When foreclosures are a small fraction of the total real estate market, they don't affect the average home price. In a normal market Realtors won't even show a prospective homebuyer foreclosed homes. They either want to a) fix them up and flip them themselves for a quick profit or b) show the buyer something more expensive in order to earn a bigger commission. But the number of foreclosed homes has long passed the critical mass necessary to impact the average home price. One indication of this is the Realtors that are organizing bus tours of foreclosed homes.
At this time, every new foreclosure on the market lowers the average sales price. Every time a bank initiates a foreclosure, they are lowering the market price on the homes they are already trying to sell. It would make sense for the banks to tell borrowers that have missed a couple of payments, "Just pay us something. If you make at least half of your required payment we'll forestall initiating the foreclosure proceedings." Then they could focus on the serious deadbeats while they try to trim their inventory of homes that they already own. The result would be a higher average home price and reduced losses.
Unfortunately, the system is set up so that the company servicing the mortgage is not the same as the one that gets the partial payout when the home is foreclosed. The servicer is losing money with each missed payment, so the servicer has an incentive to foreclose as quickly as possible. But the servicer is not responsible for the value of the property when it is sold. To the servicer, what matters is cash flow, not loss mitigation. So as property values drop, homeowners have less incentive to make their monthly payments and foreclosure filings accelerate. The whole thing creates a negative feedback loop that floods the market with empty homes and reduces the value for all homeowners.
The drop in home prices has been long enough and hard enough that pessimism in the real estate and homebuilding industry is at an all time high. The prevailing wisdom is that this will continue for a long time to come. Yet the latest home price data offers a reason for hope. While home prices continue to drop, the veocity of the drop seemed to hit its peak in the first quarter of 2008. The rate at which home prices are decreasing slowed in April and May.
Some of this can be explained by seasonal patterns. Home prices tend to rise faster in April through August than during the rest of the year. But that seasonality explains only a small part of the flattening prices. It's dangerous to make long term projections based on just a few months of data flattening the curve, but it's now beginning to appear that home prices in general will continue to drop for the next 12 months or so, but are starting to stabilize.
Since California and Florida are two states of high interest, I've prepared two graphs that show the direction of home prices indicated by the current data. The graphs show forecast results up through August 2009.
If you are interested in other cities, please reply to this post and let me know where your real estate interest is.
The data right now is pointing to a return to prices that represent a 4% to 5% annual return since 2000. Four percent is a sustainable level of return. The curves shown are simply a reversion to the mean. The data right now is not pointing to an overcorrection which would give us a 10-year annual return significantly less than 4%. If the economy were to go into a significant recession, an overcorrection would be not only possible, but likely.
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