Foreclosures and the Neighborhood Housing Market

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1 Foreclosures and the Neighborhood Housing Market Dr. Jeremy R. Groves Assistant Professor of Economics Northern Illinois University

2 Current Statistics 6.0 Total Delinquency Rates

3 Current Statistics 18 Delinquency Rates By Type Prime Subprime 8 FHA 6 VA

4 Current Statistics 10 Percent in Foreclosure By Type Prime Subprime Federal Housing Administration loans Veterans Administration loans 4

5 Current Statistics Third Quarter Foreclosure Starts for One to Four unit homes stood at 6.99% Prime/Fixed 0.34% unchg Prime/ARM 1.77% 5 basis Sub Prime/Fixed 2.23% 23% +16 basis Sub Prime/ARM 6.47% 16 basis FHA 0.95% unchg VA 0.59% +2 basis Source: Mortgage Bankers Association 5

6 Current Statistics Nine states were above average: Nevada, Florida, Arizona, California, Michigan, Rhode Island, Illinois, Indiana, & Ohio. Serious delinquency rates increased from the second to third quarters. 6

7 Implications One foreclosure is estimated to cost a local government $34,000 in direct costs. Foreclosed homes tend to remain vacant for some time creating a haven for crime and an eye sore for the neighborhood. Foreclosed homes sell for a lower price and put downward dpressure on all home values. 7

8 Current Statistics Percent Change in Cass Shiller Index (1/ /2008)

9 Current Statistics Percent Change in Housing Price Rockford MSA Office of Federal Housing Enterprise Oversight 9

10 Current Statistics Percent Change in Housing Price Rockford, Chicago, & St. Louis Rockford Chicago St. Louis Office of Federal Housing Enterprise Oversight 10

11 Current Statistics Percent Change in Housing Price Rockford, Chicago, & St. Louis Rockford Chicago St. Louis Office of Federal Housing Enterprise Oversight 11

12 Current Statistics Percent Change in Housing Price Rockford, Illinois, & Wisconsin Rockford WI IL Office of Federal Housing Enterprise Oversight 12

13 Current Statistics Percent Change in Housing Price Rockford, Illinois & Wisconsin Rockford WI IL Office of Federal Housing Enterprise Oversight 13

14 So why do foreclosures cause lower prices? Direct Impact on Market Supply and Demand: This increases the supply of houses on the market and owners are forced out of themarket reducingdemand. demand. Indirect Impact on Market Foreclosures create a negative externality in their neighborhoods. h Banks have no interest in making money on a sale, only transitioning the asset into cash so they take a lower price. Psychological leffect on the area when nearby homes are foreclosed on. Foreclosed homes are different than other homes being sold. 14

15 Direct Impact on Market An increase in the number of foreclosed homes increases the supply of homes on the open market. What makes foreclosed homes different than an increase in the number of homes being sold by homeowners? The key is what happens to the sellers e s and why homes are being sold. 15

16 Direct Impact on Market In a typical housing market scenario, sellers sell to buy another home (upgrading). This produces a shift in the supply of homes AND a shift in the demand for homes. An upgrader enters both as a seller and a buyer. 16

17 Direct Impact on Market 17

18 Direct Impact on Market 18

19 Direct Impact on Market Generally homeowners that are foreclosed on do not re enter the market (at least not directly) resulting in only a SUPPLY shift. This problem is compounded as foreclosure rates growbecause of the stricter loanrequirements employed by banks reducing the number of demanders. 19

20 Direct Impact on Market 20

21 Direct Impact on Market 21

22 Indirect Impact on Market Early foreclosure research (Forgey et. al. 1994) focused on the sale price of the foreclosed home. Research found a 23% discount in the market price of a foreclosed home. Argued discount caused by incentive of institutions to liquidate rather than make a profit on home. This result drew much criticism given the assumptions of rational market theory. 22

23 Indirect Impact on Market Responses to Forgey s work (Carroll et. al., 1997) focused on the surrounding neighborhoods as a driving force behind this discount. Discount dropped to only 8% once zip code was used as a control. Discount was also found in nearby homes NOT foreclosed on. 23

24 Indirect Impact on Market Neighborhood effect was followed up by Schuetz et. al., 2008 and was pinned to four factors: Home may sell at a discount (see direct impacts). Lower maintenance of foreclosed home (even during foreclosure process). Home sits vacant for some period after foreclosure. Increased likelihood of home being sold to investor and transitioned to rental. 24

25 Indirect Impact on Market Schuetz s work resulted in three basic conclusions: Proximity to foreclosed homes matters There is a threshold before spillover effects really start to matter Neighborhood matters; at risk neighborhoods see larger impact than average neighborhoods. 25

26 Indirect Impact on Market Most commonly cited work is by Immergluck and Smith (2006). Show a home within 1/8 th mile of a foreclosed home sells at a $1,870 discount (per foreclosed home). This result depends on the riskiness of the neighborhood measured by the type of loan and holder of the load (i.e. government, bank, etc.) 26

27 Indirect Impact on Market Immergluck and Smith result is supported with Saint Louis County, MO, data by Rogers and Winter(2008). Find spillover effect decreases with distance. Find spillover effect decreases with time. Okay, evidence exists for a spillover effect, but what is causing it? 27

28 Indirect Impact on Market Future Work Work by Groves & Rogers (2008) link foreclosures and Homeowner Association (HOAs) literatures. HOAs tend to contain more concerned or active homeowners HOAs have the ability to maintain properties and then charge geowner. HOAs might attract a different type of homeowner. 28

29 Indirect Impact on Market Future Work HOA vs. non HOA homes: A smaller number of HOA homes are foreclosed on but both follow same trend. HOA homes do sell for a higher price, ex ante. HOA homes areyounger than non HOA homes. In Saint Louis County, HOAs make up about 50% of the housing stock. 29

30 Indirect Impact on Market Future Work Annual Percentage of Foreclosures 0.05 mean year Total RCA 30

31 Indirect Impact on Market Future Work Preliminary Results of HOA foreclosure effects: Foreclosed homes within HOAs see a smaller discount than non HOA homes (about a 6% difference or about $10,000). Spillover effects are different for HOA and non HOA homes. Specifically, HOA homes have no spillover effect whereas non HOA homes do. This holds for both homes inside and outside HOAs. 31

32 Indirect Impact on Market Future Work Results imply that there is something about HOAs that limit their exposure to the foreclosure effects. Are HOAs only in low risk neighborhoods? Is it connected to the institutions of the HOAs? Is the spillover effect directly tied to maintenance issues that are resolved by the HOA? Do people perceive HOA homes as different? 32

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Providing Subprime Consumers with Access to Credit: Helpful or Harmful? James R. Barth Auburn University

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