Conventional wisdom is that foreclosures reduce neighborhood values. It turns out, that isn’t the case. It’s easy to see why people come to this erroneous conclusion. Properties that go through foreclosure often sell for less than recent comparable sales, particularly after the peak of the housing bubble when values were grossly inflated and ripe for a serious correction. However, it wasn’t the foreclosure that caused the discount, it was a motivated seller dealing with a property in poor condition that ultimately caused prices to fall.
You wouldn’t know it by the huge inventories they currently manage, but lenders are not in the real estate business. They don’t profit from the real estate they own. They only obtain real estate when the profitable loan they made turns bad. The asset management departments of major banks are supposed to be capital recycling units who extract the original loan capital from a bad loan through orderly disposition of real estate owned. Obviously, it hasn’t worked out that way over the last six years.
As the toxic loans from the real estate bubble caused wave after wave of defaults, lenders began acquiring properties at unprecedented rates. In fact, they obtained so much property so fast, that their resale activities began to negatively impact market pricing. It got so bad in 2008 that lenders collectively decided to withhold their own real estate owned from the MLS, and they decided to stop foreclosing on delinquent mortgage holders and allow them to squat in their homes without making payments. With their own visible inventories of real estate owned ballooning and an even more massive shadow inventory building, lenders had a real problem.
Lenders would like to wait until prices recover to peak values before liquidating their real estate owned. Any liquidations carried out at lower values cause significant losses. Too many of these losses, and lenders go bankrupt. To raise property prices and lower lender’s cost of capital, the federal reserve has lowered interest rates to zero. Lenders can borrow money at little or no cost from the federal reserve and depositors, so the pressure to liquidate is greatly reduced. The lower interest rates raises thresholds of affordability and allows buyers to borrow large amounts to make the inflated prices of the housing bubble relatively payment affordable.
With no cost push and high payment affordability, the only thing preventing house prices from going back up was the supply of houses requiring liquidation. Beginning in early 2012 across the Southwestern United States, lenders slowed their foreclosure rates and dramatically decreased the rate at which they acquired new properties at foreclosure auctions. This has enabled them to reduce the number of real estate owned properties on their books. Lately, real estate owned has not been a bargain because lenders have quite a bit less of it.
If foreclosures caused neighborhood values to drop as many contend, why are recent bank liquidations fetching prices higher than comparable resales? The problem was never foreclosures, it was always an issue of seller motivation and property condition. Previously, lenders had so much property they needed to discount it in order to find a buyer. Currently, lenders don’t have so much real estate owned, so they don’t need to discount it in order to sell. Since lenders have less supply to liquidate, and since they have no cost pressure or regulator pressure to liquidate, they can hold out for higher prices.
Another major reason lenders used to discount their prices on real estate owned is due to its poor condition. No borrower facing foreclosure spends any money on upkeep. One of the biggest fallacies of shadow inventory is that it’s better to have an occupant in a property than leaving it vacant. Perhaps in rough neighborhoods prone to property crime this may be true, but for the most part, occupants break things and don’t repair them. Houses deteriorate when occupied by delinquent mortgage squatters because they are loathe to spend a penny keeping up a property they are doomed to lose. As a result, when lenders finally take back these properties in a foreclosure auction, they are run down and in poorer condition than a traditional sale. Further, lenders who are already going to take a large loss rarely spend money fixing a property even when it is cost effective to do so. Lenders sell their run down real estate owned “as is,” which usually means “as is trashed.”
The bottom line is that seller motivation and poor property condition are largely responsible for lower resale values of bank-owned properties. Once these properties are brought back to the standards of the neighborhood, their resale values are indistinguishable from other properties. In fact, if these properties are improved, they actually increase neighborhood values. Most third-party purchases at auction are bought by flippers who improve the properties and sell them for a premium. The success of these entrepreneurs is testament to the fact that foreclosures do not reduce neighborhood values.
Foreclosures’ small effect on nearby prices
A foreclosure in the area won’t bring prices down that much: report
Aug. 6, 2012, 5:18 p.m. EDT — By Amy Hoak, MarketWatch
CHICAGO (MarketWatch) — Recent research suggests that properties near foreclosures normally suffer falling home prices, but a new paper from the Federal Reserve Bank of Atlanta challenges the claim.
It’s the condition of the distressed property progressing through the foreclosure process that weighs most heavily on home prices in the area, not the finality of foreclosure itself, the study found. The negative effect on nearby home prices actually peaks before the distressed property even completes the foreclosure process.
After foreclosure, when a lender-owned property is in below-average condition, nearby houses will trade at lower prices; when it’s above average condition, nearby homes will trade at higher prices.
But even then, if there’s a delinquency or foreclosure down the street, there’s not a huge economic effect on the prices of nearby homes.
When a large number of neighborhood properties are occupied by delinquent mortgage squatters who won’t maintain them, then the condition of the entire neighborhood deteriorates. That will lower neighborhood values. A small number of bad loans in a desirable neighborhood will not.
The study found that a property in serious delinquency for less than a year or a property foreclosed on and now owned by the bank reduces values of homes within a tenth of a mile by about 0.5% to 1%, “an amount that would most likely go unnoticed by the typical seller who does not have many distressed homeowners living nearby,” according to the report. Researchers analyzed housing information, including public records in 15 metropolitan areas, with a focus on single-family homes.
“We find that while properties in virtually all stages of distress have statistically significant, negative effects on nearby home values, the magnitudes are economically small, peak before the distressed properties complete the foreclosure process, and go to zero about a year after the bank sells the property to a new homeowner,” the authors wrote in the report.
Once a property losses is identity as a distressed sale, the value get’s merged into the values of the surrounding neighborhood. Just because a property sold at a discount once doesn’t mean it will be permanently value impaired, particularly if the new owners make improvements to bring it back up to neighborhood standards.
In 2010 Las Vegas, I used to see resale properties selling for 20% to 30% less than new houses in close proximity. I never understood why anyone would pay such a huge premium for a new house. Within a year or two, the values of these properties will equalize, and the purchaser of the resale will be significantly better off than the buyer of the new home.
“The estimates are very sensitive to the condition of the distressed property, with a positive correlation existing between house price growth and foreclosed properties identified as being in ‘above average’ condition.”
It’s assumed that the owners of the distressed properties aren’t making as much investment in their properties or are doing as much general upkeep as foreclosure looms. And that’s what’s impacting nearby prices.
“The most important take-away is the effect [on nearby home prices] starts when the property is delinquent. It’s not the foreclosure itself that is the problem,” said Paul S. Willen, an economist at the Federal Reserve Bank of Boston and co-author of the report, in an interview.
This would suggest that lenders should clear out their shadow inventory. The properties occupied by squatters for as long as five years are going to be run down. These properties will require discounts when they finally get recycled, not because they’re foreclosures, but because they are in very poor condition.
In order to minimize the effects that foreclosures have on the surrounding area, it’s best to minimize the time that a property spends in serious delinquency and in bank-owned status, the authors concluded. To do that means accelerating the foreclosure process and putting pressure on lenders to sell bank-owned properties more quickly.
Unfortunately, we all know this isn’t going to happen. Lenders are going everything they can to kick the can down the road in hopes that prices will recover.
Moreover, policies that delay foreclosures, slowing down the transition from delinquency to foreclosure, don’t protect the neighbors, Willen said. These policies are exacerbating the effect of distressed properties.
“When you talk with community groups… they’re aware that long, drawn-out foreclosures are not good for the community,” Willen said. “The first choice is for the foreclosure to be prevented in a way that is good for the investor and the homeowner. Failing that, it’s good to get this process done it a faster, more humane way.”
Perhaps if the general public understands delinquent mortgage squatters bring down neighborhood values, they will be less tolerant of this practice. Right now, most believe these squatters are helping their values by keeping these properties off the MLS. In reality, these squatters are running these properties down so they will require a larger discount when they finally do hit the market.
More than doubled their mortgage
The former owners of today’s featured property created their own mortgage distress by more than doubling their mortgage since they bought it. Since Newport Beach properties were not immune to the problems created by excessive borrowing, resale prices fell, and these Ponzis could not sustain their borrow-and-spend lifestyle.
- This property was purchased on 8/2/2000 for $255,000. The owners used a $229,500 first mortgage and a $25,500 down payment.
- On 9/17/2001 they obtained a $50,000 HELOC so they could extract their down payment.
- On 7/30/2002 they refinanced with a $223,800 first mortgage.
- On 3/27/2003 they obtained a $150,000 HELOC.
- On 5/26/2005 they refinanced with a $523,750 first mortgage.
- On 1/23/2008 they refinanced with a $505,500 first mortgage and a $70,000 stand-alone second.
- Total property debt was $$575,500. Total mortgage equity withdrawal was $346,000.
They made the payments for a while, but when the Ponzi borrowing was cut off, they couldn’t make the payments, and the bank took the property back on 11/15/2011.
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Proprietary OC Housing News home purchase analysis
872 HALYARD Newport Beach, CA 92663
$349,000 …….. Asking Price
$255,000 ………. Purchase Price
8/2/2000 ………. Purchase Date
$94,000 ………. Gross Gain (Loss)
($20,400) ………… Commissions and Costs at 8%
============================================
$73,600 ………. Net Gain (Loss)
============================================
36.9% ………. Gross Percent Change
28.9% ………. Net Percent Change
2.6% ………… Annual Appreciation
Cost of Home Ownership
——————————————————————————
$349,000 …….. Asking Price
$12,215 ………… 3.5% Down FHA Financing
3.55% …………. Mortgage Interest Rate
30 ……………… Number of Years
$336,785 …….. Mortgage
$110,449 ………. Income Requirement
$1,522 ………… Monthly Mortgage Payment
$302 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$87 ………… Homeowners Insurance at 0.3%
$351 ………… Private Mortgage Insurance
$591 ………… Homeowners Association Fees
============================================
$2,853 ………. Monthly Cash Outlays
($227) ………. Tax Savings
($525) ………. Equity Hidden in Payment
$14 ………….. Lost Income to Down Payment
$64 ………….. Maintenance and Replacement Reserves
============================================
$2,178 ………. Monthly Cost of Ownership
Cash Acquisition Demands
——————————————————————————
$4,990 ………… Furnishing and Move In at 1% + $1,500
$4,990 ………… Closing Costs at 1% + $1,500
$3,368 ………… Interest Points
$12,215 ………… Down Payment
============================================
$25,563 ………. Total Cash Costs
$33,300 ………. Emergency Cash Reserves
============================================
$58,863 ………. Total Savings Needed
The property above is available for sale on the MLS.
Contact us for a comparative market analysis, a cost of ownership analysis, or information on how you can make an offer today!
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Nearby Foreclosures
Gain a competitive advantage over other buyers. By locating distressed properties -- before they hit the MLS -- you can discover where tomorrow's REOs and short sales will appear. Most of these properties are not listed on the MLS, but they will be soon. Research properties in advance and get a jump on your competition. Don't miss out on another deal because you couldn't act quickly. Use this tool to your advantage! The red properties are already bank owned. As soon as REO asset managers prepare them for sale, they will be on the MLS. Get ready! The green and blue properties have owners who are not paying their mortgages. They may be offered as short sales, or they may go through foreclosure and become REO. Either way, they will also likely be available on the MLS soon. Find your next home! Be prepared to offer on these properties by researching them in advance or risk losing out to buyers who are have done their homework. Start your research today! To find distressed properties, enter your desired location and press search. Scroll through list by pressing "next."  |
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0.23 miles 2 bd / 2 ba 1,313 Sq. Ft. |
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0.77 miles 3 bd / 2.5 ba 1,634 Sq. Ft. |
15 Responses to “Conventional wisdom wrong, foreclosures don’t reduce neighborhood values”
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Mark this one down as wishful thinking.
Freddie Mac: Shadow Inventory Unlikely to Bring Down Prices
Freddie Mac isn’t afraid of shadows.
The GSE released its U.S. Economic and Housing Market Outlook for August on Wednesday, examining recent trends in home price indices and speculating on the impact of shadow inventory on home prices.
The Freddie Mac Home Price Index (HPI) for the country showed a 4.8 percent gain in the second quarter, the largest quarterly pickup in eight years. Year-over-year, the national index posted a 1 percent increase, the largest annual appreciation since November 2006.
Other HPI metrics also suggest a strengthening market, with CoreLogic’s index rising 2.5 percent year-over-year for June and FHFA’s HPI posting year-over-year gains through May.
In addition, the recovery was broad-based. From June 2011 to June 2012, 34 states (and the District of Columbia) posted gains in home prices. This was the largest number of states reporting annual appreciation since April 2007.
Freddie Mac speculated that even if national HPIs dip in the usually weaker autumn and winter months, the second-quarter HPI gains will likely overshadow any expected declines.
While prices have shown positive growth in many states through this year, concerns about shadow inventory-the stock of single-family loans that are seriously delinquent— have some experts worried about prices taking another tumble.
Freddie Mac asserted that although delinquency rates may be higher than they were before the recession, the “shadow” over the housing market is not as long as some may think.
“While the shadow inventory persists, there is an important difference in today’s market compared with those of recent years, and that’s the substantially reduced amount of excess vacant housing,” said Frank Nothaft, VP and chief economist for Freddie Mac.
Vacancy data from the Census Bureau showed that vacancies in U.S. homes for rent or for sale continued to decline in the second quarter. Rental vacancy rates have fallen to 8.6 percent, the lowest rate since the second quarter of 2002. For-sale vacancy rates have dropped to 2.1 percent, the lowest since the second quarter of 2006.
Additionally, the for-rent market now appears to be in relative balance, with rental stock close to overall rental demand. This results in normal vacancy levels.
The continuing drop in excess vacant stock is important because it means that in most markets, REO homes on the for-sale market don’t have to compete with an oversized vacant inventory.
“The housing recovery may finally be coming out from the shadows,” Nothaft said.
Thanks for the article. The first step in rehab is admitting you have a problem. I have argued with many people regarding shadow inventory…their response is “prove that it actually exists.” If the chief economist at Freddie Mac says it exists what more do you want. Didn’t Freddie Mac also say that they wouldn’t need a bailout before it all hit the fan. Read between the lines here!
I am always mystified by the people who deny shadow inventory. I have regular daily posts with houses where people have been squatting for three years or more, many of them owned by the bank for a year or more. If people can look at specific examples of shadow inventory and still deny it exists, that’s a powerful confirmation bias getting in the way of seeing reality.
Keith Jurow shared with me the latest figures from the Northeast where most of the states use judicial foreclosure. Prices there are not rebounding like here in the Southwest. With the additional supply coming, prices there will continue to crumble.
LPS: Judicial States See High Share of Aging Past Due Loans
A report from Lender Processing Services (LPS) revealed that in judicial states, the share of aging past due loans is significantly higher than in non-judicial states.
In judicial states, nearly 60 percent of borrowers with loans in foreclosure have not made a payment in 2 years, whereas in non-judicial states, that percentage is at about 30 percent. Among those with loans 90 days or more past due, 50 percent of borrowers in judicial states have not made a payment in more than one year, compared to slightly more than 40 percent in non-judicial states.
The LPS report also found a surge in HARP refinance activity for those with higher loan-to-value ratios (LTVs) from January to June this year.
“Since the beginning of this year, high loan-to-value refinances have increased significantly. As an example, 2006 vintage GSE loans with six percent interest rates and LTV ratios between 100 and 125 percent increased from a 10 percent annualized prepayment rate at the end of 2011 to more than 40 percent in June 2012,” said Herb Blecher, SVP at LPS Applied Analytics.
Blecher added that LPS data also shows this rise extends beyond that subsection and holds true for other vintages with the similar characteristics
Other data from LPS showed that the delinquency rate for June now stands at 7.14 percent, down 30 percent from the January 2010 peak when the rate was 10.57 percent. Month-over-month, the delinquency rate in June rose 3.4 percent, but was down 7.3 percent.
The rate of properties in foreclosure inventory maintained historically high levels at 4.09 percent for June; in December 2005, the rate was 0.44 percent.
Foreclosure starts totaled 173,556 in June, which down 20.7 percent from May and 20.5 percent year-over-year. Despite the decrease, foreclosure starts still outnumber foreclosure sales at a 2:1 ratio, according to LPS. Foreclosure sales numbered 74,000 in June.
For June, the states with highest percentage of non-current loans, which includes loans 30 days or more past due plus foreclosures, were Florida (21.2 percent), Mississippi (17 percent), Nevada (16 percent), New Jersey (16 percent), and Illinois (13.7 percent).
The states with the lowest percentage of non-current loans were Montana (5.5 percent), Alaska (5.1 percent), Wyoming (4.8 percent), South Dakota (4.8 percent), and North Dakota (3.6 percent).
At least one banker is going to jail…
Former FirstCity Bank President Receives 12-Year Sentence
The former president of FirstCity Bank of Georgia, Mark A. Conner, was sentenced to 12 years in federal prison for bank fraud conspiracy and perjury, SIGTARP and U.S. Attorney for the Northern District of Georgia Sally Quillian Yates jointly announced Friday in a release.
Conner, 46, was charged for his role in a multi-million dollar conspiracy to defraud FirstCity Bank and for hiding and lying about assets in his personal bankruptcy case.
The now defunct FirstCity Bank was seized by state and federal regulators March 2009.
According to the release, Conner held a variety of top positions at FirstCity Bank between 2004 and 2009. During that time, Conner and his co-conspirators defrauded FirstCity Bank’s loan committee and Board of Directors into approving multi-million dollar commercial loans to borrowers who were actually purchasing property owned by Conner and others involved.
Conner and the co-conspirators got at least 10 banks to invest in the fraudulent loans based on misrepresentations. Through the scheme, Conner made almost $7 million in proceeds.
To make FirstCity Bank look better, Conner and co-conspirators also made loans to buyers to purchase the bank’s foreclosures without requiring a downpayment from the buyers.
In his Chapter 7 bankruptcy petition, Connor also stated he had a little over $3,000 in cash and financial accounts and essentially no interests in real estate when in fact he controlled off-shore accounts holding over $545,000. In addition, Conner had made some $4 million in loans from his off-shore accounts.
Conner pleaded guilty to the charges on October 21, 2011 and has been in federal custody since his arrest on March 20, 2011.
In addition to 12 years in prison, Conner was ordered to pay 19.5 million in restitution to the FDIC and victim banks. Conner also agreed to forfeit $7 million.
“Our state, which leads the nation in bank failures, is still recovering from a banking crisis of epic proportions. These failures have a ripple effect in every workplace and household in the State. This sentence should serve as a warning that regardless of your position or the complexity of your scheme, bank officers and directors who place FDIC-insured funds at risk through fraud and self-dealing will be brought to justice,” said Yates.
Other defendants for the case include the failed bank’s former top loan officer, Clayton A. Coe and the former top lawyer, Robert E. Maloney, Jr.
Coe, who pleaded guilty in June, is awaiting sentencing. Maloney is scheduled for trial in January 2013.
As lenders hold back from selling, home prices are benefiting
As homeowners hold back from selling, home prices are benefiting, according to a report from Redfin, which tracked home prices in 19 U.S. markets.
While prices remained flat month-over-month (-0.1 percent) from June to July, Redfin found prices rose 3.2 percent from July 2011 to July 2012.
However, the number of homes for sale fell 28.1 percent during the same one-year period and also declined 5 percent from June.
According to Redfin, the biggest challenge the housing market is facing is selection, and the problem will persist until the end of the year.
Among 19 markets measured by Redfin, 16 saw yearly price gains, with Phoenix seeing the biggest gain at 28.7 percent.
San Jose and Denver also had noteworthy gains at 11.9 percent and 8.5 percent, respectively. On the other hand, markets that saw yearly decreases included Long Island (-6.6 percent) and Chicago (-3.1 percent).
On a monthly basis, Phoenix actually saw prices dip 2.1 percent. Out of the 19 metros, eight others also saw month-over-month losses, including San Francisco (-2.5 percent), Washington D.C. (-1.9 percent), and Chicago (-1.9 percent). San Jose and Portland had the biggest monthly price gains, 4 percent and 2.1 percent, respectively.
With inventory low, Redfin found the percentage of new listings that were taken off the market within a matter of weeks remained high. For single-family homes, 27.8 percent were under contract within 3.5 weeks from their debut day in July.
Redfin also stated low inventory led to a slowdown in home sales, with July seeing a decline of 12.4 percent from June, but still up 6.8 percent from a year ago.
Here’s a typo:
“Conventional wisdom wrong, foreclosures don’t reduced neighborhood values”
should be
“Conventional wisdom wrong, foreclosures don’t *reduce* neighborhood values”
Thanks. I read that twenty times, and my eye never picked up on it.
What it all boils down to is demand continues to be pulled-forward.
Unfortunately, for those touting “recovery is finally here”– prices/sales volume in OC are up due to easy comps and availablility of 30yr money @ about 100bsp lower YoY — NOT from rising real household incomes.
As a result, a lot of weak hands are going to be ‘flushed-out’ in the coming weeks and months.
Unless we get rising incomes, affordability is going to become a problem once interest rates begin rising again. I could easily see a set of circumstances where prices recover to the limit of affordability only to be knocked down again by rising rates.
‘A 1% change in rates allows house prices to inversely move 10% and maintain the same level of affordability’.
Government meddling appears to be working. It may work in the short term but will prove to be a disaster long term. This sophmoric way of handling a crisis is folly on a national level.
I think foreclosures shape buyer expectations, especially when they happen in large numbers. They fuel the perception that the market is declining (which it may be, but the foreclosures put more fuel on the fire). Likewise low interest rates make people think the market is stabilizing or even appreciating, but unless the low interest rates are followed by increased incomes, the “gain” in value is illusory, because purchasing power has been manipulated. If or when that manipulation stops the price gains that it produced may not last.
Lenders are working to change potential buyer’s perceptions more than the underlying reality. They know they have a huge problem, and if they don’t get sheeple to step up and take one for the team, they will never get out of this mess.
Can’t agree with this one. Of course foreclosures bring down neighborhood value. Foreclosures are in much poorer condition than resales and most are then rented out and not flipped if purchased by an investor. Even if it is re-appraised after it’s rehabbed it’s still prone to be appraised by the same comps it was when it was last appraised. It’s been my experience that appraisers don’t put enough weight on the condition of the property. If anything pat yourself on the back for keeping prices low.
[...] that foreclosures reduce neighborhood values. Another recent federal reserve study concluded the conventional wisdom is wrong, foreclosures don’t reduce neighborhood values. I have long contended that foreclosures are not the problem, they are the cure. The real problem [...]