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Foreclosures/Short Sales affecting Neighborhood Property Values & a Radical Solution Idea

By George L. Duarte MBA, CMC

“The Real Deal Guy” sm

May 15, 2008

One of the most unfair and disturbing things about the foreclosure situation that is not necessarily readily apparent is the knock-on effect on the other neighbors who may be having no problems making their mortgage payments, but who may, for their own reasons, want to sell or refinance their homes in the normal course of their lives.

I recently have had several situations with previous clients who are in that exact position. The problem is with the property valuation process- most of us know that the primary valuation method of residential properties is the “comparative sales” method, meaning that the value of a subject property is primarily derived from a comparative analysis of houses that have sold and closed in the neighborhood, preferably within a half-mile radius. There are 2 other methods of property valuation, but they are used primarily for commercial properties, and not very relevant to residential properties.

So the problem is when a bank owned property (REO) goes on the market, the bank only wants to get paid back what it is owed or close to it. If there was a lot of equity in the property, or if there was a second loan on the property, the bank doesn’t care and will price the property low enough to get their loan back, (wiping out the second loan, by the way, more on this later). If the bank loan was a high LTV, with little equity to begin with, the bank will decide how much of the loan it is willing to eat and price the house accordingly, which could be a substantial discount of 25-30-40%. This could represent a great a opportunity for a speculator investor, or someone who has been priced out of the market in past years, but is terrible for the rest of the neighbors who may wish to sell their homes legitimately, or refinance.

Another side effect of this situation is that now it is also very difficult to get a second loan or equity line of credit, most of these lenders have fled the market completely, primarily for the reason mentioned above.  There are some lenders who are servicing these loans, Countrywide and GMAC in particular, who have notified their customers that the customers would no longer be able to take any additional draws on their lines of credit, particularly in areas of “declining market value”, which California is.

Is there anything that can be done about this situation? As long as this process keeps occurring, it will just prolong the recovery time of the residential property values.

I have an idea that has no chance of being adopted- what if the appraisal and valuation process were temporarily altered to allow the REO’s and short sales infection of a neighborhood to be ignored in valuation of “legitimate” transactions of people who are not in trouble on their loans? In effect, creating a two-tier system of valuation along the lines of a statistical bell curve- the REO’s and short sales would be at the low end of the scale, or better yet, ignored completely. I think this valuation method would be completely fair to everyone, and in fact, would help to hasten the property values recovery by A. limiting the valuation damage exposure to “good” homes”, B. recognizing that low property values are an anomaly relative to a statistically insignificant number of “bad” properties, and C. creating incentive to purchase and therefore creating inherent higher value in foreclosed properties, because as soon as they sold, they would then have instant equity created by being valued as a “good property” again.

I think we have to look at this foreclosure situation like a virulent epidemic- it is unfortunate for the people whose loans went bad and “caught” the disease, but like a plague, those properties should be “quarantined”, and not allowed to “infect” the good properties, whose loans are being serviced and in good standing.

Wow, I thought of that all by myself! It’s amazing what can happen when you have a chance just to sit down and think for awhile.

What do you think? Let’s go to Congress with this, I’ll bet Barney Frank would love this—

Till next time- won’t be so long, I promise

George Duarte, MBA, CMC

“The Real Deal Guy” sm