They say if you don't help save your neighbors house from burning, yours might catch fire too.
Solutions to the "foreclosure crisis" are being floated everywhere you turn, by congress, internet pundits, even the President. Their "solutions" generally involve government regulation of the market. Proponents claim that if we don't step in and help out now, we're all going to be hurt eventually through lower home values.
But is that argument accurate? Do "bargain priced" foreclosures hurt values throughout the neighborhood, or throughout the whole city?
Enter the Foreclosures...in an already competitive market; a group of very motivated sellers is growing, sellers in foreclosure. These may be short sales or bank owned, in either case these sellers are highly motivated to sell. Their price is often set low (perhaps artificially low) to encourage a fast sale.
Foreclosure sellers typically value a quick close, over top dollar. In order to compete, sellers staring down a sea of foreclosures must offer a compelling price. This drives prices down in the short run.
But, foreclosures are not the only competition out there. All sellers have been fighting for buyers for a few years now. How does the recent rise in the number of foreclosures affect the market?
First things first...a look at the numbers:
Year Total Home Sales Foreclosure Sales Percent of Total Sales
2005 20,531 †† 1681 † 8.2%
2006 17,526 †† 3042 † 17.4%
2007 * 15,000 * †† 5500 * Ω 36.7%
* = estimates
† = Data from Housing Link
†† = Data from RMLS
Ω = Data from Hennepin Co. Foreclosure Task Force Report, published 10/18/07
In ‘05 foreclosures made up about 8.2% of sales. In ‘06 they were 17.4%. Still a relatively percentage over all, but much larger than in ‘05. The forecast for this year isn't any better, if the estimates prove accurate, 36.7% of sales will have been in foreclosure.
Foreclosure numbers are rising fast, and are more concentrated is certain areas. The map below, from Housing Link, shows for example foreclosures in Dec. 2006.
Note the clusters in foreclosure in isolated areas.
So, back to the question... How does the recent rise in the number of foreclosures affect the market?
Competition is the key. To be competitive in today's market, in any neighborhood, sellers must offer buyers a good value, in other words high quality for a good price.
Neighborhoods with large numbers of foreclosures become targets for investors looking for a great deal. Price can dominate these markets, hurting values throughout the neighborhood. Price can become more important than quality.
In an area with very few foreclosures, sellers with quality rise to the top. Sellers who can afford to invest in detailed cleaning, staging, and making all the necessary home improvements, stand to compete very well with other homes in their market.
Just as an example look at the two neighborhoods of Minneapolis with the largest drop in median value ‘05-'06, Powderhorn, and North. These were also two of the neighborhoods with heavy numbers of foreclosures. Values fluctuate on a lot more than foreclosure, but it can make an impact, and I believe it has in these cases.
Conclusion: The result of the "foreclosure crisis" is a drop in values only in areas with the highest concentration of foreclosure. The effect is strongest in neighborhoods that can least afford it.