Signs of a foreclosure sale can leave neighbors wondering about the value of their homes. Owners of surrounding homes are concerned that a foreclosure might affect property values. They worry that this reduced-price property could negatively affect the perceived value of their home as a comparable in the neighborhood.
The change in the value of your home will depend on the type of property appraisal method that is used when two separate homes are compared. The changing value of your home can also be dependent on the neighborhood or area itself.
Having a Foreclosure Neighbor
For the most part, foreclosure homes vary in appearance. Some foreclosure sales are handled quietly and resold quickly by the lender. One day a moving van pulls up, loads the occupant’s belongings, and departs. This event will be shortly followed by a real estate broker's sale sign. A few weeks later, a sold sign pops up and new owners move in.
In other situations, a foreclosed home might be boarded and plastered with large signs advertising it as a bank-owned or real-estate-owned (REO) property. Some foreclosed homes may remain abandoned for years. The weeds grow high enough to cover sidewalks, pranksters throw rocks through second-floor windows, and the home becomes an eyesore for the neighborhood.
What Appraisers Consider "Comps"
If two comparable home sales are regular transactions—with no problems with title or ownership claims—and one is a foreclosure or short sale, the appraiser may use that distressed sale as a comparable property. An appraiser can use the cost, income, or market value approach when appraising a property.
- The cost approach method considers the cost to build the home plus the value of the land included with the home.
- The income approach compares multiple units based on capitalization rates (cap rate). Cap rate is the return on investment (ROI) that a particular property can be expected to generate.
- The market value approach compares the subject property to three comparable sales in the neighborhood.
In the real estate world, comparable sales are also known as "comps."
How Appraisals Work
Derek Yuke, an appraiser at Yuke & Associates in Sacramento, explains the process used by their firm, in business since 1996. The firm tries to find arms-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. Neither party is under duress or related. Even if it means pulling comparable sales from an adjacent neighborhood and adjusting for value, most appraisers can find arms-length transactions to use in an appraisal.
"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 asserts that foreclosures do not represent market value, and his team can always find regular sales to incorporate into appraisals.
"If there are only foreclosures in an area, then that affects the market because it becomes the value."
Foreclosures Make HOAs Vulnerable
If there aren’t any regular transactions, then you may be stuck. Condo developments can be a problem, especially if the only sales have been short sales or foreclosures. According to Yuke & Associates, those are the best comps for that development because they are the only comps available.
Distressed sales within a homeowner’s association also mean it’s unlikely that the owner paid that unit’s pro-rata share of the HOA dues. If the homeowner’s association fund runs low, it is the other homeowners who end up paying the tab in the form of higher association dues.
Unfortunately, although many homeowner associations have the power to foreclose if dues are in arrears, few have the money or means to do so. Those who do often forego the process when the mortgage amount is higher than the value of the unit.
Foreclosures Weaken Nearby Prices
Although some studies show that neighborhoods with high foreclosure numbers see a drop of 1% in home value, the value drop is not always due to the number of foreclosures. Often, falling prices come from buyers’ perception of the area, coupled with the previous owner’s extreme neglect of the property.
Some foreclosure sales appear to self-perpetuate. As soon as one homeowner goes into default, others nearby seem to follow. If the owner in default is evicted or abandons the property, the deserted home falls into disrepair. Homes with no curb appeal that need significant repairs do not sell for market value.
Part of the drawback to buying foreclosures is that the homes are sold “as is,” and buyers have no guarantee of the home's condition. Some homeowners who are losing everything due to foreclosure might think nothing about selling the built-in appliances and ripping out the copper plumbing to sell for scrap. Houses with missing features also lower neighborhood prices.