“We should pay heed to foreclosure activity, which have reached their highest level in at least the last five years. As these homes are put up for sale, we may see some further dampening in home prices.”

– S&P Case Shiller Home Price Index 4/27/2010

“We expect the high rates of negative equity and foreclosures to keep national home value appreciation near zero for some time, possibly as long as five years.”

- Zillow Real Estate Market Report 5/10/2010

We have made the point several times over the last six months that the foreclosure situation will have the greatest impact on home values throughout the rest of the year. How many foreclosures will occur? When will they be released to the market?

The ‘shadow inventory’ of homes that are in this category is growing rapidly and it seems that they are about to be brought to market. Let’s take a closer look at the issue and examine the pieces to be aware of: 1) Existing Foreclosures, 2) Negative Equity, and 3) Strategic Defaults.

1. Existing Foreclosures

Just this week, Calculated Risk reported that foreclosures on government loans surged 59% compared to last year:

The combined REO (Real Estate Owned) inventory for Fannie, Freddie and the FHA increased by 22% in Q1 2010 from Q4 2009. The REO inventory (foreclosed homes) increased 59% compared to Q1 2009 (year-over-year comparison).

Many of these homes will come to the market sometime this year at discounted prices. That will put downward pressure on home values throughout the year.

2. Negative Equity

First American CoreLogic’s May Negative Equity Report showed that:

More than 11.2 million, or 24 percent, of all residential properties with mortgages, were in negative equity at the end of the first quarter of 2010, down slightly from 11.3 million and 24 percent from the fourth quarter of 2009. An additional 2.3 million borrowers had less than f iv e percent equity. Together, negative equity and near-negative equity mortgages accounted for over 28 percent of all residential properties with a mortgage nationwide.

Negative equity, often referred to as “underwater” or “upside down,” means that borrowers owe more on their mortgage than their homes are worth. Negative equity can occur because of a decline in value, an increase in mortgage debt or a combination of both.

Why is this important? Negative equity triggers many borrowers to stop making their mortgage payments even if they have the financial ability to pay. This is known as a strategic default.

3. Strategic Defaults

The number of people choosing to strategically default (‘walk away’) is increasing dramatically. The Chicago Booth/Kellogg School Financial Trust Index reported:

The researchers found that the number of homeowners willing to default when the value of a mortgage exceeds the value of their house, even if they can afford to pay their mortgage, dramatically increased compared to just a year ago. The percentage of foreclosures that were perceived to be strategic was 31 percent in March 2010, compared to 22 percent in March 2009.

As more and more borrowers ‘walk away’ from their mortgages, there will be a wave of distressed properties coming on the market.

What does this mean to you?

There is little doubt that there will be a growing number of distressed properties entering the market as the year goes on. If you are thinking of selling, do it now before this discounted inventory becomes your competition.