Why REO Rehab Is Making a Comeback

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Real estate owned property managers can differentiate themselves and earn more business by bringing focus back to distressed property rehabilitation.

As the market and default capacity stabilize, the servicing and REO management industries need to adapt to the changing needs of their lender and investor clients. In many cases, the client may not even realize that value lost through property sale is an issue.

At the height of the crisis, servicers and REO groups were overwhelmed as operating platforms built for 1% to 2% delinquencies were overloaded with 10% delinquencies, while financial institutions' capital ratios experienced immense pressure.

Lenders taking back large volumes of REO properties did not have the time or the resources to understand what their properties really needed. Most were working on improvements like paint and carpet, but overlooked other jobs required to add value, such as repairing molding, or replacing doors and cabinets. At the same time, prices seemed to always come in lower no matter what was done.

REO owners believed that repairs were not paying off, so many simply stopped doing repairs altogether. Properties were coming in so quickly that their primary concern became managing the size of the inventory and the core function of the REO manager shifted.

As REO management became more of a volume management business, the new players in the space dialed in to those needs and selling as-is became common. Investors gorged on the supply, helping to transform the fragmented single-family rental business into an institutional asset class. Interestingly, despite the overall volume of inventory coming down, the trend of as-is sales going directly to investors is increasing.

Now, lenders and investors are recognizing that the right REO management strategy can help sell properties at retail prices to owner occupants as opposed to selling at lower wholesale prices to investors. Capturing this value at the tail end of an investment is a skill set that lost some luster in the downturn but will be a key driver of success in the years to come as traditional strengths of REO managers gain greater appreciation with lenders and investors.

Creating ROI is easier said than done, but it is something at which REO managers used to excel. Asset managers generally know their markets well and have a sense for the broad range of enhancements that can positively impact the sale.

For example, in Chicago we know that there are some areas that should get granite countertops, top-end cabinets and stainless steel appliances because the market is largely comprised of first-time homebuyers who want the "new car feel" and most likely won't have access to a home equity loan to remodel the property after the purchase. When the market supports it, go all-in and price accordingly.

Often, REO managers try to piece together a rehab project leaving many items unfinished only to find themselves completing them later to satisfy appraisal requirements. This is a costly mistake, as the additional repairs were not priced in the original marketing plan.

Alternatively, REO managers should be aware of changing tastes: maybe that small extra bedroom in an older home should be turned into a master bath and walk-in closet to increase the appeal and compete with the newer homes on the market.

In many neighborhoods, bringing a property up to Federal Housing Administration lending standards will open up the buyer pool tremendously and the REO manager needs to understand those dynamics.

RealtyTrac recently reported that owner-occupant buyers accounted for 63.2% of all residential single-family home and condo sales in the first quarter of 2015, which is down from 65.8% last quarter and from 68.6% a year ago.

There is still plenty of room to improve execution levels. REO managers that can effectively apply a rehab focus and retain some of the "fix and flip" profits for their clients will be better positioned than others who maintain their focus on speed.

Glenn Brooks is senior vice president of REO at Fay Servicing

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