The current rate of disposition for foreclosed properties has been significantly slowed by a new phenomenon known as "For Sale by Banker."

Real estate owned by banks has increased to record levels. August 2010 REO increased 3% over July 2010 and 25% compared with August 2009, according to the most recent data from Realty Trac.

As new mortgage defaults show signs of leveling off, the August figures suggest nearly 100,000 properties were repossessed nationwide, topping the previous peak experienced in May 2010 by 2%.

During the past 24 months, as banks halted new loan originations and focused on "workout" solutions for past due mortgages, the velocity of REO disposition has not kept pace with the inflow of repossessed properties.

The growing levels of REO combined with the sluggish velocity of sales have created an alarming stockpile.

Though the current glut of bank-owned properties has reached peak levels, the worst is yet to come. As of June 2010, the level of REO for U.S. banks equaled about $44 billion including residential and commercial assets based on banks' reported asset book values. However, during the same period, the supply of future REO is even more disturbing, with nearly $350 billion in noncurrent real estate loans on banks' balance sheets. Noncurrent loans are properties with payments more than 60 days past due.

Though not all noncurrent real estate loans end in foreclosure, as many as 60%, or approximately $200 billion, could eventually be converted to REO. Therefore, it is estimated that over three times the current level will crowd banks' balance sheets in the near term. Though the slowing rate of new defaults has been well publicized, on average 100,000 new residential default notices have been added each month from January to August 2010.

A contributing factor to inefficient REO market flow stems from many banks' insistence on managing the disposition of REO in-house. In a market environment with banks' capital and resources already stretched and limited, the piling on of unfamiliar disposition management responsibilities generally results in a less-than-satisfactory outcome.

Similar to the limitations associated with "For Sale by Owner" properties, banks experience many of the same challenges when attempting to value, stabilize, maintain, complete, list, contract and transfer REO.

Some of the pitfalls include:

Rearview mirror valuations — List prices are often established based on recent appraised values. Appraisal reports by nature are backward looking, only considering historic data, in many cases several months if not years old. In most markets, appraisals tend to be 20% to 30% above actual market values.

Listing it and forgetting it — Listing an REO property is only one piece of the puzzle. Deferred maintenance and repairs, construction completion and real-time knowledge of market trends require weekly if not daily strategic flexibility.

Response failures — All offers and contract negotiations require immediate responses and open lines of communication. Delays in responding rarely satisfy the time requirements of purchase offers. Simply put, buyers move on if offers aren't responded to within 24 to 48 hours.

Perceived value vs. market value — The owner of the property in a for-sale-by-owner situation typically focuses solely on the property without consideration of current market conditions, inflating the value of the property. Offers at market value are therefore considered low and are often rejected.

All of these pitfalls increase the time required to dispose of the REO properties. Further, disposition decisions without proven asset disposition strategies are many times based on limited, if not incorrect information. Unfortunately, many bankers do not have the time or expertise to efficiently sell REO in the shortest amount of time at the highest possible value.

The five-year trend of delinquencies, foreclosure auctions and REO inventory suggests the U.S. is only halfway back to a normalized residential real estate market. This assumes market absorption based on sound, market-driven REO disposition strategies.

On average, the carrying costs associated with each REO property equals approximately 1.5% per month or 18% on an annualized basis of the asset's book value.

With current bank disposition practices in place, the traffic jam of REO will only grow resulting in longer holding periods, increased physical deterioration and significant negative impacts on the residential real estate market.

Rob Haney is the chief executive of Terranova Group, a Greenville, S.C., firm that provides outsourced asset management, stabilization, construction completion and disposition services for lenders.

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