Foreclosure starts indicate future housing supply and pricing
Investors, realtors, and homebuilders watch foreclosure starts closely. Foreclosure starts forecast future housing 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.
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 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.
Foreclosure starts are falling steadily. Two years ago, starts approached 200,000. In October, they ticked down to 81,400—the tenth consecutive month below 100,000. This is a 31.5% decline from last year.
Impact on homebuilders
Increased foreclosure activity affects homebuilders—such as Toll Brothers Inc. (TOL), D.R. Horton, Inc. (DHI), PulteGroup, Inc. (PHM), and Lennar Corporation (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. These companies can increase prices. Currently, gross margins are experiencing seven-year highs.
Investors can also participate in the homebuilder sector through the SPDR S&P Homebuilders ETF (XHB).