This question,"Which is better - an REO or a foreclosure auctioned property" is very common and investors seem to confuse the issues of these two ways to buy wholesale properties. REOs are already bank-owned and have been through the foreclosure auction. The other properties that must go through the foreclosure auction will have to be purchased in an open auction atmosphere.
Foreclosure auction properties are generally not available for viewing by a perspective buyer before the auction. Research must be done to determine any and all liens (mortgages, code violations, code liens, judgments or other encumbrances) that are against the property. The junior mortgages and personal judgments will be extinguished at the foreclosure sale but the city or county liens and IRS liens will not be extinguished at the sale. Because of the open bidding nature of the foreclosure auction, often novice investors over-bid for the properties they want.
REO properties are already bank owned and have extinguished junior liens. Also, the properties can be viewed at the buyer's leisure so a complete interior and exterior assessment of repairs can be made. This single ability to inspect the property before it is purchased makes it worth it to buy REOs over foreclosures at the auction.
However, if an investor understands the risks associated with the auction and controls his bidding, there is potential for deals at the auction. Even better, once the property has been analyzed for title encumbrances and if there is a second lien on the property, another possibility exists. This opportunity would be where a second mortgage note exists and the note holder realizes his note will be totally extinguished at the sale.
Second and further junior liens will be worthless after the auction sale. Many times the first lien holder is foreclosing and there is equity in the property if there aren't second note holders. If you approach the second note holder to buy the note at a significant discount to 5% of the face amount of the note, you can use this note as a credit to bid at the auction.
The way this works is the second note holder will transfer the note to you and release the lien or cancel the note as is the usual way a note is paid off. You will now own this note at its full face amount, not just what you paid. So a $50,000 original face amount plus any unpaid payments could likely be bought for $2,500 or less, in some cases only $500. If the second note holder doesn't sell the note before the auction, he will get nothing after the sale.
Armed with the $50,000 note, you can go to the auction and bid on the property. The first bid should be for the minimum allowable by the county - usually $100. This bid means the final judgment amount the court granted the first mortgage holder plus $100. If there are bidders beyond this point, the proceeds will go to the second note holder (you) to the total amount of $50,000. If there are aggressive bidders for the property, you should be bidding yourself to keep the price moving.
As an example, if the final purchase price at the auction is $150,000 and the first mortgage was $100,000, the net result is you will receive approximately $50,000 for the note you paid $2,500 for. This is not only a great return on your investment it is likely a larger profit than wholesaling the property. Your competitors for these notes are the professional investors who buy properties at the auction on a daily basis.
In summary, buying an REO is simpler than purchasing a property at a foreclosure auction and should get the investor-buyer a better price. He will also have less or no lien issues as with auction properties. Every property is different, and if the investor can buy a second note at a discount, do his lien and title research, and control his bidding at the auction, he might get a better deal than an REO. The key is doing your homework on the property and determine its reasonable ARV (After Repaired Value) so you can formulate an exit strategy before you buy it.
