REO and Cash for Keys: When a Note Becomes a Property

REO, short for real estate owned, is what a defaulted note turns into when the lender ends up with the property, through a foreclosure sale nobody outbid or a deed in lieu. From that day you are a property owner, not a lender. Cash for keys is a payment to whoever is living there to hand over the keys and leave by an agreed date, and it is often cheaper than an eviction.

This page picks up where the note ends. How to choose an exit in the first place is covered in exit strategies for non-performing notes, and whether you have the right to foreclose is covered in can I foreclose as the owner of a note. Here the question is what to do once the loan is gone and a house is in its place.

What REO means for a private note owner

Banks use REO as a balance sheet label for property they took back. For a private investor it means the same thing on a smaller scale: the note and its interest income have ended, and you hold title to a property that earns nothing until you rent it or sell it. You usually get there one of two ways:

• The foreclosure sale. If no third party bids more than you, you take the property with a credit bid, meaning you bid some or all of the debt you are owed in place of cash.
• A deed in lieu of foreclosure. The borrower signs the property over to you in exchange for a release from the debt, or part of it. The mechanics are explained in our page on the deed in lieu of foreclosure.

Either way, three checks come first. Order a title search to see what survived: unpaid property taxes, a senior lien if you held a second, homeowners association dues, and anything recorded against the borrower that the route you took did not clear. Ask your attorney whether the state gives the former owner a redemption period after the sale, a window in which they can buy the property back, because that limits what you can do with it in the meantime. And move the insurance into your name the same day, since the borrower’s policy does not protect you as owner.

Deed in lieu as the start of an REO

From the investor’s side, a deed in lieu trades a faster, cheaper route to title for less certainty about what comes with it. A foreclosure can wipe out junior liens; a deed in lieu generally does not, so you take the property subject to whatever is recorded after your loan. That is why the title search comes before the borrower signs, not after.

A deed in lieu is also where cash for keys most often appears. The two are frequently negotiated together: the borrower signs the deed, receives a release from some or all of the debt and a relocation payment, and leaves by a set date. Your attorney should prepare the deed, the release and an estoppel affidavit, a sworn statement that the borrower is giving up the property voluntarily and not under pressure. That affidavit helps if anyone later challenges the transfer.

Cash for keys: how it is structured

Cash for keys is a written agreement in which you pay the occupant to move out. It works with a former owner after a foreclosure or deed in lieu, and it can work with a tenant, subject to the tenant protections described below. A sound agreement covers:

1. A move-out date, usually a few weeks out, long enough to be realistic.
2. The condition of the property at handover: empty of belongings and debris, often called broom clean, with fixtures, appliances and systems left in place and nothing stripped.
3. The keys, garage remotes and codes handed to you or your agent in person.
4. Payment only at move-out, after a walk-through confirms the terms were met. Paying in advance removes your leverage.
5. A release in which the occupant gives up any claim to the property and agrees that belongings left behind may be disposed of.
6. Utilities left on until the handover, so the house is not damaged by a freeze or a shut-off.

Some owners scale the payment to the date: more for leaving in two weeks, less for leaving in four. Keep the tone businesslike. The occupant is often going through a hard time, and a respectful offer gets accepted more often than a demand. Have a local attorney draft or review the form, since states differ on what such an agreement may say and on how abandoned property must be handled.

An illustrative example

The figures below are invented round numbers for illustration only. Your attorney and local agent can tell you what an eviction actually costs and takes where your property sits.

On these assumptions the $3,000 payment saves about $6,500, and the bigger gain is time: the house is on the market or ready for a tenant three months sooner. The damage line matters too. An occupant who leaves on good terms has a reason to leave the property intact, and one who is evicted does not.

Eviction basics

If the occupant will not leave, the legal route is an eviction, which in many states is called an unlawful detainer or ejectment action after a foreclosure. In outline:

• You serve a written notice to vacate, in the form and with the notice period state law requires.
• If they stay, you file in court. The occupant may contest, which adds time.
• A court order allows a sheriff or marshal to remove the occupant. Only the officer does that.

Never change the locks, remove belongings or shut off utilities to force someone out. Self-help eviction is unlawful in most states and can turn you into the defendant. Tenants have extra protection: the federal Protecting Tenants at Foreclosure Act generally requires notice of at least 90 days to a bona fide tenant after a foreclosure and can let a lease run its term, and many states and cities add their own rules. Hire a landlord-tenant attorney in the state before you serve anything, and keep cash for keys on the table even after the case is filed.

Holding costs while you own it

Every month between taking title and selling or renting costs you money. Budget for:

• Property taxes, now yours, including any back taxes that survived.
• Insurance. A standard homeowner policy often limits cover once a house is vacant, so ask for a vacant property policy.
• Utilities and winterization to protect pipes and systems.
• Securing and maintenance: changing locks after the handover, lawn care, regular inspections.
• Association dues, if the property is in an HOA or condominium.
• Repairs to make it sellable or rentable, priced after a proper inspection.
• The cost of selling: agent commission, closing costs and any transfer tax.

Get an outside view of value before you spend. A broker price opinion in both as-is and repaired condition tells you whether repairs pay for themselves.

Sell or rent

Selling turns the property back into cash you can put into the next note. Renting keeps the asset and adds an income, but it also makes you a landlord, with tenants, repairs and vacancy, which is a different business from holding paper. Our comparison of notes and rental property sets out the trade.

A few questions usually settle it:

• Does the rent, after taxes, insurance, repairs, management and vacancy, beat what the sale proceeds would earn in another note?
• Will the house sell as-is to an investor, or does it need repairs that tie up more cash first?
• Are you set up to manage a rental in that state, or would you pay a manager?
• Is there a third choice? Selling the property on owner financing creates a new performing note, which you can hold or sell later.

An illustrative comparison: a repaired house would sell for $150,000 and net about $138,000 after costs. Rented, it brings $1,400 a month, about $10,000 a year after expenses and vacancy, roughly 7 percent on the $138,000 you could have taken out. If you can place that cash at a better return with less work, selling wins on these numbers. If you want the property for the long run, renting may still make sense.

If your goal is to stay with paper and leave property to others, tell us when you join the buyer list, and say which kinds of notes and states you want to see from those we broker.

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