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Distressed Property: The Impact on House Values

We are honored to have Chip Wagner, an icon in the appraisal industry and our good friend, as a guest blogger yesterday and today. Yesterday, Chip defined the role of the appraiser in today’s real estate market.  – The KCM Crew

Today, Chip will discuss the impact distressed properties have on housing values.

Contrary to the alarming nature being used in reporting that appraisers are killing deals, I would bet that most of my peer appraisers are not seeking the lowest possible sales to use in their appraisals. They are searching the data available in the real estate market for the best comparables out there. But the reality is that good comparables are hard to find.

Just last week, I was finishing up an appraisal in a condominium in a Chicago suburb.  It is a 246-unit development that has 24 listings available. In the past 12 months, there were 5 sales, of which 4 were distressed (short sales and foreclosures). The one arm’s-length transaction sold pretty low too, and when confirming with the listing agent, we found that the owner needed to sell (but not under duress) and understood the oversupply in their marketplace and didn’t want to sit on the market for a year or more competing with the overpriced competition. In this same condo development, in the previous year (13 to 24 months ago), there were 15 sales of which 6 were distressed (still 40%, but not 80% of the market). As a result, the average sales price has dropped over 15% in the past year.

First of all, with 24 competing on the market and only 5 sales in the past year, which is a 2.5 year supply of inventory. A balanced market is 4 to 6 months, so a 2.5 year supply of inventory is going to place significant downward pressure on prices.

What does this mean to overall values?

According to RealtyTrac.com, foreclosures, on average, sell for a 35% discount and short sales sell for a 10% discount. These distressed properties might not be in the same physical condition as the non-distressed properties. However, at sizable discounts, many purchasers are more than willing to absorb the risk of purchasing a property “as-is” and doing the necessary repairs as well as playing the waiting game with lenders in purchasing short sales.

There comes a point where distressed market competition becomes the marketplace. The appraiser may consider making an adjustment for the “terms of sale.” For example, if using a short sale or a bank-owned foreclosure comparable in an appraisal, an adjustment could be made to reflect the discounted value of that comparable. I have done this in many of my appraisals, without underwriter or appraisal reviewer concerns. The appraiser must support this adjustment and thoroughly explain why it was made.

There are other scenarios where distressed competition is a very small portion of the market, and these sub-markets appear to be doing better.  But even if there are not distressed sales flooding the marketplace, we are still often challenged with finding decent comparables – and that is the volume of sales taking place.

In the entire Chicago area, according to local MLS data, in January 2006 we had over 83,000 detached homes to sell in the previous 12-month period. In July 2011 it has fallen to 38,300 detached homes to have sold in the past year. What this tells us is that on average, neighborhoods that once had 20 comps to select from for consideration in our appraisal reports, now have 8 comps to select from. And you can bet with the typical market having 30% distressed competition, this is down to 4 or 5 arm’s-length transactions. This is making the appraiser’s job more difficult than ever. Comparables are limited, and the motivations and terms of the sale are complicated.

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13 replies
  1. Chip Wagner, SRA, SCRP
    Chip Wagner, SRA, SCRP says:

    Again, the message today is 1) Real Estate is local, and 2) Real Estate Professionals (brokers, appraisers, lenders) need to work through this together.

    Too many times I read articles and hear people talk and give interesting statistics that are “regional” or even “national” and we all know that some areas and sub-markets are doing better, and some are doing worse.

    Secondly, I believe that real estate brokers and agents have the local knowledge and can profile a buyer and competing areas, and this is often an appraiser’s weakness. Appraisers have been trained to choose most similar comps in close proximity, often times just considering data that is most recent and closest to the property. Regulations have contributed to this as Fannie Mae appraisal guidelines for years, said comparable had to be within one mile from the subject property.

    But as agents know, a buyer doesn’t come into the town and say I want to live in the “XYZ Subdivision” – they say to their agent please show me properties in this price range, within this distance to schools or employment areas, and homes that are this size with “X” Bedrooms. Also, buyers preferences for newer or older homes, as well as other locational influences such as larger lots, etc. Some appraisers tend to look for comps in the XYZ Subdivision, and not searching for how buyers compare and select properties.

    In relocation appraisals, we call this identifying the “Market Segment” which is the area in which potential buyers for the subject property may look for substitute properties. It is definitely a strength of the Realtor and a weakness for the appraiser. Realtors, help the appraisers out.

    In my example in the blog above where there were only 5 sales in the past year, 4 were distressed, I went out of the condo complex to a competing development less than 1/2 mile away for a recent arms-length sale for a comparable sale. The property was similar in age, style, functional utility, condition and price. It was in the same Market Segment, which is the same area a buyer for the subject would also consider this competing condo development.

    Reply
  2. Geo
    Geo says:

    “In my example in the blog above where there were only 5 sales in the past year, 4 were distressed, I went out of the condo complex to a competing development less than 1/2 mile away for a recent arms-length sale for a comparable sale. The property was similar in age, style, functional utility, condition and price. It was in the same Market Segment, which is the same area a buyer for the subject would also consider this competing condo development.”

    Chip, you stated that “There comes a point where distressed market competition becomes the marketplace. ” So in the condo complex that you had the assignment at, you said there were 5 sales of which 4 were distressed.
    How many listings were distressed?
    Well 4 of 5, that’s 80% is it not? 80% certainly IS the marketplace within that specific development. If that is what is occurring, at the very moment, then that is the market condition in that complex. By going outside, you are have chosen comps that do not necessarily reflect the subjects immediate on-site market- the complex of 246 units (which is a significant amount of units) Sure, the other complexes may compete with the subject, but that is somewhat a subjective assumption to make. Perhaps ‘Market Segment’ comes into play, but it certainly takes a fair amount of presumption. How about this; if the 3 of 5 sales were arm’s length, would you have gone outside of the complex? I’m going to guess no. But because the lender or client or whoever might bristle or raise a flag, you utilized comps from another complex. If the subjects complex is mostly distressed sales, then that is the current state of the on-site, micro-market of that complex. By using outside data, you are manipulating the outcome of the opinion of value. Sure, you can present an argument for- as I can present an argument against. My point is, distressed sales are vital to an appraisal, to indicate what is happening and the current market conditions in any specific locale. I would have used all 5 sales from within. I then would have utilized 3 or 4 sales from competing complexes and presented the deltas of the mean and median sold prices of each complex. My final opinion of value would be drawn from within the subjects complex, but also I would be able to show the the spread between the competing properties.
    After adjusting for ‘type of sale’ I’m sure that the spread would be less than 35%. I cannot imagine that prices in any area of Chicago are rising and inventory is probably increasing, right? The distressed sales are a part of the market, I know lenders would like to pretend they don’t really exist, but the fact is clear, that they do. They are are also as you stated, plentiful as substitutes and offer direct competition for non-distressed properties.

    Reply
  3. Brett Reichel
    Brett Reichel says:

    My biggest issue with appraisals currently is that lender pressure continues, despite “new” regulations. What I mean is the pressure that Fannie Mae and Freddie Mac put on the appraiser to use changes in median prices to justify adjustments for time. I see appraisers using this justification consistently, despite the fact that this has never been acceptable concrete evidence of change in value. Would you comment on that, please?

    Reply

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