Matthew Ferrara, Philosopher
 

Why There’s No Reason to Fear Foreclosures

Contrary to popular belief, a wave of foreclosures would be the best solution for the housing market. In fact, they’re already amongst the best performing assets in the market.

Nothing dispels myths better than data. And if Richard Smith, CEO of Realogy Corporation, the nation’s largest provider of housing services is correct, it’s time to shed some light on the “wave of foreclosures” myth. Mr. Smith should know, because nobody sells more foreclosures nationwide than the brands that make up the Realogy network.

For five years, the fear of a mythical “shadow inventory” of foreclosures lurking just beyond the market has fueled speculation that prices were header for another big drop. The so-called “wave” of foreclosures threatened to flood the market with a price-crushing over-supply. We were told, unless foreclosures were delayed, modified or prevented, we’d get a double-dip, or even housing collapse.

According to Mr. Smith, it’s a myth that foreclosures are “piling up” somewhere waiting to be released en-masse into the market (time-shift video to 5 minutes). Just the opposite is true: foreclosures are selling as quickly as they are released into the market. Smith notes that Realogy is selling them at their most rapid pace in 30 years: about 56 days from list to contract to close, which is half the industry average. And two-thirds of the transactions are cash.

Maybe some of us were confusing cause with effect. The exact opposite of the “foreclosure effect” seems to be occurring, as buyers have re-entered the market alongside foreclosures. Here at our heretical blog desk, we’ve long contended that foreclosures are necessary and good for a market recovering from a bubble (note the phrasing). Now it seems the data is telling us that foreclosures are the best performing transactions in the entire housing market.

This means that foreclosed properties are even outperforming almost every other kind of transaction, from owner-occupied homes to inheritance of property.

Now that’s something brokers and their clients need to think about. Few markets in America are selling owner-occupied homes in 60 days on market. We suspect we won’t find any city in the infamous Case-Shiller index with such metrics. Buyers and investors have decided to “call the bottom” and come off the sidelines. They’ve are riding the foreclosure wave back into the market.

If all of this is true, then what can we conclude about the market, foreclosures and the future? First, it would seem that few REALTORS have noticed this story: at least not those with twelve-month listing agreements on most of their listings…. but let’s move on: Second, the foreclosure fear has distracted us from noticing that foreclosures have become the market. Buyers are saying so. One-third of foreclosures are purchased by owner-occupying first-time buyers. The rest are being snapped up by cash-carrying investors turning them into rental units. Just follow the transactions.

The foreclosure myth has misdirected our attention on reminiscences of the past, ones where “mom and dad” were our typical clients, getting married, starting a family, and buying a home. We’re far away from the markets where people “save for college” through housing. Younger buyers don’t plan to stay put long enough to recover their commission fees, let alone equity. Those agent working with sellers trying to get equity back might be better off advising advise them to just stay home.

The rapid sale of foreclosures is also the largest and best free-market stimulus to the local and national economy. It takes about $15,000 to get a foreclosure up-to-code for rental. That’s money spent at local home improvement stores, with local service professionals. It generates local sales taxes. Every foreclosure sale is stimulative to the white-collar economy, too: commissions are paid to agents, title companies, appraisers and attorneys. The ripple effect continues outward to stimulate movers, painters, landscapers and dozens of ancillary industries that create jobs and pay wages with every foreclosure transaction.

More foreclosures, waves of them, are what’s needed to stimulate the economy.

Could waves of foreclosures cause existing prices to drop further? It’s doubtful for a few reasons. First, sensible owner-occupied sellers have already priced foreclosure prices (and pace) into their offering price. If they haven’t, they aren’t in the market anyway. A drop in their fantasy-emotional price is irrelevant to the market. Second, the pace of foreclosure sales is so brisk that prices should stabilize: It’s only rotting inventory that causes downward price pressure on the stock. If turnover remains high, prices will level off. Third, if more foreclosures stimulate local economies, wages and consumer sentiment will rise, sparking an up-tick in demand.

More foreclosures will cause prices to rise not fall.

Misplaced emotional sentiment and unfounded fears have tied the invisible hand of the market for five years. As we’ve come to realize that jobs, not higher home prices, are the key to economic recovery, we must admit that more foreclosures, not less, is exactly what we need to jump start the American economy.

But we have to overcome our fears, first.

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  • WJF

    Matthew,

    Another home run. We’ve discussed this for what seems like years now, you were always the voice of reason and logic. There’s no question that the market should take care of itself, and that’s the quickest and surest way to recovery and a return to normalcy… although as we know the new normal won’t look like the old normal… but it will be normal! ~bf

  • Shadow Inventory just seems like a made up term Economists came up with no real support to their claim

  • Eric:

    Thanks for your comment. I don’t think I agree. Shadow inventory refers to a very specific and measurable phenomenon in the housing market, specifically homes “in foreclosure” but not yet sold (or for sale). Such “distressed” properties can be measured, and this creates uncertainty which causes buyers to change their habits. It also skews the number of homes for sale in “industry” reports because they are often not included in REALTOR or housing industry charts, even though buyers can access them. So sellers are competing with these properties even though their real estate agent might not have been able to statistically account for them and make pricing judgements.
    Why do you say you think “shadow inventory” was made up? I’d be interested to know.
    — Matthew

  • I guess I feel that way because we never actually saw a second wave of foreclosures. On a site I don’t have any more I wrote about shadow inventory and tried to figure out what it might be for my area, but I couldn’t find good data to come up with a number. Eventually I just went with…the market is what it is and went with the data I could pull from the MLS…kind of like what you mentioned above concerning the market reports.

    I think I primarily feel that way because, depending on the source, the definition changes. One source will quote one number while another source will quote something else. In the end I think I felt that maybe they just came up with a term, but didn’t really have much to support it with, but I do like how you described it. I think that makes more sense to me.

  • Eric:

    Now I understand where you’re coming from. In some areas, there wasn’t enough inventory for a second wave – and in some areas, it’s yet to come. Last year, foreclosures (the so-called second-wave) were disrupted for a few different reasons. The government sued banks (the robo-signing scandal which turned out to have harmed NOBODY but still resulted in a billions of dollars in “fines”) – a shakedown of banks that caused them to stop all foreclosures while they could review. Then, in the fall (just before the election? Hmmm) Fannie and Freddie announced they would be halting foreclosures “for the holidays” and in the northeast, foreclosures were halted for a few weeks during the after-effects of Hurricane Sandy. It’s safe to say that those “pent up” shadow inventories will be coming back into the market, at an increased pace, this year.
    As for sources of inventory, I completely agree with you that the data is hit-or-miss, often skewed by the “reporting” source’s political views. Worse, much of the data released is usually meaningless – for example, Case-Shiller is often reported as an “average of the index” which is totally meaningless since a house selling in CA doesn’t “average into” the price or inventory of one being sold in New Jersey… but the media mixes it up because nobody really understands markets, just numbers. I think of it like the employment numbers – multiple sources report different numbers each week/month, and even then, they “revise” them three months later. It’s junk news. What matters is that your local broker has very good, accurate data – often a mix of industry/MLS data and their own local efforts to collect it – so they can know the hyperlocal foreclosure inventory for the market that matters most: their particular clients’ market.
    Nice chatting. This is a tough issue, and we haven’t heard the last of foreclosures in some states for YEARS to come.
    — Matthew