Evaluating Profitability of REO Investment Properties

In a previous article, I pointed out that coming up with the funding to support commercial real estate purchases may be both intimidating and even prohibitive for many real estate investors.
If this scenario rings true for you, then you might consider something a little more basic to help build some investing momentum and to also put some cash in your pocket as you’re doing so. One of the best ways to make some big bucks in the current real estate market is by flipping REO properties.

Just so we’re all on the same page, REO properties are those that have been foreclosed on, and are now back in the hands of the bank. There is no homeowner to negotiate with, properties generally have clear title, they are often discounted, and investing in them is very much a repeatable process.

So, how do you evaluate REO properties to optimize their potential profitability? It’s really not that much different from evaluating any other investment. There are still considerations of repair or renovation costs, holding costs, and costs to close the deal. The real kicker with REO properties lies in properly assessing market value.

The issue with market value is often not an easy one with REO properties, for two common reasons. One, market comparable sales are currently all over the place, with the volatility that exists in the current real estate market. For a given 4-bedroom property, you could see sales values ranging from $180,000 to $250,000. How do you gauge a good purchase price from this, much less determine what you could likely sell the property for as a flip?

I have some suggestions that I think will help. First, if your group of comparable sales is comprised of ten properties, remove the two highest and the two lowest values in the group to tighten the comparable sales values you will be evaluating. In this case, you still have a group of six to compare, which is reasonable.

Another thing you can do is to eliminate any foreclosures from the group of comparables. Because REO properties are often discounted, their sales values may not be an accurate reflection of true market value.

Last but not least, it’s never a bad idea to shoot low with your offers, just to make sure you end up with a quality deal. The worst that happens is that the lender (the seller in this case) declines your offer, in which case you can simply move on to the next deal. You always want to make sure you have some ability to sell your deals at slightly less than market value, to increase the odds that they will sell quickly when the time comes. When you keep market value in mind, your ability to successfully flip REO properties for profit will be a mother process.