Nationwide, 1 in 4 mortgages were underwater by the end of 2009. Recent research suggests when a negative equity hits 25% (i.e., the borrower owes 25% more than the market value), borrowers tend to walk away from their mortgage, even if they are perfectly capable of making the payments. These two trends, taken together, can spell disaster for real estate values.
It does not take a genius to figure out that when foreclosures become increasingly common, there is a kind of “contagion” effect of cascading foreclosures, because every additional property thrown onto the market negatively affects all others. This is particularly the case when distressed property is sold, because the departing homeowner typically leaves the property is poor condition, and, very likely, after a prolonged period of deferred maintenance. Once these foreclosures sell, that becomes the new comp for the neighborhood, dragging down the prices of even non-distressed property. For an example of this, look no further than Fort Myers, Florida. Go to Realtor.com and punch up single family homes. When I did it recently, there were 53 houses on the market for less than $20,000. The cheapest one priced at $1,000. Or check out Las Vegas – almost as grim.
It has taken quite some time, but it appears that lenders are finally waking up to the fact that foreclosure will cost them a large amount of money in the short term – to say nothing of the detrimental effect on the neighborhood, and, on other loans in their portfolio. One consequence of this is the increased popularity of the short sale (when a lender avoids having to foreclose, by accepting less than the amount of the note, once the borrower finds someone to pay something close to market value for the property.) When short sales began to show up in great numbers, banks were famous for making them almost impossible to close. In many cases, no decision would be made by the bank until so much time had passed that the property (given the steep downward trajectory of the market) was no longer worth what the prospective buyer had offered. So no sale would take place, and the bank would dump another foreclosure onto the market. The banks’ stubbornness and simple failure to make a decision became something of a Catch-22 (and still is in many cases.) However, the signs all point to an increasing flexibility and acceptance of short sales by the lending community.
This is not done for altruistic purposes: in Las Vegas, for instance, “banks make $80 per square foot on foreclosures but $130 per square foot on average in short sales.”
Thus, the latest news from Nevada is that Las Vegas may move from the country’s foreclosure capital, to the capital of short-sales. Wishful thinking perhaps, but let’s all hope more lenders get on board and put an end to the vicious circle.