Editor’s Note: In this installment of his column, Valuation Issues and Answers, John Lifflander, ASA, explains how to handle foreclosures and short sales when choosing comparables.
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By John Lifflander, ASA
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Question: Please explain the difference between an actual foreclosure sale and a short sale. Should short sales be used as comparables? – M.S.
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Answer: A true foreclosure sale represents one extreme on the continuum of sales that include an element of duress. In many locations, foreclosure sales are auctioned off “on the courthouse steps.†Buyers of these types of properties usually are required to pay the purchase price in full with a cashiers’ check as soon as the bidding is over. Bidders will have conducted research to make certain they are bidding on a first trust deed and not a second. They often have not entered the property to ascertain its condition. Because some owners have been known to vandalize their homes before they are forced to relinquish them through foreclosure proceedings, foreclosure-sale buyers account for this risk and generally bid quite low. Sales of this type would almost never be used to determine market value and they are generally not in multiple listing services.
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On the other end of the spectrum are short sales which have become more common in recent years. Strictly speaking, short sales are not foreclosure sales but they do involve some duress. With short sales, the owner is typically behind on the payments and often owes more on the home than it is worth. This condition is often referred to as being “upside down†in the property. The lender, hoping to avoid the expense and time of foreclosure, allows the owner to list the property with a real estate agent, with the condition that the lender will approve the sale price. Depending on the terms of the agreement, the owner may be relieved of the obligation to pay for the loss if the property cannot be sold for the full amount of the outstanding mortgage. Or, the agreement may leave the owner open to a deficiency judgment, which would require payment of the difference between the sale price and the mortgage amount if the lender elects to sue to try to collect in court.
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Lenders prefer short sales because they save the time and expense of a foreclosure, and because homeowners are often cooperative and do not damage the property since they have a vested interest in the sale price. Short sales are listed in the local multiple listing service (MLS) just like any other property, so unlike foreclosures, they are not limited to a certain type of buyer.
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Picking Comps
While it’s true that there is an element of duress involved in a short sale, if there are numerous short-sale properties available in an area there is a good chance that potential buyers will opt to purchase them over conventional listings to save money. Eventually, homeowners selling for the typical reasons will have to lower prices to compete. In this way, short sales may become the predictor of where the market is going.
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Appraisers in areas where short sales make up a large portion of sales often find that they must use them as comparable sales to determine market value. If you are in such an area, I would caution you about ignoring short sales without a disclaimer explaining why they were not used. Otherwise, if the subject property sells for less than the appraised amount in the future, you may find yourself with liability for their omission. Â
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Please send your questions to john@liffland.com. Find regular installments of Valuation Issues and Answers in the WRE online edition, reaching 45,000 appraisers via email every other week.
About the Author
John Lifflander, ASA, is a Certified General Appraiser in Washington and Oregon. He teaches appraisal courses and has been published numerous times. He is the author of Fundamentals of Industrial Valuation, a textbook for industrial appraisers published by IAAO (International Association of Assessing Officers). He is a former administrative law judge for property tax appeals for the Oregon Department of Revenue and specializes in providing expert witness testimony and consultation for complex valuation litigation.Â
6 responses so far ↓
1 William Pegg // Feb 18, 2009 at 6:06 am
John,
I did not see any mention of REO’s, as distinct from “court house step sales”, that are often called “foreclosures”. In much of California, REO’s dominate the market. I believe this is true throughout many areas of the nation. Therefore they must be considered in most valuations. There are often more REO’s than even “Conventional” sales in many market areas.
Bill
2 Susan Trotter // Feb 18, 2009 at 7:20 am
Yes, John and Bill. Can we please get more discussion on this subject. I had a refinance in an area where REOs (listed as foreclosures) were 70% of the market and 75% of the other listings were short sales. The builder in the area was also liquidating inventory. There were so few market or normal sales, that those available did not qualify as comparables under standard guidelines. Can others please help with educated direction and experienced feedback? Thank you.
3 Jon Haasch // Feb 18, 2009 at 7:39 am
John -
I have been appraising in Wisconsin for 15 years, but back in 2001 also became licensed as a sales broker and have practiced as an exclusive buyer’s agent.
I’d like to expand on two points touched on in your article: Short sales and Duress.
As with many markets out there, the one I operate in has a significant amount of foreclosure and/or short sale activity. I did learn first-hand however, that a short sale is really just that: SHORT. It DOES NOT necessarily indicate any other credit problems or late payments though. I learned this first hand when a buyer client of mine closed on a a sale. While the seller was “short”, it was merely a product of the housing market and had absolutely nothing to do with personal credit conditions. The seller was taking a significant promotion, and their past relationship with their lender was solid…the lender took a (relatively small) personal note for the difference and it seemed as though it was a “no-brainer” for them because the seller had excellent credit.
On the point of duress sales and whether to use them as comps or not, I found your suggestion to use a disclaimer to be an interesting point. I would add however, that there is a “built-in” reason not to be using them on most appraisals, and that reason is the definition of market value. Not all, but most foreclosures & short sales in my area seem to conflict with the parameters set forth by the definition. I for one can argue the point for either case because the definition has so many ambiguous terms: “duress”, “atypical”, “typically motivated”, “best interest”, etc. I don’t think that today’s market environment was envisioned when the standard definition was crafted, but we are nonetheless held to it.
I’d dare to say that Fannie & Freddie could re-work the definition, but I am a firm believer that they should really be stripped of some of their oversight regarding appraisal…hey, they DID get caught cooking the books ahead of the largest mortgage meltdown in our history. I think that form/rules development for appraisal should be left with a separate entity (maybe the AQB?).
Good article.
Jon
4 Claire B // Feb 18, 2009 at 8:30 am
In some of the areas I’ve recently completed appraisal work, although not more than 50%, there are enough REO or short sales that do effect the market. When I see 10 out of 40 area sales that are “distressed” in some manner, it seems that at least 1 comp out of about 5 should reflect this market factor. Also, in the MLS systems I use, foreclosure or lender owned sales are included and are being marketed for sale. Unless a property is severely damaged, the average purchaser would probably consider this type of home realizing a substantial savings in some cases. In a true market value sense, wouldn’t an average buyer consider a lower price for the same house? It seems that at least some representation of these sales would almost have to be included in a market value.
5 Joseph Lynch // Feb 18, 2009 at 9:19 am
This article really doesn’t address a significant issue in my market in Northern California. My market features significant numbers of REO and short sales. However, despite the general indication of this article, short sales are not more desirable than REO sales because of the slow response time from banks involved in short sales. It is typical for banks to take 60 to 90 days to respond to an offer on a short sale while responses to REO sales are much faster. Thus, short sales are less favorable for real estate agents to work and are often less favorable for buyers.
6 Alan McElwain // Feb 18, 2009 at 10:50 am
I agree with the above comments. In our area of California’s central coast in some areas the when appraising a home in the lower price ranges it is quite often all REO and Short Sale comparables as that is what the current market is. Some of the Realtors I know do not even show Short sale properties as the banks take as mentioned 60 to 90 days or more for an answer and are very frustrating for the agent and buyer to deal with. REO properties on the other hand are now quite often put on the market at a price low enough that there are multiple offers and sell for a little over the list price with a market time of 5 to 20 or so days. Of course there the ones still that are over priced by a bank that is being unrealistic.
Alan McElwain,
Certified General Appraiser, Real Estate Broker
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