Short sales damage house prices just like REO

Many market pundits claim lenders should focus on short sales rather than foreclosures. They contend short sales offer better capital recovery than foreclosures and they are less harmful to market pricing. This is not an accurate assessment.

First, not all foreclosures become REO. About a third of all foreclosures are purchased by third parties who either flip them or hold them as cashflow investments. Flippers generally improve the property and sell for full market value, so their activities don’t push prices lower. And obviously, cashflow investors don’t push prices lower because they don’t sell their properties.

Both short sales and REO resales require discounts to sell. REOs require a discount because lenders are loathe to spend any money fixing them up. Short sales require a discount because buyers won’t put up with the arduous process unless there is a reward for their patience. Sales prices of REOs or short sales do not differ much because both require discounts to sell (REOs -34% and short sales -21%). And since short sales and REO don’t differ much, and since both negatively impact prices, whether lenders choose to sell as short sales or as REO is irrelevant to the health of the market. Both short sales and REO are distressed sales.

As Foreclosures Fall, Fears of Crisis Abate

Filings in April hit the lowest level seen since July 2007.

By Claire Easley — From: BUILDER 2012, Posted on: May 17, 2012 12:03:00 PM

After months of ominous warnings that a second title wave of foreclosures was coming, the impending tsunami seems to have been downgraded to something more akin to a tropical storm, thanks in part to an increase in the use of short sales by some of the largest mortgage servicers.

A torrent of short sales will hurt the market just as much as a tsunami of foreclosures.

Foreclosure filings hit the lowest level seen in nearly five years in April, down 5% from the previous month and down 14% year-over-year, according to data released today by RealtyTrac.

While there is still plenty of pain to be felt in many regional markets with backlogs to work through, “More and more, it’s looking like short sales are going to take the air out of that expected bubble in foreclosures we were thinking would happen this year,” said Daren Blomquist, vice president at RealtyTrac, on a call with Builder this week. “At the end of the day, foreclosure activity will be up slightly this year compared to 2011. We’ll still see increases in filings in local markets … but short sales are helping to siphon off a lot of the potential foreclosures that are out there.”

Banks tried to do more short sales in early 2010, but were unsuccessful in resolving more loans that way. Perhaps with more government bailout dollars to pay off second mortgage holders and with requirements for write offs with the mortgage settlement deal, lenders will be in the mood to approve more short sales.

That’s promising news for home prices, which have been pummeled by the onslaught of distressed sales in recent years.

Why? Short sales are also distressed sales requiring a significant discount to sell. This is the kind of poorly reasoned nonsense pervading the mainstream media.

As of January, the latest month for which RealtyTrac has pricing data available, the average price of a short sale was 21% lower than that of a non-distressed sale; meanwhile REOs averaged a 34% price drop compared to non-distressed prices.

If lenders have fewer REOs and begin approving more short sales, the discounts will likely reverse. Short sale discounts will go up, and REO discounts will lessen. There is no reason for short sales and REO to sell for different prices on comparable homes. In the past REOs have sold for deeper discounts merely because lenders were more motivated to liquidate properties they already owned. If they own fewer REOs, their motivation to liquidate will lessen, and with less motivation, they will hold out for higher prices.

The shift may be due in large measure to the deal struck between the states’ attorneys general and mortgage servicers. Among the five largest lenders involved in that settlement—Ally, Bank of America, Chase, Citi, and Wells Fargo—the ratio of REOs to short sales is less than 1.5 to 1. Other lenders are averaging more than 2.5 REOs for every short sale performed. “That to me is an indication that the lenders in the settlement are more motivated” to avoid the foreclosure process, Blomquist said. “Those lenders account for a huge percentage of the loans being serviced. That alone is going to impact the industry, because the way they do things will be repeated by others.”

The lenders in the settlement deal have to write off a large dollar amount through short sale, so they are shifting gears until they reach their write-down targets. This is the kind of politically motivated change that’s very difficult to forecast. If not for the settlement, lenders likely wouldn’t have changed gears.

The post 8.7 years to clear Orange County distressed inventory at stable liquidation rate, had some astute observers who took exception to my numbers because they said many of the REO I said were coming were going to be resolved as short sales. To that I say, “so what?” Both REO and short sales are distressed sales, and both negatively impact the market. Resolving bad loans through short sales does not help the market in any way. As evidenced by articles like the one above, many people don’t understand that basic fact.