This article series examines how proactive Department of Real Estate (DRE)-licensed mortgage origination providers — MLOs — can ride out the ongoing downturn in origination fees. Part 3 explains how to shift into foreclosure mode to earn fees for services needed by foreclosing lenders.
Look back at Part 1 for how a recession disrupts fees earned by MLOs, and the timing of the mortgage industry’s recovery from what is fast becoming the 2023 recession.
See Part 2 for how to continue to earn fees from an evolving base of homebuyers and sellers, even as the volume of traditional cash-to-new-loan sales and refinancing slows to a trickle.
An REO is born — again
When home prices decline, recent homebuyers quickly find themselves underwater, weighed down by a mortgage balance larger than their home’s fair market value (FMV) — a detrimental condition known as negative equity.
When the inability to make mortgage payments or the need to relocate strikes, some of these homeowners will seek out mortgage modifications or short sales.
Alternatively, many will simply head toward foreclosure, waiting for the trustee’s sale to compel them to vacate. These homes will become real estate owned (REO) properties in the portfolios of mortgage lenders.
The last time REOs were a significant presence in the housing market was in the years following the 2008 Great Recession and foreclosure crisis. In 2009, REO sales made up a whopping half of all home sales. Thus, any real estate professional who wanted to make a living needed to work with REO properties, on both the buyer/seller side and the bank/servicer side.
Further back, recall the Resolution Trust property disposal unit formed following the modest 1991 recession to sell seemingly endless quantities of property taken back by defunct savings and loans associations (S&Ls), providing a fiesta for investors with auction paddles they couldn’t keep from holding up.
While the REO share in 2023-2025 will not rise to the significant levels of 2008-2012, REOs will rise to swallow a significant share of the market — and MLOs who want to continue to make a decent living in the leaner years ahead will take note.
Watchful brokerage offices, typically the small ones, will set up REO and MLO departments to capture this unconventional sales market dominated by lenders.
Today’s minimum down payment homebuyers are in big trouble
The necessary broker price analysis (BPA)
The lender who bids an amount equal to a full credit bid at the trustee’s sale, or the sum of all monies owed under the trust deed note, will quickly find themselves with REOs stacking up on their balance sheet, unable to breakeven. This buildup of vacant unlisted homes — shadow inventory —damages all home values, as well as the lender’s balance sheet.
The lender who bids the full amount fails to recognize the property’s current FMV, or what today’s homebuyers will pay for a comparable property on the market. Instead, they prefer to avoid reporting a loss on the books and kick the “REO can” down the road, hoping and praying the property’s FMV will rise to the level necessary to justify their full credit bid in the near future. Mortgage lenders are not well informed about the economics of real estate, just government guarantees on those mortgages.
However, contrary to the lender’s bet, during a recessionary environment, their REO’s value is likely to fall further and further underwater, a repeat of the REO disaster in the 1991 recession period.
Mortgage holders need to seek out a broker price opinion (BPO) or broker price analysis (BPA) early on — certainly before the trustee’s sale and preferably some 90 days into a default. Without a BPA, mortgage holders have no data for taking steps to greatly reduce the risk of further costs, or worse, a loss by a full-credit, high bidder posture at the trustee’s sale.
A Department of Real Estate (DRE)-licensed MLO is ideally placed to quickly prepare a BPA, distinct from an appraisal which is less helpful for lenders in a rapidly shifting downward-trending market.
Appraisers are essentially historians opining on events past. But a BPA allows a DRE licensee to step up with current market conditions, including:
- the pricing of properties closing escrow today (rather than over the past six months); and
- the direction the market is heading, important for when the foreclosure process takes six months to one year in the future to end up in a trustee’s sale and as an REO on the lender’s balance sheet.
Forming a BPA
The MLO calculates a BPA using data available by downloading a property profile — title condition — on the home and a printout of recent sales in the surrounding area from a title company website.
REO sales by lenders are not to be used as comparable sales to set property values for property. Mortgage lenders, their services, and private and government guarantees for consumer mortgages set the stage for REO inventory to be “dumped” by a lender — to get rid of the unwanted asset after settling the lender’s claim as a loss.
Editor’s note — Don’t think for a minute that REO re-sales do not set values in the open market: they do and will continue to do so when the number of REOs rise in 2023-2025, as REOs listings compete with private sellers — conventional listings — for the limited stock of homebuyers able and willing to buy during the recession.
A broker’s BPA is documented with a comparative market analysis (CMA). The CMA is a worksheet used when estimating a property’s value based on prices recently paid for comparable properties. The CMA reflects observations on a visual inspection of the comparable properties, noting in each property’s column for itemized features distinguishable from the subject property the dollar adjustment needed to correct for its greater or lesser value than the subject property.
When preparing a CMA, licensed brokers and agents have a duty to be honest and truthful. As part of this, the comparable properties are to be fully analyzed before giving an analysis. In a word (or two): due diligence.
Without supporting data, the BPA documented with a CMA is merely a guess and thus a dishonest analysis with no basis for being accurate. [See RPI Form 318]
A BPA illustrated by a CMA will confirm:
- how ownership is vested and who has authority to employ management;
- the liens on the property and their foreclosure status;
- any use governed by covenants, conditions and restrictions (CC&Rs) affecting occupants;
- comparable sales figures in the area; and
- price adjustments for:
- livable space; and
- amenities. [See RPI Form 318]
The MLO who offers BPAs as a service will see increased fee generation during the coming downturn, as well as set themselves up to perform other REO services foreclosing lenders need.
Advising clients through a cooling real estate market
Inspect vacant REO properties
When lenders pile on the number of REO properties, someone needs to manage these assets. But who? That’s where the creative MLO comes in.
Simply put, lenders employ a DRE licensee charged with confirming frequently that nothing deleterious is occurring on their REO properties. This includes checking for:
- squatters or adverse possessors;
- vandalism; and
- performance of maintenance.
This management activity may be part of an agent’s agreed-to activities under a listing agreement employing the agent’s broker to locate a buyer for the REO property. For these additional activities, the agent may charge a fee separate from and in addition to the fee for marketing the property for sale. [See RPI Form 102]
Unlike agents and brokers who lack an MLO endorsement, MLOs are key insiders in the mortgage industry. An MLO already has a direct line to mortgage lenders, the future holders of REOs who will be in need of this service. Advertising your ability to manage REO properties today ensures you are the first in line to take on these additional fee generators when REOs flare up (and they will).
Head of the REO line
When a private homeowner lists their property, they turn to an agent they trust, often someone who is referred to them by a person in their inner circle of friends and family. This is known as word-of-mouth marketing, and agents and brokers are adept at navigating this type of referral network.
But when a lender or servicer lists an REO, they are often out-of-state entities with no local contacts or true insiders to turn to.
That’s where an MLO-endorsed licensee comes in.
To be first in line for fees when the REO situation snowballs, an MLO first needs to forage for contacts among the mortgage lenders they have worked with in the past. The goal is to obtain employment agreements when foreclosure sales are completed — listing REOs for sale.
Once an REO listing agreement is secured, that’s when the real work in negotiations begins — not price discussions with a buyer, but with the employing REO lender.
Too often, the lender will play the game of taking offers, rarely making counteroffers when a potential buyer’s price comes in “too low,” instead demanding a higher resubmitted offer over and again. This tactic demands the buyer to negotiate with themselves, removing the lender from price setting in an offer-counteroffer bargain. Ultimately, this behavior disincentivizes the prudent buyer from continuing their pursuit of the REO property due to the difficulty and interminable nature of dealing with the lender — a deal killer.
Lenders thus retain control by doing nothing until pressured by government agencies to sell the properties. Worse, government agencies may well need to take over lenders who mismanage. At this point, the agency does the selling, which happens fast, as occurred in the early 1990s with the Resolution Trust arrangement.
Kickbacks as a RESPA Violation
When price negotiations stall, a long adjustment period occurs as. Over time, the REO’s value continues to diminish — alongside buyer interest in the property. Thus, the lender or mortgage guarantor ultimately ends up suffering a larger loss than would have occurred had they simply priced the property appropriately and negotiated with the buyer to begin with.
Of course, lenders do not know how to sell a property, as that is not part of their job description. However, agents and brokers do know how to attract buyers — doing so is in their professional DNA. Even better, an MLO-endorsed broker is comfortable in both corners, sandwiching themselves into deals as savvy in both home sales and lender dealings.
Don’t overlook the fact most all buyer-occupants of an REO home need a purchase-assist mortgage, a well-known DRE MLO service, funded by a lender other than the lender who foreclosed. Performing multiple services means multiple fees may be properly earned. there being no referral/kickback fee situation as the MLO involved packages the origination — all in house.
Prepare for the REO resurgence now
While REOs are not yet a fixture in California’s housing market, the potential for REOs rises with each passing day of declining home sales volume and pricing.
Ensure your future access to fees by forging relationships with key players in the REO landscape — namely, servicers and lenders — today.
These relationships will send servicers of REO property first to you to manage the sale of REOs, immensely helpful for ensuring a future income stream when traditional listings are few. They will also lead you to REOs before they hit the market, enabling the homes with the best investment potential to reach your desk before they hit the streets.
To learn how to use your MLO experience and mortgage lending contacts to shift your focus regarding the type of services needed when dealing with investors — and speculators — during a real estate recession, watch for Part 4 of this series in next week’s Quilix newsletter.