REO Investments: Cash Cow or Cash Drain?

Novice and professional investors find themselves in competition over Chicago REO and foreclosure opportunities. The goal of building a long-term, profitable investment is the same for both groups, but the professionals have an institutional advantage. They have systems in place and experienced personnel who bring a high degree of confidence to their estimates of the financial tradeoffs for any candidate property. Novices have to rely on their own calculations.

For readers unsure of that ‘REO’ expression, it’s an acronym that is short for ‘real estate owned.’ Not very illuminating, is it? Better is what most people mean when they describe a local REO: a property whose ownership has reverted to a lender.

Whether buying with cash on the courthouse steps or taking advantage of record low mortgage rates, every investor needs to boil down the cash flow versus potential net return when evaluating any REO’s potential. First step: consider the ongoing out-of-pocket expenses:

  • Leasing costs
  • Management cost
  • Capital costs

While leasing and management fees are fairly predictable, a REO home often requires more deferred maintenance attention than does a typical occupied home (which means higher upfront capital expenditures). These expenses help offset the tax burden future income would create – and there are more:

  • Insurance
  • Taxes
  • Lawn care
  • Tax return preparation fee

New investment property owners might assume that everything they do on their property is a write-off. However…not so fast! The IRS has a different opinion. Appropriate tax-deductible repairs can include painting, fixing a broken sink or replacing a faulty lock. Improvements, on the other hand, add value to your property – and that means they are not immediately deductible. Investors must instead recoup the cost of improvements by depreciating that cost over a number of years. Improvement examples include new kitchen counters, a new deck or a garage addition. Perhaps the biggest write-off for investors who opt to finance the investment comes once mortgage payments begin. The Form 1098 “Interest Paid” amount is usually fully deductible.

Once costs and deductions have been projected, the investor can determine whether rental rates being charged for comparable homes are adequate to support the purchase price being contemplated. So, whether it’s your 1st or 50th investment, income properties should be evaluated with the long term in mind. Today’s foreclosure and REO market offers tempting record low prices, but careful analysis still needs to be done. If you are considering buying a REO in Chicago, call me anytime. Whether buying or selling, with the right tools it is possible to produce a valuation model accurate enough to assist your decision-making process.

By | 2017-03-18T20:07:23+00:00 July 24th, 2015|

About the Author:

Mike McElroy is the Founder and Managing Broker of Center Coast. He and his team of agents run a real estate practice grounded in proven methodology and accelerated by ground-breaking technology and powerful relationships.