The latest FNC Residential Price Index (RPI) indicated that U.S. home prices declined steadily in the last half of 2011. Since July 2011, prices on non-distressed properties (excluding foreclosure sales, REO sales and short sales) have fallen 4.5 percent averaging nearly 1 percent per month, according to the RPI. The persistent downtrends in home prices are driven primarily by conditions in the distressed market where the excess supply of foreclosed and REO properties —many vacant and neglected — continue to place downward pressure on home prices.
The overall economy, however, continued to grow at an annualized rate of 3 percent in the fourth quarter of 2011. Meanwhile, the labor market began to show signs of improvement. Nevertheless, high unemployment continues to constrain housing demand despite record lows of mortgage financing costs and home price affordability.
Looking ahead, the housing market is potentially positioned for a recovery in 2012 as policies are being deployed to promote bulk sales of foreclosure and REO properties to investors for rental conversions. Because GSEs and the FHFA hold more than 50 percent of REO properties (source: Calculated Risk), the program is widely expected to help stabilize home prices and promote the housing recovery. Additionally, the recent $25 billion settlement between the nation’s five largest banks and state-federal government will also prevent some properties flowing into the for-sale market.
Definition of the foreclosure price discount
Using a market value-based approach, price discounts in distressed sales are calculated by comparing a property’s sale price to its estimated market value, which is the price the property would have received had it not gone into mortgage default and foreclosure. The size of the difference — namely the foreclosure price discount — underscores the impact of market distress and foreclosure activities on property values.
Prior to FNC’s release of the market value-based foreclosure discount, there was no accurate industry data on true value discount priced into foreclosure or REO sales. Available measures of foreclosure price discounts typically compare the median sale price of foreclosed properties to the median price of regular, non-distressed properties. While useful as a general indicator of market distress, median price comparisons can be inadequate because underlying property conditions of distressed and non-distressed sales are generally not directly comparable. It is commonly known that foreclosed or REO properties frequently suffer from impaired property conditions.
Estimation of a foreclosed property’s market value in the absence of foreclosure events is based on FNC’s RPI. As a gauge of underlying home value, the RPI excludes sales of foreclosed homes. It is important to point out that the presence of any sizable foreclosure price discount does not necessarily mean money left on the table by sellers, or that potentially quick arbitrage profits exist in buying and reselling foreclosed properties. In addition to potentially large repair costs required to restore the properties, buying foreclosed homes can come with other hidden risks such as inadequate transfer of ownership.