Chapter 8. Apples and Oranges (How to Determine Whether Buying a Foreclosure Is a Good Deal) - Part
Updated: Dec 19, 2021
In the last article, I said that in order to know exactly whether foreclosure houses are cheaper than regular houses, you need to take a close look at not only the listing price but other things.
And if Foreclosure houses are cheap, how cheap is it for Foreclosure?
(2013 December Top 20 Foreclosure discount city, Source: www.realtytrac.com)
If you look at the far right of the table above, you will find the "average" discount rate for Foreclosure houses by city. Places like Fort Mayer in Florida seem to be more than 60% cheaper. The discount rate is calculated using the third column, the average foreclosure selling price, and the fourth column, the average non-foreclosure selling price.
That is, the table above is calculated under the setting that the conditions of general foreclosure houses (location, size, internal state, etc.) are the same as the size and condition of non-foreclosure houses. However, in general, the condition, size, and area of non-foreclosure houses are better than those of foreclosure houses, so the discount rate calculated in the above table has to be larger than the actual discount rate.
If so, what is the discount rate when comparing the case of foreclosure and non-foreclosure with the same house?
Everyone knows Zillow's Estimated price, right? Zillow calculates the Real Foreclosure Discount by comparing the Zillow estimated prices of foreclosure houses (if the houses were sold as non-foreclosure houses) and the actual selling price as foreclosure houses.
(I know many real estate industry people will say that the Zillow Estimated Price has a lot of error. But the actual margin of error is gradually decreasing. At least in the local houses where I help customers, if you go to Cloud CMA, the actual margin of error is +/- +/- You can see that it is formed within 5%.)
The graph below shows the difference between the average Foreclosure Discount and Real Foreclosure Discount.
The dotted line is the change in the average foreclosure discount rate across the US, and the solid line is the change in the real foreclosure discount. When looking at the average value, there were times when the discount rate was severely close to 60%, but in the case of the actual RFD, the lowest was 23.7% in September 2012. In particular, even in 2012, when the foreclosure boom occurred after the subprime broke out, the RFD discount rate was only 7.7%.
*One thing to remember here is that most of the foreclosure houses need TLC. So, you need to calculate if the cost of the TLC and make the house livable or sellable will be lower than the 7.7% discount.
Then, "How much is the Foreclosure discount rate in our neighborhood?"
Compared to the table at the top of the article, areas like Fort Mayer FL, have quite a large discount. Also, cities in the rustbelt show large discount rates. This demonstrates that Foreclosure's discount rate does not deviate from the most basic of economics, the law of supply and demand.
Think about the rustbelt cities. There should be many reasons for these greater discount rates in this area. However, as everyone knows, the Rustbelt region has an uprising unemployment rate, divorce rate, and high school drop-out rate.
Increasing unemployment and divorce rates have led to an increase in the supply of housing, but demand has declined by those leaving the area for the same reason such as few available jobs and bad education. Naturally, there is surplus supply and the home prices including foreclosure fell. The decline is eventually seen as a large discount rate.
So, if there is a big foreclosure discount in your area, you must check the supply and demand trend in the area as well. And if the demand is decreasing, I would recommend you not to buy real estate there and find another area where demand is increasing to keep your asset.
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