Investor Caution: Beware of Heat in Distressed Housing
As real estate investors rush to buy distressed properties and reap the rewards of a still-heating rental market, two distinct phenomena are suggesting caution, perhaps extreme caution.
The first is in sales of foreclosed homes that the banks now own (REO) and short sales (when the home is sold for less than the value of the mortgage, with the bank eating the loss).
With banks looking to unload not only homes they’ve repossessed but homes with delinquent mortgages, they are courting more investors.
Reports of bidding wars are growing louder, but home prices are not moving higher with all the action. In fact, most homes sold in April received just two or three offers and sold for below list price, according to a new survey from Campbell/Inside Mortgage Finance.
“The average price for non-distressed properties declined 1.5 percent from March to April, while the average price for short sales dipped 1.7 percent. For damaged REO [bank-owned] the average price fell 1.4 percent and for move-in ready REO the average price slipped 0.3 percent,” according to IMF’s HousingPulse.
The high share of distressed property sales, (47.9 percent of all home sales on a three-month running average) is contributing to downward price pressure, but appraisals are also holding the market back.
“Yes, we are experiencing bidding wars on desirable properties, but many times the appraisals don't come in at the [contract] price. The appraisers are keeping the [transaction] prices down even when buyers see the value and are willing to pay more,” complained one real estate agent responding to the HousingPulse survey.
The second phenomenon is more disturbing, and it’s happening in some of the hottest foreclosure markets, like Phoenix, Arizona. Investors are flocking there, as we’ve reported widely on CNBC, and that is creating huge competition and a big problem: Foreclosed properties sold to investors at the courthouse steps (that is, when an investor outbids the bank) are, according to one source, selling for prices above market value.
“Investors have lost all sense of rationality and control in Maricopa County, Arizona,” says mortgage analyst Mark Hanson. “The third party sales (non-REO) are so hot that winning bids for houses in need of major rehab are selling for over 100 percent of fully rehabbed present value.”
According to Hanson’s sales data, by the time an investor spends the cash to rehabilitate the home to rental condition, he/she is likely 25 percent underwater on the home. And these are the same sales that Hanson claims were selling for 60 percent of present value just 18 months ago.
Unfortunately, third party sales don’t count as comparables, nor do the post-rehab houses that investors rent. The buyers can’t sell them post-rehab for what they paid, so the values never make it into price statistics.
Investors in California are not quite as crazed as Arizona, according to Hanson, but they are still paying 90 percent of rehabbed value; that also puts them underwater on the investment once they’ve fixed up the home.
Yes, investors will get rental returns, but depending on monthly financing costs, and the upfront investment, they may not see the kind of returns they originally expected, and they may not be able to sell in the time frame they originally planned.