Real estate investors who buy distressed properties at foreclosures have telegraphed a possible slowdown in the housing market for the past six months.
A deeper dive into foreclosure buyer behavior reveals which markets are most likely to see a home price correction over the next six months.
Foreclosure auction buyers began bidding more conservatively in the second quarter of 2022, as measured by proprietary data from marketplace Auction.com. Auction.com accounts for nearly half of all sales to third-party buyers at foreclosures nationwide.
A key measure of foreclosure bidder behavior is the ratio of the winning bid to the estimated property value – in this case, the estimated “actual value” of the property based on an outside appraisal or drive-by agent price opinion. The inverse of this ratio is the purchase discount from the buyer’s perspective.
That ratio hit an annual high of 89% in the first quarter of 2022, which translates to an 11% average purchase discount for foreclosure buyers. First quarter numbers reflect a pandemic-driven housing fever dream that impacted the distressed housing market as badly as it did the retail housing market.
To put the impact of the pandemic fever dream in perspective, the average foreclosure sale discount in the third quarter of 2019 was 21%, almost double the discount in the first quarter of 2022. Before the pandemic, the average foreclosure sale discount had never fallen below 20% in each quarter where nationwide data are available, Q1 2015.
But the fever broke in the second quarter of 2022, at least for local community developers, who are the main buyers at foreclosures. These buyers tend to know the dynamics of their real estate markets better than anyone, especially as their returns are dependent on what the market will be like over the next three to six months – the time it typically takes them to renovate a distressed property and to renovate Put it back on the retail market for sale or rent.
In the second quarter, the average purchase discount rose 4 percentage points to 15%, and in the third quarter it rose another 8 percentage points to 23% — more than double the average discount just six months earlier and at pre-pandemic levels, it averaged 22%.
The nationwide return of average home discounts to pre-pandemic norms suggests that most local real estate investors are no longer counting on the heady 15% to 20% rise in home prices they experienced from late 2020 to early 2022, and are turning about back to average pre-pandemic purchase discounts when home price increases averaged about 5% per year between 2015 and 2019.
“I don’t think we’re going to see that big of a drop (nationally) unless unemployment spikes a lot,” said Paul Lizell, a Florida-based real estate investor and coach who buys distressed properties from Auction.com. “Where you see those prices drop… Southern California, Las Vegas, Arizona, Florida will be affected.”
Price correction risk by region
Other distressed homebuyers are also anticipating a more severe slowdown — and possibly a correction — in home prices in a few select markets. Auction.com data shows that local real estate investors buying in the western region of the country gained an additional 16 point cushion between Q1 2022 (9% average purchase discount) and Q3 2022 (25% average). purchase discount added to their average foreclosure purchase discounts).
The West was the only region where the average purchase discount in foreclosures in the second quarter of 2022 was above pre-pandemic levels, suggesting that local investors are anticipating a more severe slowdown in that region. In the other three regions, average home purchase discounts in the third quarter were still at or below their pre-pandemic levels, suggesting that local investors are only expecting a return to normal, boring levels of house price growth in those regions at this point.
Price correction risk from Metro
At the metro level, the greatest risk of a home price correction, as reflected in foreclosure buyer behavior, was in San Francisco’s western market. Average foreclosure discounts in San Francisco increased 16 points in Q3 2022 compared to Q3 2019. That was the largest jump among 95 metropolitan statistical areas analyzed in Auction.com’s data.
Other western markets in the top 10 for home price correction risk were Pueblo, Colorado, San Diego, Riverside-San Bernardino, California, Tucson, Arizona and Phoenix. The average foreclosure discount in Q3 2022 was at least 8 points above pre-pandemic levels across all five markets.
There were four markets outside the western region in the top 10 for home price risk: Pensacola, Fla., Minneapolis-St. Paul, Lakeland, Fla. and Davenport, Iowa.
Among the top 10 for home price correction risk, based on comparison to pre-pandemic levels, Phoenix saw the largest six-month swing in average foreclosure discounts. The average foreclosure discount of 22% in Phoenix in Q3 2022 was 28 points higher than just six months earlier, when foreclosure buyers bought homes at 6%. Above the estimated actual value on average.