How to Buy Bank-Owned Properties

If you’ve ever wondered “What are REO’s?” just talk to John Soforic. He reached financial independence in his 40s after learning how to buy bank-owned properties, and today owns over a hundred of them.

But he certainly didn’t start out that way. At 30, John Soforic was broke. But he had a vision: he wanted to earn $220,000 per year in passive income. So he wrote himself a check for $220,000, which he set aside where he would see it.

That vision became a reality, and as he earned more money from rental properties, he semi-retired from his career as a chiropractor in his mid-40s.

If you want to learn how to buy bank-owned properties, take the next five minutes to learn exactly how John reached financial independence and retired early (FIRE) with REO properties.

What Are REO’s?

Short for “real estate owned,” REO properties are bank-owned properties that the lender took back at foreclosure.

Most properties don’t actually sell at foreclosure auction. Mortgage lenders typically set the starting bid at the balance they’re owed — which is usually more than the home is worth. So no one bids, and the bank ends up taking the property back.

After a lengthy legal process to change the ownership on the deed over to the lender, including a title search and transfer, the bank contacts a local real estate agent. The Realtor inspects the property, and advises the bank whether they should sell the property as-is or repair it.

Eventually, most REO properties get listed for sale on the multiple listing service (MLS). However you can sometimes get access to a lender’s REO list before other potential buyers, if you develop a relationship with their REO manager.

Getting Started with REO Property Investing

I asked John about his very first deal: how he bought it, the purchase price, cash flow, all the usual questions. Before getting into the details, he took pains to explain how seriously he took his real estate education.

“For a year, I studied rental real estate investing as if it were an occupation. I immersed myself in podcasts, audiobooks, and every book I could find. I especially immersed myself in all things related to estimating renovation costs, appraising real estate, calculating rental cash flow, and calculating after-repair value of renovated properties.”

Because if the numbers don’t work, if you have negative cash flow on a rental property or lose money on a flip, that’s where you run into the worst trouble as a real estate investor. It’s why we offer a free rental cash flow calculator, and take such pains to educate investors on accurately forecasting cash flow.

“What I’d like to stress is that I treated this like a college education to gain competence before I entered the game. I studied for ten hours a week for a year. It was especially helpful to follow several real estate forums and groups to learn how to buy foreclosures, reading the questions and answers of other real estate investors.

“But then there came a time when it was no longer productive to study. It was time for action.

“I called a real estate agent and set up an appointment to look at a pair of duplexes. And that started a process of me calling agents, looking at properties, and pretending like I knew what I was doing. My goal was to become familiar with looking at rental properties without buying anything too soon.”

John knew the importance of learning real estate investing theory. And its limitations, understanding that there’s only so much you can learn from reading. At a certain point, you have to go out and start looking at properties for yourself.

John’s First REO Property

“I entered a single-family house listed at $39,000. It was a bank-owned property taken back after foreclosure, listed on the MLS. I was looking for a house that seemed to be a mismatch (in terms of price) for the street. The street in this case was lined by houses that had sold for $75,000.

“What I recall most was that I couldn’t find anything wrong with this house. It jumped out at me as a no-brainer. Compared to all other houses, it was a gem. And I sensed that even the Realtor was getting interested in this house as we inspected it. Having never bought an investment property before, I was tempted but scared to make an instant offer.

“The house sat on a solid street of blue-collar houses in a blue-collar town. It had a decent location, within walking distance to the local hospital. I slept on it, and the next day I made an offer on the house. I gave them the full asking price of $39,000.”

John bought the bank-owned property and updated it using cash from his own savings. “I used cash for repairs that amounted to another $7,000 for carpeting, windows, painting, new lights fixtures. After repairs, the house appraised for $72,000. I refinanced with a rental property loan of $40,000. And with rent at about $650, I netted about $200 monthly.

“So in the end, I invested around $46,000. I then refinanced to take back $40,000 with a 30-year mortgage. My cash-on-cash return therefore was around 40%: $2,400 / $6,000 = $40% return.”

Granted, those numbers don’t include his closing costs. But if he incurred $4,000 in closing costs, that still puts his cash-on-cash returns at 24%.

All of which sounds great, but John made a classic rookie mistake: he glossed over the tenant screening process. “I accepted the first tenant who applied, who turned out to be a drug addict. He trashed the place, within a year, and I had to put another $5,000 into it.”

Ouch. But John never made that mistake again, and not only runs tenant screening reports but takes other thorough tenant screening measures such as contacting employers, current landlords, and former landlords.

How to Buy Bank-Owned Properties

The tenant screening snafu with the criminal tenant notwithstanding, John was hooked. He knew that if he kept buying foreclosed homes like his first one, he’d quickly be able to cover his living expenses and reach financial independence.

As he continued learning about how to buy foreclosures, John also continued setting aside savings. He bought a second bank-owned property listed on the MLS, and then a third. He began to spot patterns with foreclosed properties that lenders had taken back at the auction. “My strategy was to get bank-owned REOs as soon as they came on the MLS.”

Why wait? Why not buy them at the initial foreclosure auction?

“I’ll never understand it, but the banks would take back a house with a $100,000 mortgage on it. If I asked how much they’d sell it for, they’d say $100,000 of course. It was rarely worth the amount of the mortgage in its present condition, and so I’d wait. And then it would come on the MLS at $45,000.”

Other investors buy foreclosures before they go to public auction. They find these distressed homes earlier in the foreclosure process using tools like Propstream or Foreclosure.com, such as the local properties below: