to the bogged-down resolution process.

Paniccia does not anticipate any imminent relief. "I don't really see courts adding the resources to increase their ability to process foreclosures, and I don't see the government directing resources in that direction [either]. There will be a fairly fast, steady stream [of REOs]" coming along, he expects. He says, "It's moving as fast as the courts can get through it for the next--who knows how long?"

As for the disposition of properties once they do attain REO status, he says, "It's all about speed and getting a good valuation. We're looking for a high conversion rate on relocation assistance and we pay for that." Paniccia adds that there is "nothing more frustrating and useless than chasing a declining [price] market."

Paniccia favors hiring REO personnel "who can look at the valuation, reconcile it and hand off to an asset manager a number and marketing plan that works. REO liquidation takes place outside the four walls of the institution. It's important for asset managers to know their brokers and people they're working with, maybe even better than their assets," he says. Specifically, SunTrust is looking for less than 5 percent of its REO properties to remain on the books past 150 days, according to Paniccia.

David Brown, vice president and director of REO for First Horizon National Corporation, Memphis, Tennessee, agrees. "How you incent a [real estate] agent is critical. I would rather pay them more, [aiming] to sell property at the highest possible dollar and quickly." Brown muses, "[I]t's easy to determine the wrong price quickly. Nothing stinks worse than getting the full, 100 percent asking-price cash offer the day you list the property," he quips somewhat painfully, adding: "That's how you know you got it wrong."

Some lessons learned

At Charlotte, North Carolina-based Bank of America, where the REO business "has been flat for two years from an inflow perspective," according to Matt Vernon, short sale and real estate-owned executive at Bank of America, there have been "lessons learned" about the distressed-assets business."

"Servicers struggled to catch up with the wave of opportunity volume that came at them with distressed customers. We struggled. The real estate community struggled in understanding the complexity of the transaction and what it created was a relationship between servicers and real estate agents that was not constructive," Vernon conceded at a short sales and REO conference in November.

"For whatever reason, we became the 'evil empire.' The real estate community looked at us as working against them, as opposed to working with them," said Vernon. But he said things have changed. "That was the state of the industry 18 months ago. Major servicers and Bank of America [have since] come to the realization that ultimately we need to work with the real estate community. We need to tear down the walls, create transparency; we need to build scale, and we need to turn what is not a mass-market product [into] as close to a normalized sales transaction as possible," he said.

Behind all the numbers and data crunching, real families and lives are being impacted by the foreclosure/REO drama and some advocates seek to help them. Among them is Gary Acosta, chairman of New Vista Asset Management, San Diego, who counsels "parties involved in these transactions should aim to keep the properties occupied. Study after study links high owner-occupancy rates to everything from improved educational achievement for children to decreased rates of crime."

Acosta adds, "Declining homeownership rates promise a new form of damage to communities already plagued by high vacancy rates, property abandonment, vandalism and underfunded tax rolls."

He expresses some pessimism about the outcome of these efforts. "Despite attempts to provide access to owner-occupant buyers, three years into this historic foreclosure cycle, data show that the mortgage industry still favors cash investors," he says. Acosta concedes, however, "investor-driven cash purchases are faster and thus less risky for apprehensive REO sellers."

He cites some supporting statistics. "Compared to the 2009 average percentage of REOs sold to owner-occupants, the first quarter of 2010 saw alarming declines: Southeast Florida, down 11.6 percent; Central Florida, down 8.6 percent; Cook County, Illinois, down 6.4 percent; California's Central Valley, down 7.9 percent; and Los Angeles, down 10.6 percent."

"To truly change the REO industry's culture," Acosta declares, "we must flip performance metrics to reward sales practices that drive owner-occupancy gains."

Repurposing REO properties

Sympathetic to such arguments but mixing in some hard-headed practicalities, Heidi Coppola, president of REO Clearinghouse, Merrick, New York, says her group is trying "to figure out how to 'repurpose' homes. The aim is to turn an REO property into affordable housing, as well as other creative options/uses."

Framing this initiative as an effort to "help servicers find unique disposition options," Coppola says when a distressed property fails to sell for an extended period of time, her group connects with the National Community Stabilization Trust, Washington, D.C., a non-profit organization that can step in and help servicers dispose of properties.

Coppola's group helps out by working to create homeless shelters, providing housing for transitional use by disabled veterans near Department of Veterans Affairs (VA) hospitals, setting up non-profit/counseling office space, and so forth. REO Clearinghouse works on about 200 properties a month, according to Coppola.

The group may be getting at least moral support from a study published last November by the Government Accountability Office (GAO), which recommended an alternative to so-called charge-offs by banks--the practice of summarily abandoning an REO property when there is no expectation that proceeds from the sale will cover foreclosure and property-preservation costs. Properties valued at less than $30,000 are widely considered likely to be charged-off.

Reacting to this trend, an increasing number of communities are instituting land banks--quasi-public entities that rehabilitate, repurpose or demolish REOs that they get from investors and servicers at deep discounts.

Overhead is a driving issue in such situations. Creighton Oswald, senior vice president, mortgage investment operations, BBVA Compass Bank, Dallas, notes that "inventory carrying costs are rising. Anecdotally, we seem to be seeing more damage to properties and more instances where there are outstanding taxes and HOA [homeowner association] bills."

Oswald uses the term "stigma" to describe the lower sales price that ensues when an asset becomes distressed. "Most institutions in the industry expect a 25 percent to 35 percent lower return" for such an REO asset, he estimates.

The bottom line is that "it is getting more expensive for the banks to manage and sell REO," says Oswald.

In addition, he says, "The public is becoming more educated about how REO inventories are managed by banks. Buyers are increasingly demanding more seller concessions, which can further complicate the transaction for all involved. Probably one of the most interesting things we are seeing, or not seeing, is a further slide in values," says Oswald. "With the millions of units of available [REO] inventory on the market and slow demand, downward price pressure is only a matter of time."

Indeed, Oswald's prediction appears prescient, given the data emanating from the S&P/Case-Shiller Composite 20 city home-price index, which revealed a 1.3 percent drop in national home values from September to October 2010.

Specifically, in California and Florida, Oswald says he is seeing "many appraisals of value, which come in with higher dollar values than are actually obtainable in a true sale. Getting good comps continues to be a challenge in many areas."

At the short sales and REO conference in November, Bank of America's Vernon described how the institution has changed its approach to REO management: "What we're doing in REO today is what I wish we could have done in short sales 18 months ago, and that's ensure that all of our processes, capabilities, capacity, technology [are] aligned for the scale that could certainly come at that business over the coming years as that foreclosure windmill begins to get executed again."

And what might that mean? "We can ensure that our title prep work is done, ensure that we have the right outsource capability, ensure that the agents that will be listing and selling our homes meet our quality expectations and can handle scale themselves," said Vernon. It also signals that, the bank is "ensuring that our radius of listings is right and that we have programs and processes that take into account the investor [and] first-time homebuyer," he said.

One revived method for disposing of REO properties is to auction them off (also called a public sale). At an REO conference last summer, a cadre of companies in the auction business attracted considerable interest from real estate professionals who were interested in networking and seeking to better understand how such transactions work.

Fannie Mae's Severn says the GSE uses auctions and bulk sales "on occasion--usually when a property has been listed with a real estate professional but has not sold. It's an alternate channel."

The auction approach

John Liszka, Fannie Mae's director of REO auctions and pool sales, explains a fundamental difference between typical home sales and auctions: "In the traditional property sales transaction, you start with a price and work down; but in an auction, it [the price] goes up." Liszka cites another key benefit to the auction process, which is that an auction is more likely to bring buyers into direct contact with a property.

"Most buyers and sellers have to come in and touch and smell the property, and walk around in it. If they've never stepped into the property, there's a greater chance of fallout or buyer's remorse," he points out. Liszka says an auction provides the setting for "human interaction and opportunity to sell and start a relationship, and there may be another property to sell to them."

According to Bret Richards, senior auction specialist with Dallas-based Hudson & Marshall Inc., "The most important thing about an auction is that it brings the best price possible--the true market value of that home." But, he cautions, "An auction gavel is not a magic wand; [rather] it is a tool to address a property to the market where a buyer is located."

And Mike Keracher, co-founder and executive vice president, sales and marketing, for, Rainbow City, Alabama, says, "Auctions are a great way to sell almost anything. They work great with unique properties, when there's no way to find a comparable. That's why they sell horses and art at auction--because there's no way to price [or arrive at] a value with comparables. It's a fun way to sell anything. If you want to know what it's worth, put it up for auction and you'll find out."

As with much other commerce in the online age, auctions and cyberspace have found comfort in their connections.

Elsa Lewis, vice president, LPS Auction Solutions LLC, Chicago, says the Internet channel "allows bidders to play online--[those] who maybe can't show up or don't want to. Technology is huge for us; it's raising our bids."

Kelly Hinerman, vice president of operations for Hudson & Marshall, is equally impressed--but with a caveat. "Online bidding [in auctions] helps with customer service, particularly keeping everyone in the loop. But I do see a downside: You actually lose that [human] interaction on the telephone. We want to create the efficiencies we can via the Internet, but let's not lose that personal contact, which builds relationships and gets people comfortable with purchasing that home when they're talking to a live voice," cautions Hinerman. "I tell my staff, 'Pick up the telephone [and] call the buyer--let's not [just] do it by e-mail.'"

Lest anyone think property auctions are not big business, consider Irvine, California--based REDC. Since 2007, the company reports selling in excess of $7.5 billion in real estate assets, conducting more than 900 auctions featuring 105,000 properties. The last auction was held in mid-June 2010, when 733 foreclosures went for $20.8 million.

Overall in 2010, REDC auctioned more than 20,000 properties for nearly $900 million.

"Interest in foreclosure auctions--live and online--is skyrocketing in Georgia, the Southeast and across the nation," says REDC Chief Executive Officer Jeff Frieden.

Just how close to home the REO story has hit was evident on a recent morning walk around the neighborhood by this author, who encountered an unfamiliar sound amidst the bird chirps, chainsaw whines and occasional passing car.

Though too distant at first to make out the purpose, it quickly became apparent that someone was chanting over an outdoor loudspeaker. Moments later, the unmistakable call of an auctioneer could be heard. "I've got one-thirty, one-thirty now, do I hear one-thirty-one, one-thirty-one can I get one-thirty-one, who'll give me one-thirty-one?," he shouted in the familiar, rapid-fire cadence of an auctioneer.

But this was a normally sedate suburban neighborhood in New England, not some Texas stockyard or Carolina tobacco farm. What was going on here? Upon closer inspection, a small crowd could be seen assembled in a semi-circle on the front lawn of a house that had stood vacant for some two years, now apparently being sold to the highest bidder that very day among those gathered in the front yard.

The house, which sold last for $342,000, subsequently went to the auction's high bidder: someone offering just $137,000. One long-time neighborhood resident shuffling from the scene moments after the final "gavel" had fallen was heard mumbling his disbelief at the turn of events. "Times sure have changed," he was heard to remark softly, shaking his head as he walked away.

Neil J. Morse is an independent writer and mortgage industry consultant based in Newtown, Connecticut. He can be reached at
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Title Annotation:Cover Report: Servicing Trends
Comment:REO Realities: servicers are dealing with massive inventories of foreclosed properties.
Author:Morse, Neil J.
Publication:Mortgage Banking
Geographic Code:1U9CA
Date:Feb 1, 2011
Previous Article:February-May 2011.
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