How Foreclosures Affect Real Estate Comps
Relatively speaking, real estate isn’t always an asset that is easy to liquidate. While we may often discuss how small cap stocks are hard to buy and sell thanks to their limited pool of traders and investors, homes are harder to sell by an order of magnitude.
That is, where it requires only capital to purchase a share, or many shares, of stock, you have to live in your home. You have to pay property taxes on it, and if it has a yard, you have to mow it. That’s a lot more than just money—it’s responsibility.
Foreclosures vs. Home Prices
Home prices are falling all over the country, but yet, in some places, a few people are still eager enough to build their own. This desire to build a home suggests to economists that, in some areas, putting up a new home still makes more sense than buying one that’s already standing. This isn’t the case for most locations.
In fact, foreclosures are having a very obvious effect on real estate values through comps, or comparative analysis. Real estate agent professionals and do-it-yourselfer’s know that when you go to list a home, you have to compare it to all the recent sales in your area. When we go to price stocks, we price them based on the last sale of the security which we want to buy.
The problem is, more of these recent sales are foreclosures. In California and Arizona, two states hardest hit by recession and the bursting of the real estate bubble, foreclosures account for 45% of all sales. Unfortunately, when a bank goes to sell a home, it wants only to protect what it has in it; namely, the amount outstanding on the mortgage lien. Selling a home for under market value isn’t much of a concern as long as it can
1) Get the home off its books
2) Get most or all of its money back on the sale
So what are banks doing? They’re selling…like crazy!
On average, each foreclosed home is being sold on the market for 35% less than homes that were not foreclosed. So, with more homes coming to market, and many of them coming to market at low prices, the value of everyone’s home is going down.
This is, by far, the biggest threat to the US economy in the short-term. While a decline in housing is not always bad—it can bring out the buyers!—it isn’t good in the short-term. When homes decline, so does the sentiment of new homebuyers. Also, those who are underwater begin to think about a grand, foreclosure-fueled exit, too.