For home builders, foreclosures and distressed sales remain a
problem even after they are sold.
They become comparable sales to gauge value, reflecting
decreased market values, forcing builders to shave prices or risk
losing a deal. It is yet another problem - and one expected to last
for some time - for the ailing sector searching for stability as
the worst downturn in decades drags on.
"They don't need any of this incremental heartache," said Robert
Curran, Fitch Ratings' lead home-building analyst. "It's like
another shoe keeps dropping for them in terms of the
challenges."
For months, builders have complained that foreclosures and
short-sales - where the borrower unloads the house for less than
what is owed - pose stiff competition because they can sell for
steep discounts. The sector even finds itself competing with
nearly-new product it built, which is pushing several builders,
including KB Home (KBH), to alter product.
But, once a property sold, it may be used by appraisers to
determine value. Most lenders now require that appraisals be based
on sales closed within three months - instead of six-to-nine
months, said Bill Garber, director of government and external
relations with the Appraisal Institute. With distressed deal counts
spiking, the comparative sales pool could more likely include a
foreclosure, especially in boom-to-bust markets including Las
Vegas, Phoenix and California's Inland Empire.
Back in the housing heyday, appraisers felt pressured by
everyone from real-estate agents to consumers to inflate value
estimates. But now, builders grumble appraisers are being
conservative, or even, they fear, discounting the value to play it
safe.
"The lenders that are using these appraisals [for] the amount
they will loan, they were just burned by appraisers being too
optimistic and liberal in the boom times, so they're going in the
opposite direction," said David Ledford, senior vice president at
the National Association of Home Builders. "It sort of contributes
to a downward spiral in values."
Garber countered that appraisers, who are certified, "don't make
the market, they simply point out what is transpiring."
Even so, both sides agree a main issue is that falling prices -
dragged down by foreclosure sales - reflect battered markets. The
latest S&P/Case-Shiller Home Price Index - which covers all
nine U.S. census divisions - recorded a 19.1% decline in the first
quarter compared to a year earlier. Since the 2006 peak, some
markets have seen double-digit price erosion.
Builders also complain the comparisons don't take into account
the added value of a new home. Foreclosures can be beat-up -
missing pipes and appliances - and require a monetary investment
and significant work to be livable.
"They are distressed sales," Curran said. "It's not reflective
of the true cost of the house."
The Appraisal Institute's Garber said the appraiser simply asks
what the property would sell for tomorrow in its current condition.
When possible, sales within an existing neighborhood are used
first. Adjustments downward are made for sales concessions such as
free vacations or cash for upgrades. There are items, such as
pools, that may not be worth as much as they cost to put in.
That has turned the appraisal process into a nail-biter for
buyers and sellers. Should the appraisals come in below the
contract price, lenders might not make up the difference - tens of
thousands of dollars, in some cases. Buyers can either come up with
more money, or ask the builder to reduce the price. Appraisals can
be appealed or reordered. If that fails, the deal just might
unravel.
Some builders are forced to search for different comparative
sales that they consider a better match. "The best thing they can
do is find the best comps, and that just takes more work on their
part," said Eric Elder, a spokesman for Ryland Group (RYL), the
nation's eighth-largest builder by annual closings.
Things only got more complicated last month with the Home
Valuation Code of Conduct applying to mortgages that will be owned
or guaranteed by government-backed mortgage companies Fannie Mae
(FNM) and Freddie Mac (FRE) - which recently have been the bulk of
new home loans.
The code prohibits selection and compensation of the appraiser
by loan officers, mortgage brokers or real-estate agents. That has
increased outsourcing the selection to third-party management
companies, which may take some of the fee. Appraisers worry lenders
are ignoring qualifications and hiring solely on cost, and there is
concern that out-of-towners unfamiliar with the market aren't
"geographically competent" to prepare a thorough appraisal.
"You risk having people unfamiliar with the marketplace having
to determine value," Elder said. "It makes their job harder and
then it makes the entire process more difficult."
The issue is expected to dog the building sector for some time.
RealtyTrac this week released its May foreclosure report, saying
the number of filings climbed nearly 18% from May 2008. It was the
third straight month with the total number of properties slapped
with filings topping 300,000.
Because the government is working to prevent homeowners from
losing their homes, it is hard to predict the ultimate number of
foreclosures. But Barclays Capital estimates new foreclosures
started this year at 2.8 million, with 3 million expected in
2010.
Meanwhile, as interest rates climb and unemployment numbers
remain escalated, more owners could be forced into short-sales or
other desperate moves, prolonging the sector's pain.
"Everything's driving values in one direction, there's no
counter-acting force," Ledford said.
-By Dawn Wotapka, Dow Jones Newswires; 201-938-5248;
dawn.wotapka@dowjones.com
(James R. Hagerty and Ruth Simon contributed to this
article.)