There are many myths about housing markets perpetuated by banks and the financial press. Two of these myths include (1) keeping people in a house keeps up the values, and (2) foreclosures reduce neighborhood values.
Many believe that allowing delinquent mortgage squatters to stay in place improves the condition of a property. Perhaps in rough neighborhoods prone to property crime, occupancy is better than abandonment, but in most neighborhoods, when delinquent mortgage squatters stay on, they property gets run down. Why would anyone spend any money to improve or even maintain a property in which they have no financial interest? If people were prone to do this, then landlords wouldn’t need to spend money maintaining rentals. Delinquent mortgage squatters have no landlord to call, so when something breaks, unless it makes the house unlivable, it goes unfixed. A property in poor condition is worth less than a well maintained one.
Many also believe 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 is, and always has been, property debt. Foreclosure removes that problem. Further, once a house goes through the foreclosure process and gets sold to a new owner, the value of that home rises to the general level of the neighborhood. Either the flipper who bought the foreclosure or the new owner improves the property to fix the problems left over from the delinquent former owner who didn’t maintain it.
As lenders have played the amend-extend-pretend game, they have allowed people to squat for as long as five years in some of these properties. The longer lenders allow these people to squat, the more these properties become run down, and the more neighborhood values drop. It’s really that simple. Plus, the cure for this problem is equally simple: foreclose on the squatters and recycle the property into the hands of a new homeowner who will care for it. But don’t take my word for it, read the report:
Foreclosure Externalities: Some New Evidence
Kristopher Gerardi, Eric Rosenblatt, Paul S. Willen, and Vincent W. Yao
Working Paper 2012-11 August 2012
Abstract: In a recent set of influential papers, researchers have argued that residential mortgage foreclosures reduce the sale prices of nearby properties. We revisit this issue using a more robust identification strategy combined with new data that contain information on the location of properties secured by seriously delinquent mortgages and information on the condition of foreclosed properties. 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 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. We argue that the most plausible explanation for these results is an externality resulting from reduced investment by owners of distressed property. Our analysis shows that policies that slow the transition from delinquency to foreclosure likely exacerbate the negative effect of mortgage distress on house prices.
The decline in value, the “negative effects,” peak before the properties complete the foreclosure process. If the decline in value were caused by the foreclosure, the values would remain unchanged until the bank listed and sold the property. That isn’t what the researchers found. This has huge implications because now banks can foreclose under the guise of improving property values.
Just say no to foreclosure moratorium
The recent change in laws in Nevada which essentially caused a statewide moratorium over the last year. The reduction in inventory also caused house prices to bottom and rise nearly 10% this year. Such occurrences would suggest broader foreclosure moratorium would help prices bottom in other locations. That is not the conclusion of the federal reserve.
Because foreclosure transitions in a given area are highly correlated with the number of outstanding distressed properties in the same area, one would find a significant, negative correlation between the sale price of a non-distressed property and the number of surrounding properties transitioning into fore- closure. Based on such results, one might conclude that implementing a fore- closure moratorium would increase house prices. However, such a conclusion would be wrong. Delaying transitions into foreclosure does not reduce the to- tal number of distressed properties, which is what exerts downward pressure on prices according to the true model. Indeed, over time, delaying foreclosures without stopping transitions into delinquency would increase the total number of distressed properties and thus serve to lower prices.
Wow! That could have been written on this blog. I have made the same argument for years. It’s shocking to see this kind of common sense in an academic study supported by real data and analysis put out by the federal reserve. There is hope for them yet.
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Proprietary Irvine Housing News home purchase analysis
$475,000 …….. Asking Price
$528,000 ………. Purchase Price
11/24/2004 ………. Purchase Date
($53,000) ………. Gross Gain (Loss)
($42,240) ………… Commissions and Costs at 8%
($95,240) ………. Net Gain (Loss)
-10.0% ………. Gross Percent Change
-18.0% ………. Net Percent Change
-1.4% ………… Annual Appreciation
Cost of Home Ownership
$475,000 …….. Asking Price
$16,625 ………… 3.5% Down FHA Financing
3.55% …………. Mortgage Interest Rate
30 ……………… Number of Years
$458,375 …….. Mortgage
$130,478 ………. Income Requirement
$2,071 ………… Monthly Mortgage Payment
$412 ………… Property Tax at 1.04%
$67 ………… Mello Roos & Special Taxes
$119 ………… Homeowners Insurance at 0.3%
$477 ………… Private Mortgage Insurance
$225 ………… Homeowners Association Fees
$3,371 ………. Monthly Cash Outlays
($309) ………. Tax Savings
($715) ………. Equity Hidden in Payment
$19 ………….. Lost Income to Down Payment
$79 ………….. Maintenance and Replacement Reserves
$2,445 ………. Monthly Cost of Ownership
Cash Acquisition Demands
$6,250 ………… Furnishing and Move In at 1% + $1,500
$6,250 ………… Closing Costs at 1% + $1,500
$4,584 ………… Interest Points
$16,625 ………… Down Payment
$33,709 ………. Total Cash Costs
$37,400 ………. Emergency Cash Reserves
$71,109 ………. 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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