More REO’s on the Rise? Another Drop in Home Prices?

That dreaded shadow inventory of homes that has captured headlines and gripped the industry and market analysts with angst is beginning to make its way out of the darkness, according to John Burns Real Estate Consulting (JBREC).

The California-based firm says loan modifications “were certainly successful in delaying the inevitable – foreclosure.” But homes that have been stuck in that neverland of somewhere between delinquency and repossession are now winding their way through the foreclosure pipeline at a quicker pace and will soon come out the other end as a short sale or REO.

In its September market report, JBREC colorfully illustrates what it calls “no more free lunch,” meaning the days of defaulted borrowers staying in their home, mortgage- and rent-free, for extended periods are coming to an unavoidable end.

One of the company’s staff members said their neighbor, who had a Notice of Default filed last September, continued to dress the home up with elaborate decorations on all holidays. Occasionally, the “owners” moved the BMW and SUV out of the driveway to pull their two jet skis out of the garage. Last month, they moved all the vehicles to clear a path for the new furniture being delivered. The Notice of Trustee Sale recently appeared.

Another JBREC staffer said a neighbor mired in divorce and job loss lived free in their house for almost a year, while having lavish birthday parties with petting zoos and buying new high-tech equipment for the home. The property recently turned over as REO and promptly sold for about $100,000 less than it should be worth. (The distressed sale price proved to be a painful comparable for the staff member when she tried to refinance her own home shortly after.)

According to JBREC, there are now approximately 2.5 million foreclosures in process, and another 2.5 million mortgages that are 90-plus-days delinquent. The company says these numbers will soon begin to trend

down, while REO (which JBREC says is currently at 562,000 bank-owned homes) and short sales will trend up.

When this happens, the company says the greatest levels of distress will be in the markets already hit hard, such as Stockton, California, and Orlando, Florida. JBREC’s assessment of the top five shadow inventory markets in terms of months of supply include Modesto, California; Miami, Florida; and Riverside-San Bernardino, California, in addition to Stockton and Orlando, which top the list.

Naturally, the question on everyone’s mind is: what will happen to prices with the shadow supply coming to light? The answer, according to JBREC, is “prices will decline, potentially significantly.”

“Prices will decline because there is more than a one year supply of homes on the market, and several bank servicing arms and REO managers have told us that they will drop price to get the loans and homes off their books,” JBREC said in its report.

The company warns that only a quick economic recovery, or a government mandate to rent the homes out, can prevent further price declines.

JBREC says tremendous affordability and investor appetite for REO could create a pricing floor that isn’t too far below today’s prices. However, the company points out that price declines are already showing up in the new home market. In the three months following the April 30 tax credit deadline, home builders dropped price an average of 3 percent, according to JBREC.

How much further will prices fall? JBREC says that varies by market and price point. But the company argues that Case-Shiller and median prices have already overstated the correction on most homes, so the declines reported in the news will be far less than what is really occurring in the market.

Not everyone is expecting such a dire outcome. According to the Wall Street Journal’s Nick Timiaros, Alan Mallach, a senior fellow at the Brookings Institution, thinks the shadow supply of homes will be much more manageable.

Based on a paper by Mallach, Timiaros says some delinquent loans have “cured,” either naturally or through loan modifications; banks are getting better about approving short sales; and even when a foreclosure happens, more investors are buying the properties at courthouse auctions before they show up as REO.

From Mallach’s analysis, Timiaros says the likeliest outcome is a steady flow of foreclosures over a longer timeframe, which will stave off another crash in home prices, but will probably lead to low or no appreciation in home prices for several years.

By Carrie Bay at

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