The Cleveland Federal Reserve Working Paper
October 11th, 2011
The Federal Reserve Bank of Cleveland released working paper entitled, The Impact of Vacant, Tax-Delinquent, and Foreclosed Property on Sales Price of Neighboring Homes.
Introduction
Recent events in housing markets are attracting much scholarly attention to foreclosures. One line of research that is developing rapidly focuses on the externalities associated with foreclosure, primarily a foreclosed home's impact on surrounding properties. There are two general deficiencies with this line of research: the nearly exclusive focus on robust housing markets, and the assumption that foreclosures themselves, rather than factors correlated with foreclosure, drive down surrounding housing prices. This paper attempts to fill the gaps in prior research in two ways. First, it focuses upon a less robust housing market: Cuyahoga County, Ohio (home to Cleveland). Second, it incorporates parcel-level vacancy and real property tax delinquency (as a measure of neglect) in addition to foreclosure.
Foreclosure, vacancy, and tax delinquency differ in important ways, though they may all lower surrounding home values or indicate distress that lowers home values. Foreclosure occurs when a debtor fails to pay a debt secured by the debtor's home, and the creditor opts to seize and sell the property instead of continuing to seek payment from the debtor. During foreclosure, homeowners have little incentive to maintain their homes, as every dollar put into upkeep or improvements will primarily benefit the foreclosing lender. Thus, recently foreclosed homes are more likely to be distressed due to deferred maintenance than homes that have not recently been through a foreclosure. Additionally, foreclosure adds a unit of supply to a local housing market. Assuming a competitive housing market, this additional supply should put downward pressure on home values. Finally, foreclosure may lower surrounding home values when they are used as comparable properties by real estate appraisers or realtors to price non-foreclosed real estate. In light of the volume of properties recently moving through REO (real estate owned), lenders lower the sales prices of homes they own in order to sell them quickly, because the carrying costs of vacant properties are high. When appraisers or realtors determine the value of a home, they may select foreclosed homes as comparable properties without considering the eagerness of the seller.
Vacancy is closely related to foreclosure, but distinct in important ways. A home that has been foreclosed upon will be vacant immediately after the foreclosure but the vacancy may be temporary,as the property is auctioned off to a new owner or to a bank or investor who usually attempts to find a new owner. Vacancy is distinct from foreclosure in that a property is vacant when it is not being occupied, which is not a result of a foreclosure in the vast majority of cases (there are seven times more vacancies than foreclosures in our data). Vacancy lowers surrounding property values in ways that closely resemble foreclosure. Each vacancy is another likely unit of supply on the market, which should put downward pressure on home values. Vacant properties are usually not maintained as well as occupied properties because no one is present on a daily basis to care for them.While they may be cared for by an owner living elsewhere, there is less incentive and opportunity to maintain them as often and as carefully as an owner-occupier would. This problem is exacerbated with long-term vacancy, which occurs naturally in less robust housing markets where there may not be sufficient demand to reoccupy vacant houses, and in colder-weather climates where a single winter can cause significant damage to a property that is not attentively maintained.
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