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Is It Done Yet? Foreclosure Inventory at November 2007 Levels

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Foreclosure completions fell in December

Foreclosure completions fell by 1,000 units to 32,000 in December, according to CoreLogic. Completions fell 23% year-over-year. That said, 33,000 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. The total foreclosure inventory fell 24% from a year ago to 433,000 homes. This works out to be about 1.1% of all homes with a mortgage. It takes us back to November 2007 levels.

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How foreclosures forecast the 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 the foreclosure activity correlate with lower home prices. Distressed properties tend to sell at a discount to non-distressed properties. Foreclosure sales prices are typically 15%–20% lower than those of non-distressed prices. Short sales tend to trade at smaller discounts—closer to 15%.

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 a lot of 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 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 because buyers anticipate lower prices.

When investing in homebuilders, you could focus on builders with exposure to markets where the foreclosure activity is winding down. Foreclosure activity is one of the biggest reasons why the West Coast markets are seeing building, 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).

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