Are Discounts Shrinking?

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Whether they are flippers or buy-and-holders, more than a few investors’ business plans rely heavily on healthy discounts between the price paid for a foreclosure or short sale and the full price a property can be expected to command after it has been renovated and rented or listed for sale.

It’s a good idea to play close attention to discount trends in your market, which may require a subscription to a good foreclosure data provider.  On the mythical national level, it’s also possible to get a sense for how discounts are faring.  Right now there are some unusual currents stirring the pond.

Like everything else in real estate economics, distress sale discounts are a function of supply and demand.  However, the factors that drive supply and demand for foreclosures may have little to do with traditional housing economics. Foreclosure supply is increasingly a function of where you live, state laws more than local economic conditions are determining the speed with which foreclosures are processed and, in turn, local inventories (see Foreclosures Split America). Short sales don’t suffer than problem, but to some degree still are limited by lenders.

On the demand side for foreclosures and short sales, is the arrival of big money hedge funds driving up prices?  What about first-time buyers who are finally waking up to the fact that market is passing them by?  Are new investors getting into the game before the rule change?  Are established investors doing as many deals as they can while discounts are still healthy?  I don’t know of any good data that answers these questions, but if you have an opinion, please leave a comment below and tell us what’s going on in your market.

The tight supply of foreclosures has been a major cause of the record low overall inventories that are driving the increase in home values this year.   Should prices for foreclosures and short rise faster than full price properties, discounts should shrink.  Depending on whose numbers you believe, though September national median existing home prices have risen from 2 to 11 percent, year-over-year.  Are distress sale prices exceeding that rate and shrinking discounts?

RealtyTrac probably has the best national numbers on discounts, since their data is based on actual transactions filed in the courthouse.  Through the second quarter discounts on properties in foreclosure or bank-owned sold at an average price that was 32 percent lower than the average price of a non-foreclosure home, a slight improvement from a 30 percent discount in the first quarter and also a 30 percent discount in the second quarter of 2011 (RealtyTrac’s third quarter data should be out soon).   So it’s safe to assume that distress sale prices were tracking overall prices fairly closely through the first six months of the year.

However, perhaps the RealtyTrac numbers don’t tell the whole story.  As any investor knows, the discount also reflects the condition of the property.  Have discounts on move-in ready foreclosures and short sales actually been shrinking or is the mix of damaged and move-in ready properties changing? Thousands of foreclosures coming on the REO market this year were tied in agonizing long processing delays due to Robogate.  No doubt they suffered damage as a result.  Demand is limited:  amateur investors and first-time buyers don’t buy seriously damaged properties.  Buyers are serious, experienced investors who know what they are doing.   Could it be that prime distressed sales have been cherry-picked in many markets, leaving the serious rehabs to the pros (See Why Short Sale Discounts are Growing & The Best Banks for Bargains)?

The National Association of Realtors conducts a monthly survey of its members called the Realtor Confidence Index .  The RCI covers a wide range of issues, from appraisals to sales to foreign investors. The NAR data is not as good as RealtyTrac, since it does not come from actual transactions but it still could give us a better understanding of what’s going on.

The September survey, posted yesterday, reported that foreclosures and short sales sold at deep discounts – accounted for 28 percent of April sales (17 percent were foreclosures and 11 percent were short sales), down from 29 percent in March and 37 percent in April 2011.  Foreclosures sold for an average discount of 21 percent below market value in April, while short sales were discounted 14 percent. (Note: It’s not a good idea to compare these numbers directly with the RealtyTrac data since they come from very different sources.)

Realtors participating in the survey also rated the median prices for damaged foreclosures and short sales in their markets.  Foreclosures in the lowest tiers, “below average” or “Bottom 1 percent” enjoyed a discount (29.4 percent to 36.1 percent) twice as deep as move-in ready properties and those requiring little work (15.2 percent to 17.0 percent).

It’s quite possible that a change in the mix of quality on the market today could be keeping median discounts  lower than they would be if the mix were the same as it was a year ago.  The fact that discounts have stayed steady in the RealtyTrac numbers may reflect this changing mix and may be masking a shrinking of the discount for top tier quality properties.  What do you think?  Share your thoughts below.

A final caveat.  Discounts aren’t the final word when deciding whether to buy a property.  As my friend Broderick Perkins advises, be sure to do your homework (Don’t judge a foreclosure by its price).

Photo: Mikko Luntiala

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About Author

Steve Cook is the editor of Real Estate Economy Watch and writes for a several leading outlets in addition to BiggerPockets, including Equifax and Total Mortgage. He also provides communications consulting services to leading real estate companies. Previously he was vice president of public affairs for the National Association of Realtors.

10 Comments

  1. With more investors turning to real estate as well as the hedge fund investors – it is getting harder & harder to find deeply discounted properties. When you do find a good deal – you have to be ready to act quickly or it will be gone before you can even get an offer in. Something that strikes me as strange in this area is there are numerous foreclosures and REO properties available, but the new home builders are still doing business selling the new homes. It is as if the bubble never happened in some instances.

    • Dale,

      Good point. The boom in new home sales caught a lot of people by surprise. There clearly has been a pent up demand among buyers who prefer a newly built property.

  2. As a property manager in Metro Detroit, we see a number of things happening:
    1. Active investors are buying as many properties as they can while you can still pick up a SFH under $30,000
    2. New investors are getting into the game.
    3. Foreign money is flooding our market like there’s no tomorrow. They often are overpaying significantly because they still think they’re getting a good deal in Detroit at $15,000 (very rarely the deal is a good one, but they don’t know this.)

    The first time homebuyers action has slowed over the last 6 months here in SE Michigan.

    Thanks,
    Trevor

    • Trevor,

      Thanks for your comment.

      I’m interested in your point about foreigh buyers. Are these largely Canadians bargain-hunting across the border? Are they individuals buying one or two propeties for themselves or investment partnerships?

      Steve

      • Steve,

        No, not really Canadians at all. Primarily, my clients are originating from Austrailia, Singapore, China, and the UK. There are several companies with offices in Detroit that sell properties back to investors from those countries. Problem is, they’re selling complete garbage back to these people and making it sound like it’s a goose that lays golden eggs each month. It’s not. These companies are basically robbing these investors.

        Trevor

  3. Bryan Jaskolka on

    You can still find good discounts out there, it’s just that like with everything else, the number of them is decreasing. You need to know where to look, and like Dale said, act quickly once you’ve found it.

  4. Steve,

    Are we building another smaller bubble? Hedge funds seem to be buying on poor criteria, inflated expected returns, and overpay on prices. Seems like what got us into trouble in the first place. Could be good in the long term for those sifting through their mistakes, but painful in the short term.

    Jason

  5. My discount to market value is actually growing, but the rehabs are more complicated, so in the end it’s about the same. Long gone are the 25% discounts on simple carpet & paint rehabs.

    That said, it takes more effort to find the deals. Two years ago I could get as many as I could without so much effort. Not anymore. I’m still able to keep up my typical volume (about 100 flips & 50 rentals per year) but have to look in more places to find them.

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