The latest Standard & Poor’s/Case-Shiller index showed that home prices in 20 metropolitan markets had fallen to new lows in January 2012. A February report in The Wall Street Journal noted that S&P/Case-Shiller index results were impacted by the prevalence of foreclosures that sold lower than their previous purchase prices because of the poor condition of the properties.

The vacancy status of a property by itself results in a certain level of deterioration, simply because the presence of an occupant keeps the property “healthier.” But many foreclosed properties also sell at far lower prices because servicers and investors often fail to carry out repairs and take full advantage of insurance coverage when properties sustain insurable damages.

In most cases, when insurable damages occur to REO properties in their portfolios, servicers and investors will file a hazard claim, sell the property “as is” and use the insurance funds to offset a reduced sale price because of the damages. What servicers and investors may not know is that they could be leaving millions of dollars on the table. By completing repairs, they can receive higher claims payments, and often significantly improve the marketability and value of the property.

Most insurance policies provide coverage for full replacement costs when properties sustain insurable damages, but only if damages are actually repaired. Without the repairs, the servicer receives the depreciated value of the damaged items.

Safeguard Properties’ internal analysis showed that in 2011, the replacement cash value of hazard claims for its clients totaled $127.7 million. The actual cash value of settled claims totaled $72.4 million, and recoverable depreciation totaled $42.3 million. In other words, an additional $42 million in settlement funds could have been recovered by completing repairs. (Note, the numbers do not add up because of deductibles.)

It may help to illustrate this with a simple hypothetical scenario. Let’s say a house sustained major roof damage in a severe wind storm and the repair estimate was $10,000. The house is valued at $200,000. The roof is 10 years old with a 30-year expected life. The policy has a $1,000 deductible.

In this case, the servicer would be eligible to receive a $9,000 claim settlement. After the hazard claim is filed, reviewed and approved, the servicer would receive payment based on the depreciated value of the roof. In this case, let’s assume the roof was depreciated by one-third. Thus, the claim payment would be depreciated by one-third, entitling the servicer to $6,000. Only if the servicer proceeded to repair the roof would it receive the additional $3,000 to compensate for the full replacement value.

It leaves the choice to the servicer or investor to accept payment for the depreciated value and sell an REO property “as is” or to proceed with repairs to receive full replacement value and sell the property in improved condition.

Today’s housing environment has turned many long-held property disposition practices upside down. In the past, selling REO properties “as is” made sense. In a robust housing market, REO properties in need of repairs presented a rare opportunity for prospective homeowners to buy properties at a discount compared to traditional market homes and save money by making repairs on their own. As a result, demand for “as is” REO properties was high.

Now, greater numbers of traditional market properties and REO properties compete side-by-side for fewer and more skeptical buyers. In this environment, completing hazard claim repairs can vastly improve the marketability and value of an REO property, in addition to increasing the insurance reimbursement for claims.

Let’s go back to the earlier example. If the servicer filed a hazard claim for the damaged roof and completed the repair, it would have received the replacement cost of the roof, less the deductible, or $9,000. Without completing the roof repair, it would have received $6,000 to compensate for the loss on the depreciated value of the roof. In addition to the $3,000 compensation difference, the condition of the roof would factor into the marketability and sale price of the property. With a damaged roof, the property would likely sit on the market for a longer period, and sell for significantly reduced cost. It wouldn’t be unusual to see a property in damaged condition sell for 25% to 30% percent less than a comparable property in good condition. On a $200,000 property, the lost opportunity may be $50,000 or higher.

Servicers and investors looking to maximize the value of their REO portfolios should focus on hazard claim repairs. Completing repairs not only increases hazard claims payments, it improves the portfolio value of the property and reduces the cost of maintenance.