Foreclosures are a leading indicator of future housing supply and pricing
Foreclosure activity is closely watched by investors, realtors, and homebuilders alike because it forecasts future housing supply. Foreclosure timelines can vary widely by state, depending on whether a foreclosure needs to be approved by a judge. The large foreclosure pipeline in the judicial states is one reason why prices are still languishing in the Northeast. Homebuyers don’t focus just on existing supply. They also focus on projected supply.
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, lower 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.
Foreclosures continue to fall
Foreclosure completions dropped by 1,000 units (or about 0.4) to 46,000, according to CoreLogic. This is down 17.7% year-over-year. That said, 46,000 is still a relatively elevated number—from 2000 to 2006, foreclosure completions averaged around 21,000 a month. Since foreclosure represents a process that may or may not wind up with the bank owning the home, foreclosure completions are a better indicator of foreclosure activity versus foreclosure starts.
Implications for homebuilders
Homebuilders like Lennar (LEN), D.R. Horton (DHI), PulteGroup (PHM), and Toll Brothers (TOL) compete with existing homes for sales. Foreclosure activity can act as a damper on the local housing market, as buyers anticipate lower prices. Investors should focus on the builders with exposure to markets where foreclosure activity has been muted. Investors who are interested in trading the housing sector as a whole should look at the S&P SPDR Homebuilder ETF (XHB).