The bargain basement fixer-upper is getting passed over for ready-to-go homes and that's putting downward pressure on the value of the heavily discounted properties.
The trend could be a boon for investors or buyers with do-it-yourself upgrade skills or it could be a bit of a bust at the lower end of the housing market.
A Campbell/Inside Mortgage Finance HousingPulse survey says demand that is outstripping supply continued to push home prices up in January to the highest levels in nearly three years, but there's a growing difference between the price of non-distressed properties and the price of damaged REO (bank or real estate-owned) properties.
The difference comes even as the share of damaged REOs is shrinking.
The average price of non-distressed properties, which accounted for 65.0 percent of total home purchase transactions HousingPulse tracked January this year, were up 5.1 percent over the past year. The average price rose from $264,700 in January of 2012 to $278,200 in January of 2013.
Moving in the opposite direction was the average price fro REO properties in need of repair, "the type banks look to unload after a foreclosure," the HousingPulse report says.
The average price for a damaged REO property sold in January was just $88,100, 17.1 percent below the $106,300 average recorded a year ago - the lowest level ever recorded by HousingPulse in its four-year history.
One reason is that ready-to-go home prices are still relatively affordable - still 30 percent below their June/July 2006 peaks, according to a recent Standard & Poor's/Dow Jones Home Price Indices report.
In January, first-time homebuyers went for a record low share of the damaged REO purchase market, only 19.6 percent.
First-timers just don't want or need the hassle of buying a home that needs to be fixed up before they can move in.
"Most owner-occupants either don't want to do rehab work or can't come out of pocket - repairs can no longer be rolled into the mortgage. Also, under $150,000 Federal Housing Administration (FHA) loans are popular and buyers using this loan must have properties meeting minimum standards. Many REO homes don't," said Hank Miller, an associate broker and appraiser with Atlanta Communities - Hank Miller Team in Atlanta, GA.
Investors planning to flip the properties or fix them up to serve as rentals are still snatching up the properties.
In January, 65.4 percent of damaged REO purchases went to investors, up from 58.1 percent a year ago, the highest level in HousingPulse's tracking history.
Investors like the properties for their discounts, but when they enter the game, the bidding wars start and the rules change for rank and file buyers.
"REO buys are not always a bargain. Multiple offers, buyers' perceived bidding against themselves and the general feeling that all is not what it seems is dissuading buyers. The properties (end up) overpriced and often the sellers will not negotiate outside of their standard price reduction schedule," said Miller.
First-time buyers, unlike investors who buy in bulk, also don't like the risk of a potentially limited return on their single owner-occupant investment.
Too many damaged, distressed properties in a market could take its toll on prices in the lower-price end of an area's market if investors cut and run.
"Once something more profitable comes along, these major investors holding real estate will dump and run and that could become an issue with values down the road. I don't see a major crisis at all levels, but I do think we'll see a flood of inventory at some point once these investor-held homes begin to require work and the math shows it's time for investors to move on," Miller said.