Prompt foreclosures may spur recovery of housing prices overall , appraisal firm finds

By Kenneth R. Harney, Friday, November 29, 8:40 AM

Why have many of the local housing markets that were hit hardest during the bust – especially in California – bounced back so vigorously and quickly, with prices close to or exceeding where they were in 2005 and 2006?

And why have many others along the East Coast and in the Midwest had a slower move toward recovery, with sluggish sales and gradual increases in values?

Although multiple economic factors are at work, appraisal industry experts believe they have isolated a crucial and perhaps surprising answer: Real estate markets rebound much faster in areas where state law permits foreclosures to proceed quickly, moving homes with defaulted loans into new owners’ hands expeditiously rather than allowing them to sit and deteriorate, tied up in court procedures for years. Prices of foreclosed homes in areas where foreclosures can be done more speedily typically are depressed and negatively affect values of neighboring properties, but they don’t remain depressed for lengthy periods because investors and other buyers swoop in and return them to residential use rapidly.

By contrast, in states where laws allow large numbers of homes in the process of foreclosure to remain in legal limbo, often empty and unsold, home-price recoveries are hindered because lenders are prevented from recovering and reselling the units to buyers who will fix them up and add value.

Pro Teck Valuation Services, a national appraisal firm based in Waltham, Mass., recently completed research in 30 major metropolitan areas; its findings dramatically illustrate the point. All the fastest-rebounding markets in October – those with strong sales, price increases and low inventories of unsold houses – were located in so-called nonjudicial states, where foreclosures can proceed without the intervention of courts.

All the worst-performing markets – where prices and sales have been less robust and there are excessive numbers of houses available but unsold – were located in judicial states, where post-default proceedings can stall foreclosure completions for two to three years or even more in some cases.

Among the best-performing areas were California markets such as Los Angeles and San Diego. California is a nonjudicial state. Among the worst performers were Florida markets such as Tampa and Fort Myers, as well as parts of Illinois and Wisconsin. All of these are judicial states.

Twenty-two states are classified as judicial foreclosure jurisdictions: Connecticut, Delaware, Florida, Hawaii, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Maine, New Jersey, New Mexico, New York, North Dakota, Ohio, Oklahoma, Pennsylvania, South Carolina, South Dakota, Vermont and Wisconsin. All other states handle foreclosures without court participation.

Tom O’Grady, chief executive of Pro Teck, says the differing rebound patterns of judicial and nonjudicial states jumped out of the study data dramatically. “When we looked closer” at rebound performances state by state, “we observed that nonjudicial states bottomed out sooner” – typically between 2009 and 2011 – “versus 2011 to 2012 for judicial states, and have seen greater appreciation since the bottom,” typically 50 percent to 80 percent, compared with just 10 percent to 45 percent for judicial states, O’Grady said in comments for this column.

“Our hypothesis,” he added, “is that nonjudicial states have been able to work through the foreclosure [glut] faster, allowing them to get back into a non-distressed housing market sooner, and are therefore seeing greater appreciation.”

California, for example, experienced severe price declines immediately after the bust hit in 2007 and 2008: Thousands of foreclosed homes flooded the market, depressing values of other real estate in the area. O’Grady calls this a “concentrated foreclosure effect” that is painful while it’s happening but that relatively quickly purges the marketplace by turning over distressed units to new ownership.

Judicial states, on the other hand, tend to be still struggling with homes flowing out of the foreclosure pipeline, prolonging the negative price effects on other houses for sale.

O’Grady noted that in nonjudicial states such as California, foreclosures now account for just 10 percent of all sales, and home listings amount to a four-month supply – well below the national average. In slow-moving judicial states, by contrast, anywhere from 25 percent to 50 percent of all sales are foreclosures, and unsold inventory represents anywhere from a five-month to a 10-month supply.

The takeaway here? Though real estate prices are popularly thought of as reflecting the “location, location, location” mantra, inherent in that concept is something less well known: State laws governing foreclosure also affect market values and govern how well they bounce back after a shock. Prices take much longer to recover when foreclosures drag out for years.