REOs (bank-owned properties) will continue to be an important part of the real estate landscape in 2010. Are they a good choice for your business?

Part 1 of this series looked at the downside of working with REOs, including issues surrounding broker price opinions, disclosures and expense reimbursement. Today’s column reveals other ways that REOs can be a money pit for your business.

4. Do you have the correct insurance?
Many agents assume that their errors and omissions insurance will cover their REO-related activities. If you are engaging in any type of property management (i.e., overseeing repairs, paying the utilities, etc.) you need a separate policy to cover that activity. In fact, most errors and omissions policies specifically exclude anything related to property management.

Editor’s note: This is Part 2 of a two-part series. Read Part 1.

REOs (bank-owned properties) will continue to be an important part of the real estate landscape in 2010. Are they a good choice for your business?

Part 1 of this series looked at the downside of working with REOs, including issues surrounding broker price opinions, disclosures and expense reimbursement. Today’s column reveals other ways that REOs can be a money pit for your business.

4. Do you have the correct insurance?
Many agents assume that their errors and omissions insurance will cover their REO-related activities. If you are engaging in any type of property management (i.e., overseeing repairs, paying the utilities, etc.) you need a separate policy to cover that activity. In fact, most errors and omissions policies specifically exclude anything related to property management.

Money pit: If you lack property management insurance and are sued, you and your broker will be personally obligated to pay for litigation costs and judgments. Furthermore, many lender listing agreements put you at additional risk.

According to Harold Justman, an attorney who specializes in working with distressed properties, many lenders "require the brokerage to assume the insurance risks that are usually covered by the homeowner’s insurance. If the lender is sued, the brokerage is required to defend the lender, even though this is a conflict of interest. The result is that the brokerage now has to pay for TWO separate attorneys to defend the lawsuit."

Justman recommends having an attorney review all lender listing agreements and to strike out this language. A different approach to limit your exposure is to set up a separate property management company.

5. The agent arranges for the repairs — who is responsible?
In virtually every transaction, buyers ask for property repairs. In general, it’s best to give the buyers a credit for the repairs and let them hire their own contractor. If there’s a problem with the work, it’s between the buyer and the contractor.

Money pit: It’s common for agents to arrange for repairs on REO properties. According to Harold Justman, "Some lender listing contracts call for a blanket indemnification of the lender on any problems arising out of the property." The result is that the agent and the brokerage are responsible for any problems with the repairs rather than the lender. It’s critical that an attorney review all lender listing agreements in order to remove any blanket indemnification language.

6. Buyer’s agents aren’t immune either
If your buyer is purchasing an REO, you also face serious risks. First, most states require you to provide the buyer with a disclosure statement, even if the lender is not required to provide one. If your state requires buyer’s agents to make disclosures about the property condition, you are subject to the same "failure to disclose" risks that the listing agent faces. …CONTINUED

Second, many lenders will refuse any offer that has inspection or financing contingencies.

Third, most lenders require buyers to submit a loan application to see if the buyer qualifies, but they generally won’t issue a new loan. As a result, the buyers normally must apply at a different lender. An additional risk few agents know about has to do with utilities and homeowner association fees.

Money pit: The best way to get an REO offer accepted is to submit it without an inspection and financing contingency. Under no circumstances, however, should a buyer purchase an REO without having a thorough physical inspection. This means that the inspection must be done prior to writing the offer. If the buyer’s offer is not accepted, many buyers become angry about paying for an inspection on a house they didn’t get.

Removing the financing contingency is also risky. If the house doesn’t appraise at the purchase price, the buyer cannot back out of the transaction without risking his or her security deposit. Again, the agent generally gets the blame if the buyers lose their deposit. Litigation is often the result.

Finally, several blog posts document unreasonable demands being made by homeowner associations and utility companies. Normally, delinquent homeowner association dues are the responsibility of the previous owner. Several bloggers are reporting that some homeowner associations are attempting to extract this money from new owners after the transaction has closed.

What’s even more distressing is what is happening with respect to the utility bills. At least two agents in Sacramento, Calif., report that the utility companies will refuse to turn on the utilities unless the new owner pays the back utility bills.

Because many buyers exhaust their available cash to close their transaction, they normally lack the funds to pay these bills. Even if they do have the money, they would have to sue the utility company to reclaim their money. When this happens, the buyers may decide to sue the agents as well. 

To minimize your exposure to the money pit, you must have the correct insurance in place, a sophisticated tracking and accounting system, an attorney to review the listing agreement to spot indemnification and other types of problems, sufficient funds to cover utilities and repairs, plus the contractors necessary to manage the property until it sells.

Finally, even if you sold 25 houses where you received a $5,000 commission, a single lawsuit could wipe out every bit of profit. The bottom line is REOs are a minefield of potentially explosive problems. Are you really willing to take the risk?

Bernice Ross, CEO of RealEstateCoach.com, is a national speaker, trainer and author of "Real Estate Dough: Your Recipe for Real Estate Success" and other books. You can reach her at Bernice@RealEstateCoach.com and find her on Twitter: @bross.

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