A new study reveals that markets in which property foreclosures exceed 8 percent of sales require deeper price discounts to move inventory. 

The study, by First American Real Estate Solutions researcher Christopher Cagan, verified two widely held beliefs: that properties at the lower end of the price range for their markets have higher foreclosure rates and require deeper price discounts to sell, and that the amount of the discounts is tied to foreclosures as a percentage of total sales in a given market.

“Discounts tend to be deeper in markets where foreclosures comprise 8 percent or more of all sales, regardless of geographic location or market type,” Cagan said.

The study found, for example, that the median discount for foreclosed properties was 20 percent in Baltimore, Md., where foreclosures made up 8.9 percent of sales during the first half of 2006. In Orange County, Calif., the median discount was a more modest 3.8 percent during the same period. But foreclosure sales accounted for just 0.5 percent of total sales in Orange County.

Nationwide, the study found that foreclosures made up 3.1 percent of sales in the first half of 2006, up from 2.7 percent in the same period of 2005 and 2.4 percent in the first half of 2004.

“While there is a slow and steady trend of increase in the prevalence, no great wave of foreclosures has overwhelmed the market,” the study concluded.

The median discount on foreclosure sales in the first half of the year was 14.2 percent — slightly better than the 14.6 percent experienced in the first half of 2005, but deeper than the median discount of 12.5 percent in 2004.

States where foreclosures made up a higher proportion of sales — and where discounts were deeper — included Colorado (9.2 percent of sales), Missouri (8.8 percent), Michigan (7.4 percent), Ohio (8.7 percent) and Pennsylvania (34.1 percent). Areas with lower proportions of foreclosure sales and little discounting included Arizona (4 percent), Nevada (0.7 percent) and Virginia (0.5 percent).

Discounts on foreclosed properties exceeded 20 percent in six of the states: Missouri (27.8 percent), Alabama (25.2 percent), Ohio (23.2 percent), New York (22.1 percent), Pennsylvania (21.7 percent), and Michigan (20.5 percent).

In looking at foreclosure sales by property type nationwide, the study found that condominiums and townhomes had a lower prevalence of foreclosure sales and less discounting. Sales of foreclosed condominiums made up 1.1 percent of total sales (compared with 3.3 percent for single-family homes) nationwide, and prices were discounted by 9 percent (compared with 14.1 percent for single-family homes).

The study also broke down foreclosure sales into four price ranges, or quartiles, at the county level, to reveal that foreclosed properties at the upper price range in their market not only made up a smaller percentage of total sales in that range, but sold at a smaller discount.

Homes in the top quartile were discounted by just 7.7 percent, compared with 20.6 percent discounts for those at the lowest. Foreclosures made up just 1.5 percent of sales of homes in the top quartile, compared with 5.1 percent of sales in the bottom.

Cagan offered a parting word of caution for those who would use the study to hunt for bargains. Foreclosure is a lagging indicator, he said, and foreclosure resales don’t occur in high numbers until well after a bear market has begun.

“People interested in picking up bargains by purchasing foreclosed properties may wish to wait for market prices to moderate or decline, for foreclosure prevalence to increase, and for foreclosure discounts to deepen,” Cagan said. “Many of the best bargains may be picked up after the actual foreclosure occurs when the lender is willing to offer a discount to avoid continued holding costs. It should be said, however, that in a market with many foreclosures and deep discounts, the general mood is against buying and investing — and so a certain contrarian mentality is often needed for this kind of strategy.”

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