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.
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Proprietary Irvine Housing News home purchase analysis
$509,000 …….. Asking Price
$315,000 ………. Purchase Price
5/8/2000 ………. Purchase Date
$194,000 ………. Gross Gain (Loss)
($25,200) ………… Commissions and Costs at 8%
$168,800 ………. Net Gain (Loss)
61.6% ………. Gross Percent Change
53.6% ………. Net Percent Change
3.9% ………… Annual Appreciation
Cost of Home Ownership
$509,000 …….. Asking Price
$17,815 ………… 3.5% Down FHA Financing
3.65% …………. Mortgage Interest Rate
30 ……………… Number of Years
$491,185 …….. Mortgage
$143,407 ………. Income Requirement
$2,247 ………… Monthly Mortgage Payment
$441 ………… Property Tax at 1.04%
$42 ………… Mello Roos & Special Taxes
$127 ………… Homeowners Insurance at 0.3%
$512 ………… Private Mortgage Insurance
$336 ………… Homeowners Association Fees
$3,705 ………. Monthly Cash Outlays
($484) ………. Tax Savings
($753) ………. Equity Hidden in Payment
$21 ………….. Lost Income to Down Payment
$84 ………….. Maintenance and Replacement Reserves
$2,573 ………. Monthly Cost of Ownership
Cash Acquisition Demands
$6,590 ………… Furnishing and Move In at 1% + $1,500
$6,590 ………… Closing Costs at 1% + $1,500
$4,912 ………… Interest Points
$17,815 ………… Down Payment
$35,907 ………. Total Cash Costs
$39,400 ………. Emergency Cash Reserves
$75,307 ………. 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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