When a borrower defaults on a mortgage, the bank’s goal is to recoup the outstanding debt, typically through a public foreclosure auction. If the property fails to sell to a third party buyer at the foreclosure auction, ownership usually reverts to the lender though a credit bid. This property then becomes a Real Estate Owned (REO) asset, and the bank must find another way to liquidate it, often turning to specialized auction companies.
The Journey to REO Status
The REO designation is a direct result of the statutory foreclosure process. In Texas, these foreclosure sales are typically held on the first Tuesday of every month at the county courthouse, as codified by law.
- Trustee Sale: This is the legitimate, government-codified auction where the property is offered for sale.
- The Credit Bid: The bank or lender will typically enter a credit bid, usually for the amount of the outstanding loan balance.
- Becoming REO: If no third-party bidder offers a price higher than the bank’s credit bid, the bank wins the property back. Since banks are not in the business of owning real estate, this property is categorized as REO and must be sold to recover the non-performing loan amount.
Why Auction Companies Are Used for REOs
Banks generally put REO properties on the traditional Multiple Listing Service (MLS) using a Realtor, but if a property is highly illiquid or has become “stale” on the market, the bank may opt to use an auction company. This strategy is primarily a marketing technique:
- New Buyer Pool: Auction houses attract a specific segment of investors and inexperienced buyers who are hunting for a “deal” and are not actively searching the traditional MLS. The term “auction” suggests a bargain, drawing new eyeballs.
- The Reserve Price: The auction company’s main pitch is that they can generate a higher price through competitive bidding. However, the bank is protected by a reserve price (a minimum bid, usually around the loan balance), meaning the property will not be sold if the bidding does not meet that floor. Buyers should know they are unlikely to “steal” the property.
While this system can be viewed as a “bait and switch,” it is effective at getting new buyer interest and generating competitive bids, ideally leading to a sale price that is higher than the bank’s minimum acceptable price.
Key Takeaways for Buyers
Buyers interested in REO auction properties must exercise extreme caution regarding the contractual terms:
- Auction Addendum: Though the transaction may start with the standard Texas Real Estate Commission (TREC) contract, it will almost always include a separate Auction Addendum.
- Superseding Terms: The terms in the Auction Addendum supersede or trump any conflicting terms in the standard TREC contract. This addendum is written to protect the seller and the auction company and must be thoroughly reviewed, as it dictates the terms of the sale, financing, and closing.