In other neighborhoods, a foreclosed home might be boarded up and plastered with large signs advertising bank-owned or REO. Some of those homes might remain in an abandoned condition for years. The weeds grow high enough to cover sidewalks, pranksters throw rocks through second-floor windows, and the home becomes an eyesore, a dumping ground for used mattresses and automobile parts.
Signs of foreclosures can leave neighbors wondering, “What about the value of my home?” Owners of surrounding homes are concerned that a foreclosure might affect the market value of their home, and rightly so.
Appraisals Include Comparable Sales, Plus Foreclosures
Property appraisals are based on three approaches:
- Cost approach. This is the value to build the home, plus the value of the land.
- Income approach. This is rarely used for single family homes and is used to compare multiple units, based on capitalization rates.
- Market value approach. This type of appraisal compares the subject property to three comparable sales in the neighborhood.
If two comparable sales are regular transactions and one is a foreclosure or short sale, will the appraiser use that distressed sale as a comparable property? To get answers, I talked to Derek Yuke, an appraiser at Yuke & Associates in Sacramento.
Yuke tries to find arm-length transactions when putting together an appraisal. These are considered sales at market value, offered for sale by a willing seller and purchased by an able and willing buyer, with neither party under duress nor related. Even if it means pulling comparable sales from an adjacent neighborhood and adjusting for value, most appraisers, he says, can find arm-length transactions to use in a appraisal.
Yuke has been in the business since 1996 and says,“If I do use a foreclosure, I explain why I used it. I say it’s not a good comp and don’t give it a lot of weight.” He says foreclosures do not represent market value, and he can always find regular sales to incorporate into his appraisals. "If there are only foreclosures in an area, then that affects market because it becomes the value," Yuke warns.
Foreclosure Sales Make HOAs Vulnerable
Yuke continues, “If there aren’t any regular transactions, then you’re stuck. A condo development is tough.” What happens if there are only short sales or foreclosures within a homeowner’s association? According to Yuke, those are the best comps for that development because they are the only comps available.
Distressed sales within a homeowner’s association also means it’s unlikely that the owner paid that unit’s prorata share of the HOA dues. If the homeowner’s association fund runs low, it’s the other home owners who end up paying the tab in the form of higher association dues. Unfortunately, although many homeowner associations have the power to foreclosure if dues are in arrears, few have the money or means to do it, and those that do often forego the process when the mortgage amount is higher than the value of the unit.
How Foreclosures Weaken Home Prices
Although some studies show that neighborhoods with strong foreclosure numbers see a rough drop of 1% in value, it’s not always due to sold value of the property. Often falling prices are due to buyers’ perception of the area, followed by a refusal to live in such neighborhoods, coupled with the previous owner’s extreme neglect of the property.
Some foreclosure sales appear to self perpetuate. Soon as one home owner goes into default, others nearby seem to follow. If the owner in default is evicted or abandons the property, the lawn isn't mowed, deferred maintenance takes over and the deserted home falls into disrepair. Homes with no curb appeal and screaming for repairs do not sell for market value.
Part of the drawback to buying foreclosures is the fact the homes are sold “as is,” and buyers have no guarantee of condition. Sellers who are losing everything think nothing about trying to salvage some aspect of their desperate situation by selling the built-in appliances and ripping out the copper plumbing to sell for scrap.
At the time of writing, Elizabeth Weintraub, DRE # 00697006, is a Broker-Associate at Lyon Real Estate in Sacramento, California.