Short Sales and Foreclosures … Bargains?

Given the way the popular press discusses short sales and foreclosures, I guess I shouldn’t be surprised at how often I get calls from prospective home buyers wanting to focus on those market segments.   It usually only takes an afternoon to educate those buyers, and to expand the search to all properties that meet their needs for price, size, age, style, location, schools, etc.  

Recently I spent a little time to assemble some market data on the subject:

Short Sales and REOs, Austin 2009

That page shows the same data twice — sorted by average sale price and then by the percentage of all sales in an area that were short sales and foreclosures.  I reviewed all MLS Areas in the Austin metropolitan area and then isolated the twelve areas with the highest and lowest rates (six each) of short sales and foreclosures.

To be clear, note that the listings I identified as “short sales” all included those words in the “Realtor® remarks.”  Some of those may not have been “short” by the time they closed, and there may well have been short sales that were not described as such in MLS.   I believe this is the most reliable way to identify short sales after the fact, however.  Listings that I counted as REOs (“real estate owned”) include bank/lender foreclosures, as well as properties owned and sold by Fannie Mae, Freddie Mac, and HUD.

Now, here’s my brief analysis:  Mortgage “issues” have generally clustered in certain geographic areas and in below-average price ranges.  The vast majority were far below the median price that was fairly steady in the $185,000 range last year.   You can see that the “Avg. SS Disc. %” and “Avg. REO Disc. %” were meaningful in most cases, but in the higher price ranges the number of distressed properties was much smaller.  

Foreclosured properties were consistently discounted relative to other homes in their market areas, as were most short sales.   However, note that in four areas the average sale price of short sales was higher than the overall average prices in the same areas.  In one area, where the average of all sales for the year was about $423,000, the average sale price of the short sales was 26% higher — $532,000!

These “discount” levels are the reason that consumers and bargain-hunting home shoppers are drawn to short sales and foreclosures.  What becomes apparent quickly as they begin to see actual properties is that there is always a reason for a property to be priced below market.  The market is very effective at matching price and value — i.e., ultimate sale price and property condition/location — and mortgage lenders are not in the business of leaving money on the table.

So … does the fact that short sales and foreclosures are often discounted mean that that’s where the bargains are?  Answer:  maybe.   When homeowners stop making mortgage payments, they almost always stop doing any maintenance in the home as well.  As the months go by on the way to short sale or foreclosure, their properties deteriorate, and they must be discounted in order to sell.  In addition, you may find significant restrictions in what sellers of short sales and foreclosures can and will pay, meaning higher costs at closing for the buyers.

An experienced real estate professional can tell you what a property should be worth in its immediate neighborhood after repairs.   If it can be purchased at a price that leaves room for the buyer to make the necessary repairs, cover any extra closing costs, and still be at or below market value, then it’s probably a good deal.  If you find one of those, buy it — quickly!  You’re not the only one looking and in the Austin area if it’s really a bargain it may be gone by sundown.

Far too often, however, these properties are priced as if they had already been repaired, and uninformed and poorly represented buyers end up investing more than they would have for another property in the same neighborhood that was in much better condition.    (If I buy a used car that needs tires, paint, and new upholstery for half of what the same car would have cost in good condition, did I get a bargain?)

My recommendation:  

• Decide what you’re looking for in your new home. 
• Discuss your needs and priorities with your real estate agent.
• Consider all properties that may meet your needs, ignoring whether they are new homes, private resales, short sales, or foreclosures.   What matters is getting the right home for you and your family for the right total investment.  
• Your real estate agent’s job is more than just sending you listings and driving you around.  One of the most important things he or she can do for you is price  consultation, so make sure they provide that service, and that you’re confident that you are making a sound, well-informed financial decision.