Although a sale is a sale, not all of them should be included in home price index calculations. Some sales are simply greater and more valid influences on market realities than others, and foreclosure sales are a prime example. We don’t typically include them among our VeroHPI considerations and there are a number of good reasons why.
There have been a great many foreclosure sales in recent years, so they are undoubtedly a large factor in some markets and, in others, have been the markets themselves. But when you drill down to the specifics of foreclosure sales, you begin to see why they really don’t belong in HPIs.
Arm’s-length transactions differ greatly from distressed sales. When a foreclosure sale happens, prospective buyers are aware that there is mostly likely work to be done to bring the property up to market grade readiness for resale. The prices are forced by the circumstances, they are sometimes purchased as a package with other properties in portfolios, and there is little resemblance to the mainstream in many other aspects.
In traditional real estate sales, the transaction parties are willing buyers and sellers and important components are present, including seller disclosure statement, buyer’s home inspection, habitability verification and various other minimum property requirements (particularly for FHA and VA loans). Sellers want to receive the best possible price for their homes and are highly motivated to make certain they show at their best. Deferred maintenance is taken care of, appearance is maximized and things that boost the property’s appeal are handled to make good impressions, often down to fine points of staging and decor.
These characteristics are less typical with foreclosure sales, of course. The property may be in great disrepair or marginally habitable, given the acrimony that generally accompanies the foreclosure process. At the least, departing owners are simply less motivated than arm’s length sellers to focus on appearance items or maintenance issues that may turn up on inspection reports. Once in the REO portfolio, lenders are often inclined to move them quickly in their “as is” condition, and just as often minimize the seller disclosure statements to avoid spending good money after bad and to reduce losses in all possible ways. The end result is that the foreclosure buyer gets little about the property’s history and can expect few if any repairs that inspections may call for. When detailed information about the property’s condition is not available, it is virtually impossible to equate the home to a valid benchmark, as is readily accomplished by full appraisals in traditional sales.
There are title issues with foreclosure sales, too. Title insurance is available, but not warranty deeds, since the chain of warranty is broken by the foreclosure and often title policies insure around the pre-foreclosure history, making things murky. When all is said and done, foreclosure sales are most attractive to those who intend to rehabilitate and flip the properties, or those who will make basic repairs and use them as rentals.
These are not the same buyers who turn up for mainstream purchase transactions. The title insurance issues, property condition disadvantages, the long transaction times and a host of other factors most often put foreclosure sales into a category all their own—one very different from arm’s length sales.
Even though markets have been driven by foreclosure sales in the past, they are overwhelmingly back to being driven by mainstream, traditional transactions. Sellers are not having to price with foreclosures in mind as they once were, and so HPI calculations that exclude these distressed sales are patently more accurate and reflective of the market realities.
The exception that proves the rule happens when markets are dominated by foreclosure sales and clearly drive pricing for traditional sellers. In those instances, the HPIs are forced to include them in order to reflect markets accurately and bring validity to the index. But these are rare and never last forever.
For HPIs to serve their purpose, they must be solidly based in reality and supported by prevailing conditions in each individual market. Investors in distressed properties are understandably opportunistic and have goals that are far different from the mainstream traditional buyers that make up the vast majority of the residential real estate market. Blending the two in an HPI can lead to an “apples and oranges” situation that serves neither buyer segment well.
Even though it may seem counterintuitive at first, the more one thinks about it the more sense it makes to exclude foreclosure sales from the indices. Separating them actually results in a more dynamic and accurate portrayal of true market conditions, and that, at the end of the day, is the essential quality of the best HPIs.
David Rasmussen is a 15-year mortgage industry veteran and senior vice president of operations at Veros. For more information, go to
