Are you realizing a lot less profit than you anticipated when you sold your last flipped foreclosure?
Are inflated discounts conveying a false impression of the REO-to-rental return on investment that is attracting hedge funds like bees to honey?
Have you been basing your business plan on foreclosure discounts reported by reputable sources like RealtyTrac or the National Association of Realtors?
The problem could be the way those organizations and others compute the foreclosure discount, according to Dr. Stan Humphries, the chief economist at Zillow.
“What’s common in these analyses is the computation of the foreclosure discount using the median (or average) sale price of foreclosures compared to the median sale price of non-foreclosures. A significant pitfall with this approach is that it is comparing apples and oranges: the typical foreclosure property is likely quite different than the typical non-foreclosure property. The homes may be different in size, location or a variety of other attributes that affect property value beyond simply their status as either foreclosure or non-foreclosure homes,” says Humphries.
Most foreclosures started out life as mid to lower-priced homes, smaller and with fewer amenities than the median of all home sold in a market. When you compare a foreclosure sales price to similar homes, you get dramatically different results. Yet Humphries has an important point. When time comes to sell your foreclosure, it is not going to be appraised based on the median house in the market but on comparable sales in your neighborhood. You’ll never realize the “foreclosure discount” used by some services, but only the difference between what you paid and comps.
In September, NAR reported that foreclosures sold for an average discount of 21 percent below market value in August, while short sales were discounted 13 percent. RealtyTrac reported the average sales price of a pre-foreclosure home in the second quarter was 26 percent below the average price of a non-foreclosure home, up from a 24 percent discount in the first quarter and a 18 percent discount in the second quarter of 2011.
Most services report discounts are shrinking (Are Discounts Shrinking), but Humphries’ number is far below the others cited above—7.7 percent. Below are his “true foreclosure discounts” for 26 leading markets.