According to a recent study by Experian RES, a nationwide real estate information company, home buyers looking to buy a foreclosed home can expect a discount of around 6 percent relative to its open market value.

Experian's study looked at a sample of REO home sales by the Federal Home Loan Bank, Federal National Mortgage Association, Housing and Urban Development (HUD), and Veterans Administration (VA) in 14 major metropolitan counties around the nation, and then compared the sale price to their open market values to establish discount levels.

Foreclosure sales by the government and quasi-government agencies account for the lion's share of the nation's stock of repossessed homes.

"REO discount levels are generally determined by the relative strength of the local real estate economy," Experian says.

Among 14 counties studied, Orange, Calif., where sales and values have recently shown increasing signs of robustness, enjoys the lowest discount level, 3.1 percent.

"In many parts of Southern California, the recent housing recovery has reduced significantly the gap between the sale price of a repossessed home and its open market value," says Experian analyst Nima Nattagh.

The impact of the recovery is most apparent in Los Angeles County, the nation's largest housing market, where in a similar study last year, Experian RES found discount levels of 9 percent compared to 5.5 percent today. The weak spot in the Southern California region is San Bernardino County, where a relatively large supply of foreclosure sales have sustained deep discounts.

Note: Discount levels established by comparing the actual sale price of a property determined from publicly recorded information to its open market value estimated by a computer assisted residential valuation model. Source: Experian RES

In contrast to Southern California, foreclosure sales in the San Francisco Bay Area are sold at a deeper discount relative to current market values because home values have elevated to a point that mortgage lenders can offer higher discounts and at the same time not incur significant asset losses. In Santa Clara County, a typical REO sells for 6.4 percent below its market values, while in Alameda and Contra Costa the rates are 6.5 and 7.2 percent respectively.

Among other regions covered by the Experian RES study, discount levels in Miami (Dade County) at 9.6 percent and Fairfax County, at 9.1 percent, are well above the average. In Seattle (King County), a typical REO sells for 6.8 percent below its market value, and a discount of 5.4 percent in Prince George's ranks the region among one of the lowest in the study area.

The Experian study also reveals a fairly wide range of discount by sellers of foreclosed property. The Department of Housing and Development, the agency that insures FHA mortgages, sells its foreclosed homes at almost 12 percent below market value, while the Veterans Administration averages about 10 percent. On the other hand, discounts by the secondary mortgage agencies, Fannie Mae and Freddie Mac, are below the average.

Bulk auction of REOs, a preferred method of nonperforming asset disposal by HUD, is partly responsible for deeper discounts. As a result, lower-priced homes, predominant in HUD's portfolio of foreclosed homes, enjoy a significantly higher discount compared to higher priced homes. An average REO home that sold for less than $50,000 is carrying a 42 percent discount, while discount on higher priced homes range from 2-7 percent.

Experian's analysis was based on a portfolio of more than 3,600 REO sales in 1997 with a combined first mortgage value of $420 million. An average first mortgage foreclosed on was $118,000 in 1997. Using a computer assisted valuation model, Experian RES determined the market value of each foreclosed home, which was then compared to its actual sale price. The Valuation model mimics the residential appraisal process, and extensive testing has shown that it estimates market values with a 5.5 percent accuracy rate. The model relies on recent sales of similar properties in the vicinity of the subject property to produce market values.

Published: May 18, 1998

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