Bank REOs And Property Disclosure

Real Estate Owned (“REO”). The abbreviation “REO” means “real estate owned.”  In banker-speak, it means that the lender has taken the home back from the defaulting borrower – voluntarily or involuntarily – and must now try to sell it to recover the unpaid balance on the loan.

The Bank Addendum. It has been my experience that when banks sell their REO properties, they do so in the following manner: Upon receiving a purchase offer, they counter it with an “addendum.”  This document is usually several pages in length, replacing many of the customary terms of the buyer’s offer.  While there may be some differences among these bank forms, the one characteristic they all have in common is their attempt to reinforce the notion that the property is being sold “AS-IS.”

Having reviewed a number of bank addendums (technically “addenda”) over the last several months, I have concluded that if we read them at another time, say three, four or five years ago, we would likely have been offended that anyone would think us foolish enough to agree to such harsh terms.  But this is today – banks have been taking properties back in droves.  These properties must be placed back on the market quickly, and with the least amount of expense.  In an effort to reduce future liability, banks have stretched the concept of an “AS-IS sale” to the breaking point.  Why?  Because they can. Even though it is a buyer’s market in Oregon and elsewhere, banks are selling some of their REOs at very attractive prices.  As a result, buyers are generally willing to accept the AS-IS terms in the bank’s addenda.

But Is It Legal? To me, this approach is of dubious legality.  Saying so does not make something so.  While I cannot presume to know the thinking of those who draft these documents, I suspect some of the AS-IS language is inserted more for psychological affect than substantive effect. As far as I know they have yet to be legally tested in Oregon.  Perhaps that means they are working….

Here are a few of the provisions I’ve seen in bank addenda that buyers (and the real estate agents representing them) should be aware of:

  • The AS-IS clause attempts to disclaim bank liability for known defects – even if they have not been disclosed to the buyer;
  • The bank reserves the right to terminate the transaction at any time – even after everyone has signed;
  • The bank limits their buyer’s remedies to a return of their own earnest money deposit – which is no “remedy” at all;
  • There is no right to attorney fees should a dispute arise;
  • The bank expressly prohibits buyers the right to specific performance;
  • The typical AS-IS clause is sometimes nearly a half page long or more, effectively removing all responsibility to disclose what the bank may have actually learned during the several months it held the property;
  • The Addendum usually provides that if there is any inconsistency between it and the buyer’s standard purchase agreement, the terms of the Addendum prevail.

Oregon’s Property Disclosure Law. When Oregon’s seller property disclosure law was first enacted in the 1990’s, banks were exempted.  At that time – before terms such as “short sale or “distressed sale” were a part of our vocabulary – the exclusion seemed perfectly reasonable; foreclosures were few and far between.

Today, however, when a large percentage of residential sales are coming from the banks’ REO departments, there is less reason for this exclusion, due to the sheer number of homes involved and the fact that many have been abandoned.  Many of these homes have suffered from deferred maintenance, increasing the risk of mold, mildew, and serious water problems.

Moreover, I doubt there is any state that permits anyone – including banks – to disclaim away the duty to disclose known material defects in a property. This is especially true if the sale is to a “consumer” who intends to occupy the property as their primary residence.  In my opinion, dubbing the transaction an “AS-IS sale” will do nothing to protect a bank if it conceals known (and potentially dangerous) material defects.

So why not address this issue head on?  For example, requiring some limited form of basic disclosure document for banks as they are putting these frequently neglected REO properties into the marketplace?  Perhaps investors can be expected to accept the inherent risk, but not if the purchasers are consumers with families intending occupy the home as a primary residence.  If the Oregon Legislature saw fit to require disclosure by non-exempt sellers for all  one to four family used residential properties (including properties the sellers have never occupied), why not banks selling their REOs?  It must be remembered that in some areas of Oregon today, REOs are the predominant type of sale.

I acknowledge the counter-argument that imposing such a requirement for bank REOs could result in pushing the otherwise attractive sale prices higher.  However, that argument falters when we’re talking about the health and safety of owner-occupying consumers.  My concern is limited to lenders disclosing known defects where non-disclosure could endanger the health or safety of persons acquiring the property as their primary residence.  Acknowledging that the issue is more  prevalent today because of the number of foreclosures, perhaps sunsetting legislation would be in order, restoring the blanket exclusion for banks once the marketplace becomes more balanced.

The reason for excluding banks nearly two decades ago made sense for a long time…until today’s recession, when thousands of homes are being turned back to lenders.  The rationale for a blanket exclusion does not apply today.  This suggestion is not to burden banks with disclosure of what they don’t know – merely disclosure to consumers of what the do know, if saying nothing would endanger them.  That way, both the banks and the consumers are operating on a level playing field during the sales process.