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Milk’s Favorite Cookie, or a Bank’s Least Favorite Property?

John R. Homsher, CCIM, Principal

Other Real Estate Owned (‘OREO’) or Real Estate Owned (‘REO’) properties are real properties owned by a banking institution not directly related to its business. These properties were typically held as collateral for real estate loans and, due to a foreclosure or “deed in lieu” of foreclosure, are now under the direct ownership of the bank. OREO properties cover an assortment of commercial real estate such as multi-family, land, office, industrial, retail, hospitality and agricultural.

Both regulatory and economic factors drive the supply of OREO properties held by the banks. The Office of the Comptroller of the Currency (‘OCC’) regulates that a national bank may only hold a given OREO property for up to five years.

The recent recession had a substantial economic impact on OREO properties. In the four year period from 2008 through 2011, there were 414 bank failures; in comparison, only 97 banks have failed from 2012 to the present.

When a bank fails, typically another bank acquires that institution’s loans, deposits and OREO properties. Per OCC regulations, an acquiring bank’s five year hold period for OREO properties begins the day it takes over a failed bank. As a result, many of those properties that were taken over in 2010 and 2011 are approaching their five year limit. These assets comprise a large part of today’s OREO market.

Bankers don’t view OREO properties in a positive light; owning these properties long term ties up their available capital and reduces the bank’s ability to meet mandatory OCC capital ratios. Banks seek to shed these assets and as such are willing sellers; investors seeking to purchase assets at significant discounts to replacement cost are willing buyers.

While these assets typically need a capital infusion from the buyers to address deferred maintenance and releasing issues, the potential upside of the overall investment is attractive to many commercial real estate investors. For the commercial real estate community, OREO properties can provide a favorable asset class and potential ROI that outperforms investment returns from a stock, bond or certificate of deposit.

  • The bank’s OREO inventory is shrinking: The upward trend in the economy is allowing owners to avoid loan defaults and encourages the sale of bank-owned properties.
  • OREO prices are stabilizing: There is higher demand for OREOs today than there was 5 years ago, enabling banks to list these properties with an increased likelihood of obtaining a favorable price.
  • OREOs are attractive investments for sophisticated buyers: Due to discounted acquisition prices, investments in OREO properties can generate high returns for investors.