Why a drop in foreclosure completions is good for homebuilders (Part 2)

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Foreclosures are a leading indicator of future housing supply and pricing

Investors, realtors, and homebuilders alike closely watch foreclosure activity because it forecasts future housing supply. Foreclosure timelines can vary widely by state, depending on whether a judge needs to approve a foreclosure. The large foreclosure pipeline in the judicial states is one reason why prices are still languishing in the Northeast. Homebuyers don’t focus solely on existing supply; they also focus on projected supply.

Shadow InventoryEnlarge Graph

Foreclosures and how they affect pricing, supply, and demand

Increases in foreclosure activity correlate with lower home prices because distressed properties tend to trade at a discount to non-distressed properties. Foreclosure sale prices are typically 15% to 20% lower than non-distressed prices. Short sales tend to trade at smaller discounts (closer to 15%). These factors lower comparable sales prices (or comps), which, in turn, lowers appraisals and the value of neighboring properties. Low appraisal values are an issue right now for a lot of borrowers, especially those that are using low down payment FHA and VA loans. If the appraisal comes in lower than the sales price, the borrower must put up a down payment or forgo the sale. So there are many ripple effects from foreclosures.

Probably the biggest effect of foreclosures in psychological. In neighborhoods with foreclosure activity, blight causes home values to decline and makes people feel less comfortable taking risk and moving up or buying a new home. Homebuilders rely on people feeling comfortable enough about their own financial situation to buy a new home.

Finally, a supply of homes in the foreclosure pipeline represents future competition for new homes. If a metropolitan statistical area has a high shadow inventory of properties in some state of foreclosure, builders are less likely to want to build there, which has the knock-on effect of less construction employment.

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