Foreclosure Discount: Definition and Dynamic Patterns

Abstract

The lack of a consistent definition of foreclosure discount gives rise to discount rates that vary from nonexistent to sizeable across locations and time. We define the foreclosure discount as the discount of the real estate owned (REO) sale price relative to a normal‐sale estimated market value. With a dataset of 1.34 million REO sale transactions, across 16 CBSAs between 2000 and 2012, we find three noteworthy empirical findings. First, a high REO sale concentration in a market increases the foreclosure discount. Second, foreclosure discount is negatively related to recent house‐price appreciation. Third, the often reported high foreclosure discount for lower value properties is likely due to property condition.

Determinants of a foreclosure discount

“…As liquidity and price changes often follow each other, with higher liquidity and closer bid-ask spreads during up markets as compared to down markets, this is closely related to liquidity. Given that this found, the results are concurrent with earlier research on foreclosure discounts, having found that neighborhood value appreciation decreases the discount on price (Zhou et al, 2015). This does however contradict studies on the price-TOM relationship that have found a greater positive impact of TOM during periods of increasing property values (An et al,2013), as a greater positive impact of marketing time should correspond to a larger negative impact caused by a forced sale.…”

“…The expected effect is that higher priced neighborhoods should be associated with lower discounts, i.e. having a positive coefficient, as this is supported by previous research such as Campbell et al (2011) and Zhou et al (2015). Earlier studies have related this combination to seller costs of protection.…”

“…Properties in markets experiencing increasing property values should be sold at lower discounts, consistent with the patterns regarding foreclosure discounts (Zhou et al, 2015) and auction sales (Mayer, 1995(Mayer, , 1998. As bid-ask spreads are likely to be smaller when property prices are increasing, forced sales that reveal true bid-prices will sell at lower discounts during such periods.…”

“…Further insight towards the determinants of a foreclosure discount is provided by the finding by Zhou et al (2015) that a high concentration of REO sales increases the discount and that recent house price appreciation decreases it. It is also found that properties in bad condition are sold at larger discounts.…”

“…Numerous articles have aimed at estimating the impact that a forced sale has on real estate sale price (Campbell et al, 2011;Carroll et al, 1997;Chinloy et al, 2016;Clauretie and Daneshvary, 2009;Forgey et al, 1994;Hardin and Wolverton, 1996;Harding et al, 2012;Pennington-Cross, 2006;Shilling et al, 1990;Springer, 1996;Zhou et al, 2015), with most estimates indicating discounts in excess of 20% (Campbell et al, 2011;Forgey et al, 1994;Hardin and Wolverton, 1996;Shilling et al, 1990). A major empirical challenge does however arise due to foreclosure status being likely to proxy for unmeasured property characteristics that negatively influence property value.…”