The discounts on distress sales are critical for investors. Discounts− the price differences between “normal,” full value properties and a distress sales like foreclosures or short sales−set the parameters for capital gains when a property is sold, especially in markets with modest price appreciation. All things being equal, the greater the discount the greater the potential gain.
Discounts for foreclosures versus short sales have been undergoing some fascinating and unanticipated changes in recent months, making short sales, which may equal or overtake REO sales this year, more attractive to investors than they once were.
The Ten Percent Gap
When they were rarely used, before the housing bust, short sales typically sold at a discount around 10 percent or so, which was about 10 percent less than the discounts enjoyed by the average REO. In about 2009, as foreclosures flooded markets in the “sand states,” the discounts for foreclosures and short sales both jumped 10 percent, to about 30 percent for foreclosures and 20 percent for short sales.
The reasoning behind the difference between short sales and REOs relates to condition. The thinking was that homeowners undertaking short sales were motivated to do so to protect their credit to the extent possible and therefore it was in their interests to maintain their properties in better condition than properties that had suffered foreclosure. Unlike foreclosures, short sales are not repossessed and original owners often remain in place until the sale is closed. Foreclosures, on the other hand, often suffer ill treatment at their hands of their defaulting owners and may languish in Neverland for years and slowly deteriorate, especially in recent years, in the wake of the Robo-signing scandal.
No longer are short sales unusual; today they are nearly as common as foreclosures. Lengthy delays in processing foreclosures in the wake of Robogate scandal, new federal rules designed to speed up the short sale process, the prevalence of software platforms for short sales and a gradual acceptance of short sales by lenders has made the process of selling homes for less than their mortgage principal easier and more popular. Bank of America is even offering some struggling homeowners payments of up to $30,000 if they sell their homes in a short sale and avoid ending up in foreclosure.
Short Sales Catch up to REOs
Beginning in 2010, as short sales became more prevalent, the difference between the two forms of distress sales began to shrink. In April 2010 short sales were averaging a 21 percent discount nationwide, REOs a 27 percent discount. By January 2012, when Lender Processing Services began reporting foreclosure and short sale discounts on a monthly basis, the difference had shrunk to 3 percent: 21 percent discount for short sales, 24 percent for foreclosures. In March and April, the latest data available, discounts were at 25 percent for foreclosures and 22 percent for short sales.
Short sale discounts are greater in markets with a heavier saturation of distress sales and less in those that are stabilizing. RealtyTrac recently found that although big discounts are still available with short sales, those discounts may be dwindling in some local markets as rock-bottom home prices draw in buyer demand, finally forming a solid market bottom, such as Detroit and Washington, D.C., although it’s likely that Richmond, Va., Grand Rapids, Mich., Birmingham, Ala., and possibly Oklahoma City and Des Moines fall into this category.
Another reason for the convergence of discounts is simply that the task of managing the large number of distressed properties in the market today is immense, which may, in some cases, contribute to suboptimal pricing of some distressed properties. Moreover, banks don’t want to compete with themselves. “Banks are getting about the same price on short sales and foreclosure sales in areas that have high levels of distressed transactions,” said Raj Dosaj of LPS. “Clearly the mortgage industry has made significant efforts to put distressed properties through the short sale process as an alternative to foreclosure.”
Finally, another factor affecting the changing difference between short sale and foreclosure discounts may be the scarcity of move-in ready REOs today. Though inventories of both foreclosures and short sales are generally low, move-in ready properties, which sell at the least discount from normal listings, are the most difficult to find today. The LPS numbers may reflect a greater percentage of deeply discounted damaged properties among foreclosures that require significant expenditures to restore to move-in conditions and therefore, higher discounts to sell. Thus, the difference between short sale and REO discounts may actually be less than LPS calculations.
Best Banks for Short Sale Bargains
Just as short sale discounts vary by market, they also vary by lender. Last week RealtyTrac released a fascinating and useful analysis of the seven best banks for short sale bargains.
1. PNC Financial Group
Avg. Pre-Foreclosure Sales Price: $133,015
Avg. Percent Discount: 40%
Avg. Days to Sell: 151
2. Government Entities (Fannie Mae, Freddie Mac and HUD)
Avg. Pre-Foreclosure Sales Price: $127,618
Avg. Percent Discount: 42%
Avg. Days to Sell: 154
3. Ally Financial (Formerly GMAC)
Avg. Pre-Foreclosure Sales Price: $143,410
Avg. Percent Discount: 35%
Avg. Days to Sell: 188
4. Ocwen Financial
Avg. Pre-Foreclosure Sales Price: $126,071
Avg. Percent Discount: 43%
Avg. Days to Sell: 168
5. Sun Trust Banks
Avg. Pre-Foreclosure Sales Price: $151,308
Avg. Percent Discount: 32%
Avg. Days to Sell: 207
6. Bank of New York Mellon
Avg. Pre-Foreclosure Sales Price: $155,488
Avg. Percent Discount: 30%
Avg. Days to Sell: 283
7. Bank of America
Avg. Pre-Foreclosure Sales Price: $166,389
Avg. Percent Discount: 25%
Avg. Days to Sell: 223