Clients hoping to take advantage of a buyer's market in real estate essentially have three options. First, they can enter into a conventional sale with the property owner. Part or all of the purchase price will pay off any outstanding loans.

Second, buyers can negotiate short sales: deals in which even the full purchase price is insufficient to cover the outstanding debt on the property. These transactions must be approved by the lender or lenders. "Short sales are tricky," says Bob Fornatto, a senior mortgage consultant at Wintrust Mortgage in Downers Grove, Ill. "Obstacles can pop up at the last minute."

Finally, clients interested in buying a home or investment real estate can look at REO properties. These properties have been foreclosed upon by a lender and have not been acquired in a foreclosure auction. Thus, they're real estate owned (REO) by the lender.

Often lenders with REO properties-usually banks-are eager to unload them, so prices may be appealing. "There are terrific opportunities in REO properties now," says John Anderson, co-owner of Twin Oaks Realty in Minneapolis, who serves as 2010 Federal Housing Policy Chair for the National Association of Realtors. "Typically you'll get a better price on an REO property than on a straight purchase. Buyers need to know the numbers, though, because REO deals are not that simple."

NUMBERS GAME

Knowing the numbers about the REO market isn't that simple, either, as various firms collect data from around the U.S. Many markets were flooded with REO properties during the height of the financial panic in late 2008 and early 2009, as banks tried to raise cash and avoid failing. By mid-2009, 33% of all properties sold in the U.S. were REO sales, according to Clear Capital, in Truckee, Calif.

Now that things have stabilized a bit, Clear Capital puts this REO saturation rate at 26% in its latest report, released earlier this year. That's the national average, though, and market-to-market variations can be extreme. According to Clear Capital, 50% of recent sales in the Riverside, Calif. metro area were REOs, over 45% in Detroit and over 40% in Orlando, with Dallas not far behind. Typically REO saturation rates are highest in Western and Midwestern U.S. markets.

Another firm, First American CoreLogic in Santa Ana, Calif., puts the national REO rate at 0.54% in January; this rate is calculated by dividing the number of REOs by the number of housing units. A year earlier, in January 2009, that rate was 0.77%, so the data points to a drop of REO properties in the past year.

"There's a lack of inventory on the market," says Michael Krein, president of Sellstate NRES (Nevada Real Estate Services) in Henderson, Nev., who heads the National REO Brokers Association. "When a desirable property comes on the market, it may attract multiple bids."

Not everyone reports the same experience. "I imagine the REO market varies from community to community," Fornatto says. "In my market it seems there is a lot of inventory."

In the second half of 2009, First American CoreLogic estimated there was a 1.7-million-unit "shadow inventory" of residential housing, up from 1.1 million units a year earlier. The shadow inventory is not yet on the market but includes estimated REO properties held by banks and mortgage companies.

First American concluded that the large amount of shadow inventory "will impact the housing market for the next few years." Therefore, financial planners who wish to help clients buy real estate may do well to understand the process of acquiring REO properties.

COMING UP SHORT

In particular, planners may need to explain to clients the difference between buying REOs and buying in a short sale. As mentioned, a short sale takes place when the deal won't cover the mortgage debt. If John Smith bought a house for $300,000 in 2006, with a $285,000 mortgage, and he can sell the house now for $250,000, this transaction would result in a loss of more than $35,000 for the lender. In order for such a short sale to go through, the lender must agree.

"Short sales take longer to get approval and they don't always go through," says Fornatto, who was recently involved in a short sale where the lender said yes. "But before it closed, we found out about a second mortgage on the house, and the holder of that mortgage wouldn't agree," he explains. Second mortgage holders may be reluctant to approve short sales if they stand to collect nothing. As Fornatto relates, the buyer may have missed an opportunity to get an $8,000 tax credit when the purchase was thwarted.