Foreclosure starts indicate future housing supply and pricing
Investors, realtors, and homebuilders watch foreclosure starts closely. Foreclosure starts forecast future housing supply. Foreclosure timelines can vary widely by state. It depends 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 weak in the northeast. Homebuyers don’t focus solely 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. Foreclosure sale prices are usually 26% lower than non-distressed property prices.
Short sales tend to trade at smaller discounts—estimated at between 15% and 25%. The factors discussed above lower comparable sales prices. These lower appraisals and the value of neighboring properties.
Right now, low appraisal values are an issue for a lot of borrowers. This is especially true for borrowers using low down payment loans—like the Federal Housing Administration (or FHA) and Veteran Affairs (or VA) loans. If the appraisal comes in lower than the sale price, the borrower has to put up a down payment or forgo the sale. There are many ripple effects from foreclosures.
Foreclosure activity is falling
The federal government has taken numerous steps to reduce foreclosures. It started with loan modification programs and encouraged servicers to pursue other means of dealing with a delinquent borrower.
The loan servicer handles the loan pool’s daily management for the ultimate investor. They’re responsible for collecting mortgage payments, forwarding the interest and principal to mortgage-backed securities (or MBS) holders, and handling delinquent borrowers.
The government aggressively targeted non-bank servicers with regulatory enforcement actions. These servicers know that the government wants to see fewer foreclosures and more loan modifications.
The most common alternative is the short sale. The homeowner sells the property for less than the outstanding mortgage. The remaining debt is forgiven. The other type of disposition is called deed in lieu. The lender offers the borrower money in exchange for the keys.
Foreclosures aren’t cheap. The lender would like to skip the foreclosure process if possible.
Foreclosure starts are falling steadily. Two years ago, starts approached 200,000. In September, they ticked up to 91,038—the ninth consecutive month below 100,000. This is a 16.4% decline from last year.
The states with the highest foreclosure percentages are judicial states—like Florida, New Jersey, and New York. Non-judicial states have mainly worked through their foreclosure pipelines. This accounts for the difference between states when looking at home price appreciation—as measured by Case-Shiller or the Federal Housing Finance Agency (or FHFA).
Impact on homebuilders
Increased foreclosure activity affects homebuilders—like Toll Brothers (TOL), D.R. Horton (DHI), PulteGroup (PHM), and Lennar (LEN)—by depressing real estate prices and competing with new homes. Lower home prices mean lower average selling prices for builders, appraisal difficulties, and a glut of foreclosures resulting in lower sales.
The overall drop in foreclosure activity over the past year is good news for homebuilders. Lately, the builders have been in an enviable position as inventory is worked off. They can increase prices. They’re experiencing seven-year highs with gross margins.
Investors can also participate in the homebuilder sector through the SPDR Homebuilder ETF (XHB).