Distressed Sales to Sandbag Housing Revival

Foreclosed properties made up 3 in 10 homes sales in the first quarter, and more could be on the way.

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Distressed properties made up 3 in 10 homes sales in the first three months of the year, as the foreclosure onslaught continues to sandbag a real estate recovery.

Third-party buyers purchased 233,000 foreclosed properties in the first quarter, with distressed homes representing 31 percent of all home sales, according to a report released Wednesday by RealtyTrac. "In a normal year, 1 to 2 percent of total home sales are distressed," says Rick Sharga of RealtyTrac. "We're in the 30 percent range—it's really mind boggling."

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The data is disconcerting because of the link between distressed transactions and home prices. "Foreclosure sales drive down prices," says Celia Chen of Moody's Analytics. "The greater the share of foreclosure sales to total sales, the greater the downward pressure on prices." On average, buyers paid 27 percent less for distressed properties than they did for homes not in foreclosure during the first quarter, RealtyTrac found.

After peaking in the first quarter of last year, the tally of foreclosed homes sales dropped 33 percent through the first three months of this year. The share of distressed sales, meanwhile, also declined from 37 percent to 31 percent of all home sales during that period. But analysts worry that the distressed share could soon move higher again.

In earlier months, many lenders delayed putting distressed homes onto the market as they waited to see if the properties would qualify for assistance through the Obama administration's housing rescue initiative, Chen says. But the program's results have been disappointing, says Zach Pandl, an economist at Nomura Securities. Of the 1.2 million trial loan modifications that were initiated through April, nearly 278,000 have already been canceled. "Many homeowners have been unable to pay their mortgages even after a modification," Pandl says. And after learning that properties won't qualify for federal assistance, banks are free to move them through the foreclosure process, which will likely drive foreclosure sales higher, Chen says.

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Meanwhile, large numbers of mortgage delinquencies are ensuring that additional foreclosed inventory will continue flowing into the pipeline. Roughly 9.5 percent of mortgage loans were at least 90 days past due or already in the foreclosure process at the end of the first quarter, according to the Mortgage Bankers Association's most recent national delinquency report. "We are still creating distressed inventory more quickly than we are burning it off," Sharga says.

Pandl says it could be another two years before the market has worked through the excess of foreclosed homes. "Unfortunately, foreclosures are likely to remain an important feature of the U.S. housing market for years to come," he says.

Distressed sales remain a leading threat to real estate values even though a recent report found surprising firmness in home prices. The S&P/Case-Shiller home price report, released Tuesday, showed that real estate values in 20 major U.S. cities increased about 4 percent in April from a year earlier. Economists, however, noted that sales activity had likely been juiced by a tax perk from Uncle Sam that has since expired. As a result, home prices are expected to decline further in the second half of the year.

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Even if the share of foreclosed home sales doesn't reach its previous high-water mark of 37 percent, it's likely to remain in the 25 to 35-percent range for some time, Sharga says. "What it suggests is that we are in for a long, slow, flat recovery," he says.

Chen expects home prices to begin increasing next year, but only at a very slow pace—thanks in large part to the foreclosure inventory.