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Foreclosure Inventory Continues to Fall: What Does It Mean?

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Foreclosure Inventory Continues to Fall: What Does It Mean? PART 1 OF 3

Why Did Foreclosure Completions Rise in June?

Foreclosure completions rose by 2,000 units in June

Foreclosure completions rose by 2,000 units to 38,000 in June 2016, according to CoreLogic. Completions fell 5% year-over-year.

Why Did Foreclosure Completions Rise in June?

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That said, 38,000 is still a relatively high number. From 2000 to 2006, foreclosure completions averaged around 21,000 per month.

Because foreclosures represent a process that may or may not end up with the bank owning the home, foreclosure completions are a better indicator of foreclosure activity than foreclosure starts.

In June, the total foreclosure inventory fell 26% from a year ago to 375,000 homes. This works out to be about 1% of all homes with mortgages. It takes us back to the levels in late 2007.

How foreclosures forecast future housing supply

Investors, realtors, and homebuilders watch foreclosure activity closely because it forecasts future housing supply. Homebuyers don’t just focus on the existing supply. They also focus on the projected supply. The foreclosure pipeline has to be added to the projection of the normal housing turnover.

Increases in foreclosure activity correlate with lower home prices. Distressed properties tend to sell at discounts to non-distressed properties. Foreclosure sales prices are typically 15%–20% lower than non-distressed prices. Short sales tend to trade at smaller discounts—closer to 15%. These discounts are narrowing as supply becomes tighter.

These factors lower the comparable sales prices. In turn, this lowers appraisals and the value of neighboring properties. Right now, low appraisal values are an issue for many borrowers, especially those who are seeking low down payment Federal Housing Administration or Veterans Affairs loans. If the appraisal comes in lower than the sales price, the borrower must increase the down payment or forego the sale.

As a result, foreclosures create many ripple effects throughout the housing market.

Implications for homebuilders

Homebuilders such as 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 because buyers anticipate lower prices.

When investing in homebuilders, you could focus on builders with exposure to markets where foreclosure activity is winding down. Foreclosure activity is one of the biggest reasons why West Coast markets are seeing building activity while the Northeast is seeing very little building activity. The demand for new construction is highest there.

If you’re interested in trading the housing sector as a whole, you can look at the SPDR S&P Homebuilders ETF (XHB).

In the next part of this series, we’ll look at foreclosures as a percentage of homes.

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