Distressed homes still drive sales

July 31, 2016

By Diana Olick, CNBCGlobalPost Writer

A boarded up house sits for sale Feb. 14, 2008 in Detroit, Michigan.
Bill Pugliano

The housing market appears to be surging ahead suddenly on all cylinders, but that does not mean it is free of the remnants of its recent downfall.

The number of distressed home sales, either bank-owned or short sales, may be shrinking, but it is still making up a significant share of the overall housing market.

Foreclosure-related sales made up 21 percent of all US sales in 2012 and short sales, when the home is sold for less than the value of the mortgage, made up 22 percent, according to a new report from RealtyTrac. Add it up and 43 percent of all 2012 sales were of distressed properties.

Banks are making more of an effort to do short sales instead of taking a home to foreclosure, and new federal guidelines are streamlining the process. That led to a 15 percent drop in sales of bank-owned homes and a 6 percent increase in short sales. This has helped home prices because short sales on average sell for a higher price than do bank-owned homes, because they are usually neither abandoned nor vandalized.

"Although foreclosure-related sales represent a shrinking share of total sales, primarily because of fewer bank-owned purchases, distressed sales are still a disproportionately high portion of the overall housing market," said Daren Blomquist, vice president of RealtyTrac. "And while distressed properties — whether bank-owned, pre-foreclosure or short sales not in foreclosure — are still selling at a significant discount compared to non-distressed properties, average distressed property prices are increasing in many markets thanks to strong demand and limited inventory."

Limited inventory continues to be the key in today's housing market, driving prices higher than most analysts expected. This is surprising, as distress in the market has not simply vanished. There are currently 1.7 homes in the foreclosure process and 1.5 million more seriously delinquent loans (90 days without a payment), according to a new report from Lender Processing Services. Banks are being more aggressive with loan modifications and principal forgiveness, but many of these homes will inevitably end up going back to the banks.

"Inventories continue to be low because non-distressed sellers are largely absent from the market, apparently waiting for prices to increase even more before they decide to sell," noted Blomquist. "I think we are seeing signs of the shadow [foreclosure] supply hitting, but more on a market-by-market basis and often in the form of short sales as opposed to REO [bank-owned] sales — although REO sales are starting to show signs of life in judicial foreclosure markets with bigger backlogs."

Strong investor demand for these properties is pushing prices higher, even creating bubbles in some of the formerly hardest hit markets, like Phoenix and Las Vegas. If prices get too high, however, and investors can't reap the returns they need, then supplies could grow. So far that has not happened, but home prices are rising far faster than anyone predicted.