By RYAN TAYLOR

The Commerce Department reported a 14.7% drop in the seasonally adjusted rate of new home sales in December. Builders unloaded just 482,000 homes, the lowest number since 1982, while the median price slipped 9.3% from December 2007 to $206,500.

Tough to find a silver lining in this release, the numbers pretty much speak for themselves.

Homebuilders are literally drowning in their own supply, as ill-fated decisions to keep building through the early stages of the housing downturn are coming back to haunt the likes of Centex, Toll Brothers and Lennar. The data could not be more clear: Buyers are not willing to pay for new homes at their current prices. Nevertheless, the homebuilders, completely out of touch with reality, are begging Congress to pass legislation to encourage buyers to step back into the market.

With so many foreclosures in areas inundated with new construction, potential buyers are opting to pay far less for houses just a few years old, while the new ones sit vacant. Builders can’t lower their prices to compete at market levels, as the losses would likely put many out of business.

Which is exactly what needs to happen.

As I have written previously, there will be no bottom in the housing market — or even meaningful stabilization — until at least one, if not more of the major homebuilders goes under. The alternative, which would dramatically extend any future recovery, would be an auto industry-style bailout.

These unnecessary zombies of companies need to start feasting on one another before their industry can return to normalcy. The time for consolidation is now!

By ANDREW JEFFERY

This post first appeared on Minyanville.

“If at first you don’t succeed, try, try again” - and you certainly can’t fault lawmakers for a lack of persistence in trying to stem the epidemic foreclosures plaguing America’s housing market.

Sadly, they insist on trying the same failed strategies over and over again.

For more than 18 months now, Congress has resolutely believed loan modifications are the path out of the housing jungle. But despite a blitzkrieg of public-relations campaigns and benevolent-sounding foreclosure-prevention programs like “Hope for Homeowners,” “HOPE NOW” and the latest, the Federal Reserve’s “Homeownership Preservation Policy,” modification efforts continue to sputter.

Even private-sector programs announced by big banks like Citigroup (C) and Bank of America (BAC) have had only marginal success.

After months of relentless pressure from the House and Senate alike, the Fed’s new policy allows it to review loans supporting the assets it purchased after it rescued Bear Stearns and AIG (AIG) for potential modifications. Barney Frank, the House Financial Services Committee Chairman, told reporters yesterday, “This is a very big deal.”

Actually, Mr. Frank, it’s not.

The assets acquired when the Fed and Treasury Department backed the JPMorgan (JPM) buyout of Bear Stearns and nationalized AIG were derivatives, not actual loans. These mortgage-backed securities are supported by thousands of individual mortgages, while the interest in those underlying loans was sliced up and allocated to countless securities, derivatives, and derivatives of derivatives.

Securities owners can’t modify mortgages: The rules about altering loan terms are pre-determined in securitization documents. It’s left up to loan servicers to implement the rules, whether the security owners like it or not.

Nevertheless, according to Bloomberg, the Fed — after identifying which loans it holds a fractional interest in — will encourage the servicers of those residential mortgage-backed securities “to implement a loan modification program that is consistent with this policy.”

Congress, Treasury and now the Fed have been trying to months now to get servicers on board with modification efforts, to no avail. Even the FDIC, whose highly touted modification program is being tried out at defunct California thrift IndyMac, has been unable to successfully – and sustainably — modify loans en masse.

The reason modification efforts aren’t working — amid evidence that Washington continues to ignore the root of the housing problem — is that the vast majority of loan defaults are being caused by job losses and negative equity. Borrowers can’t get a new loan without a job, nor can they qualify for a modification if they owe more on their house than it’s worth.

According to data released by JPMorgan yesterday, average equity for subprime loans stands at less than 5%.


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It’s negative for all Alt-A adjustable rate mortgages.



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Average equity in jumbo prime loans, which are experiencing defaults at faster rates than either subprime or Alt-A, has tumbled from 45% in January 2006 to less than 20% at the end of last year.


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And, even as regulators force mortgage rates down to record lows to encourage buyers to step in — catching the falling knife of tumbling home prices and risking financial ruin for the benefit of the rest of us — property values continue to fall.

Meanwhile, regulators and lawmakers continue to parade bold foreclosure-prevention efforts before the public. And they’ll keep trying - even if it bankrupts the country.

By ANDREW JEFFERY

In contrast to the silver lining of higher-than-expected home sales tallied in yesterday’s release of Existing Home Sales, this morning’s Case-Shiller November Home Price Index registered the worst year-over-year performance on record.

Property values in November 2008 tumbled 18.2% from the prior year and 2.2% from the previous month. As measured by the Case-Shiller’s 20-city index, home prices have retreated 25% from their mid-2006 peak and now sit close to levels not seen since 2004.

Like a CD stuck on repeat in the guy down the hall’s dorm room while he is away at class (you try listening to Chumbawumba’s Tubthumping for 3-hours straight and not being driven to drink at 3pm), annual price declines were the worst in Phoenix and Las Vegas, followed by San Francisco, Miami, Los Angeles and San Diego.

News that home prices are falling, however, isn’t exactly news. So let’s look at what this Case-Shiller Home Price Index is anyway, and how it differs from the less murky Median Home Price data released every month by our friends at the National Association of Realtors (the NAR).

As Cirios statistics’ wizard Austin Nelson explained last week, the median home price is simply the middle price in a list of sales. So, the NAR grabs data on all home sales in a given month and picks out the one with the same number of sales on either side. The logic behind using this measure, rather than the more commonly understood average, is that it reduces the effect of outliers, or sale prices that are either much higher or much lower than the prevailing trend.

Case-Shiller, on the other hand, uses what are known as “paired sales” to evaluate home prices. By examining sales in a given month, then looking back to find the most recent sale price and date for each house, statisticians are able to back into an annual rate of decline.

For example, if house A sold in November ‘07 for $250,000 and again in November ‘08 for $200,000, Case-Shiller would say the annual home price decline was 20%. By limiting the search only to sales that have a relevant pair (ie, previous sale), the methodology limits sample size, potentially leaving margin for sampling errors. Sample size is something I’ll let Professor Nelson explain in further detail at a later date.

So, which method is better, paired sales or median price? As is typical with such economic questions, the answer is a resounding neither.

Median Home Price measurements provide good information about the distribution of sales, and in the current environment reflect that since Jumbo mortgages are nigh impossible to get and foreclosure sales are driving most markets, cheaper houses are selling far more often than more expensive ones.

Case-Shiller, on the other hand, represents a more accurate level of home price declines for specific homes — far more important to the average homeowners. Of course, a number slapped on a metro area is fairly meaningless when it comes to an individual property, but it’s still more useful than a bucket of houses being sold for different reasons by different sellers in different neighborhoods.

With Case-Shiller a month behind the NAR data, keep an eye out next month to see if the silver lining found in December’s median home sales data is reflected in the paired sales analysis. If it is, you can be sure calls for a bottom in housing will once again abound.

By AUSTIN NELSON

The National Association of Realtors released figures on existing home sales for December, showing an “unexpected” rise in sales volume for the month. Across the US, data showed a 6.5% increase in volume month over month. The surprise increase was bittersweet however, as median home price declined almost 3% month over month and were down 15.3% for all of 2008.

The Western region led both these trends last month, showing a 13.6% increase in sales volume and an 11.6% decrease in median sale price. Furthermore, in 2008 the West saw a 31.6% increase in sales volume and a whopping 31.5% decrease in median sale price. (Click here for more on median sales price figures compared to average prices.)

While this month’s data could simply be a small bump on the otherwise sharply downward roller coaster ride of residential real estate, in the West region at least it is indicative of a trend. As home prices “bottom” out or at least hit lows not seen in a decade, homes start to actually become affordable for the people who live in the area. Combine that with more favorable lending conditions and voila!, you’ve got an increase in sales volume.

This trend is even more accentuated the more you drill down to individual neighborhoods. We have seen neighborhoods in the San Francisco Bay Area that are seeing two fold increases in sales volume as prices reach affordable levels. Indeed, the further the drop in price, the more likely an increase in sales volume will be seen.

The important thing to keep in mind here is that prices are still continuing to drop even amidst the increasing volume. So even though your neighbor successfully sold his house in time to avoid foreclosure, you will likely end up selling yours for less. This is a result of the continued high levels of short sales and foreclosures that are flooding the market. Even with increases in buying activity and eligible buyers in the market, there are still enough properties for sale that the buyer can afford to be a stickler about price.

With that in mind, perhaps the most important number to watch is the housing inventory, which is simply a value calculated by taking the number of homes currently on the market and dividing it by the rate at which homes are being sold (seasonally adjusted, of course). This gives you the approximate time it would take to sell every home currently on the market (assuming the rate stayed the same and no new homes came on the market). That number was on the rise through the middle of last year but seems to have stabilized.

If this month’s data is an indicator of a future downward trend in inventory it could be the first true sign of improvement on the horizon. The question is, how far away is that horizon? And, given the current state of the US economy and banking system, will that improvement have staying power?

In the short run, savvy investors can take advantage of the increased liquidity in the housing markets by buying at a discounted rate and selling right back into the increasing demand. This will require careful analysis of the sales trends for a particular area as well as precise valuation of any property under consideration.

By ANDREW JEFFERY

This post first appeared on Minyanville.

$100 billion just isn’t what it used to be.

Over the weekend, Freddie Mac (FRE) requested a second draw on its Treasury Department credit facility, saying $30-35 billion would suffice to keep its net worth above zero, thank you very much. After taking $14 billion in the third quarter of last year, Freddie has now chewed through almost half its $100 billion taxpayer-provided safety net in just 5 months.

According to Bloomberg, Freddie’s fourth -quarter operating losses triggered the need for additional funds, as its massive mortgage portfolio continues to sour. Analysts expect Freddie’s sister company, Fannie Mae (FNM), to request a similar draw when it announces fourth-quarter results in February.

As one analyst told Bloomberg, “[Fannie and Freddie’s] losses are going to be much higher than anyone anticipated. The more and more that people are digging into these portfolios, they’re finding out the more and more these guys were doing subprime and Alt-A loans and classifying them as prime.”

Defaults on prime mortgages, which are supposed to be given out to borrowers with good credit and stable jobs, are now increasing at a faster rate than the subprime loans that get so much headline play. According to the latest Mortgage Bankers Association Delinquency Survey, 2.87% of all prime loans were delinquent in the third quarter of last year, up 85% from the same period a year ago.

Keep in mind those figures are through September 2008 and don’t include the abysmal economic conditions of the past 4 months. And as layoffs mount and the economy continues to contract, the previously well-to-do are facing the same economic hardships those “subprime” people have been dealing with for almost 2 years.

Fannie and Freddie, despite not technically being involved in subprime lending, drove industry trends, and, in many ways, set precedents followed by the rest of the mortgage industry. Their drive to automate the loan underwriting process created massive opportunities for fraud. Both savvy and ignorant originators easily duped the system, jamming subprime borrowers into prime loans, which neatly showed up on bank balance sheets as AAA-rated assets.

The sieve-like automated systems were adopted by other big lenders, such as Countrywide, Washington Mutual, Bear Stearns, Lehman Brothers, IndyMac and Wachovia.

Now that none of those firms exist, loans originated under the guise of “prime” are turning out to be anything but. Bank of America (BAC), JPMorgan (JPM) and Wells Fargo (WFC), heretofore the strongest banks in the country, who absorbed many of those defunct lenders, are now faced with mounting losses on loans they thought were of the highest quality.

As I noted about this time last year, while everyone was so focused on subprime, prime mortgages — a market about 4 times as large — quietly presented a far bigger threat to the financial system. Now, as the government has bailed out 2 of the 4 remaining big American banks, those loans threaten the federal balance sheet.

Where’s TARP 2 when you need it?

By RYAN TAYLOR

Just when you thought the market for new homes couldn’t get any worse, it did.

The National Association of Home Builders (NAHB)/Wells Fargo January builder sentiment index dropped to 8 from 9. While the homebuilders were setting records for new home sales in 2005 and 2006, they’re now setting records for the lowest confidence on record, as 8 breaks last month’s record low of 9.

The homebuilders are very clear on what needs to happen to bring back their confidence and revive the market for new homes (Hint: It has nothing to do with building homes that people want to live in for the right price.)

“Conditions in the nation’s housing market aren’t getting any better, and they aren’t going to get any better until the federal government takes substantial action to encourage qualified buyers to get back in the market.” NAHB Chairman Sandy Dunn said.

One of the biggest reasons we are in this housing crisis is that builders put millions of buyers in homes they couldn’t afford. Through questionable relationships and kickbacks, builders partnered with lenders to encourage buyers to stretch beyond their means. This common practice during the boom created a massive over-supply of homes which has yet to be worked through.

As a result, homebuilders are left with basically two choices – 1) offer homes at prices that are reflective of the current market conditions or 2) do not sell any homes and plead for Uncle Sam to help them.

Needless to say, they’re not going for option number one because it will put most of them out of business. Furthermore, the NAHB seems delusional on why people are not buying their homes.

“Qualified buyers are clearly in the wings but they’re looking for a significant signal from the federal government that now is the time to return to the market” NAHB Chief Economist David Crowe said.

This statement makes the assumption that qualified buyers are not in the new home market because the government needs to give them some kind of divine signal to know when to buy. As an alternative explanation, I think qualified buyers are not buying new homes because they’re far away from job centers, listed above market and were built by companies that frequently stop work on projects halfway through– existing residents be damned.

Until one of the major publicly traded home builders goes out of business, we are not near the bottom in the housing cycle.

By ANDREW JEFFERY

This post first appeared on Minyanville.

Increasingly, US real estate is becoming a tale of 2 markets.

In low-income neighborhoods, overbuilt suburbs, and other areas besieged by foreclosures, home sales are through the roof.

Data released this week by MDA Dataquick, a real estate information service, show December 2008 sales in Southern California’s hard-hit Riverside and San Bernardino counties up a whopping 300% from a year ago. Southern California as a whole has seen transactions spike more than 50%, while pockets of the San Francisco Bay Area are showing similarly robust numbers.

Prices, however, continue to plunge.

Foreclosure sales are driving distressed markets, and since repossessions disproportionately affect lower-priced homes, data are being skewed downward. Record-low interest rates, bottom-fishing investors and relentless marketing efforts by the National Association of Realtors are all spurring renewed buying activity.

Lenders are so overrun with new business that Wells Fargo (WFC), which plans to cut over 10,000 jobs as it absorbs recently purchased Wachovia, is hiring hundreds of temporary workers to handle mortgage applications, according to MortgageDaily.com.

Meanwhile, buyers are on strike in high-end markets, and supply is creeping towards materially unhealthy levels.

Jumbo loans – those not guaranteed by the government via Fannie Mae (FNM) and Freddie Mac (FRE) – are nigh impossible to get, leaving would-be buyers of expensive homes in the lurch. Transactions are down in some of California’s — and indeed the country’s –  most prestigious markets, leaving a host of recently minted real estate millionaires wondering if they’re next to get stuck in the subprime slime.

Conventional wisdom among real-estate professionals is that these well-to-do areas are in “wait-and-see” mode. This attitude, while comforting to the rich, is dangerously naïve.

Transparent, real-time sales data is carefully concealed from the buying public by the country’s real estate brokers; it tells a very different story. In these illiquid high-end markets, inventory is building, forced sales are on the rise, and prices are starting to head south.

And contrary to popular belief, value drops aren’t just taking place in far-off exurbs where palatial Toll Brothers (TOL) McMansions litter flattened hilltops. Established neighborhoods — many close to job centers with top schools – are seeing home prices fall for the first time in decades.

These high-priced markets, particularly because of the troubles in the jumbo loan market, have become dangerously illiquid. In many neighborhoods, just a handful of homes are currently listed for sale. If one seller gets antsy, loses his job or otherwise jumps at a low-ball offer, the entire market can gap down. The new, lower price sets the bar at which potential buyers begin their negotiations, putting sellers at the whims of their skittish neighbors.

Due to dramatic appreciation during the boom, many wealthy homeowners are sitting on huge equity cushions. While not something they often complain about, this could encourage quick sales, as sellers don’t need to hold out for the absolute highest price like their poorer, more levered neighbors on the other side of the tracks.

All this adds up to an increasingly bifurcated market. The most distressed areas are currently going through the final, violent throws of a real estate collapse for the ages. The process could still take months to run its course and some communities, sadly, may never recover.

Previously strong areas, on the other hand, are just now beginning to feel the pinch. Many, after decades of unfettered appreciation, have a very, very long way to fall.

By ANDREW JEFFERY

This post first appeared on Minyanville.

In recent months, headlines have been popping up noting that rents – finally – are beginning to follow home prices into the abyss.

Since the housing market began to crumble, would-be homeowners were forced to become renters, keeping demand for rental units relatively strong even as home prices fell. Now, however, as landlords convert condos into rentals, supply is beginning to move in tenants’ favor.

And while this is welcome news for millions of renters around the country, its impact on consumer price measurements could materially impact mounting deflation expectations.

The reason can be found in the nuances of how the US Bureau of Labor Statistics measures the Consumer Price Index, or CPI. The CPI is the most widely quoted gauge of inflation, it being the easiest to explain to the consuming public. Tally up a basket of commonly purchased items, see how their prices compared to last month, then last year and voila! consumer prices at your fingertips.

In realty, of course, it’s a bit more complicated: Just take a gander at this sophomoric equation from a recent CPI release:

Riiiiiiiiiight.

The most heavily weighted item in the CPI is something known as Owners’ Equivalent Rent, or OER, which accounts for almost 24% of the total index. OER is the government bean counters’ preferred method for measuring the cost of owner occupied housing, calculated by figuring out how much the median homeowner in the country would have to pay to rent his or her family’s dwelling.

Many observers, Minyanville’s Professor Mish Shedlock included, believe the CPI has been understating inflation for years by ignoring housing prices. Now, that rents are beginning to fall, however, inflation readings could become dire.

As Professor Kevin Depew noted last week, the December CPI registered the lowest inflation reading since 1980. And while most media outlets touted the effect of dramatically lower energy prices, OER is quietly reversing a long-standing trend and contributing to the decline.

Examining the data, available on the BLS’ website, OER has been steadily trending upwards for years. Even though the housing market peaked in late 2005, OER rose in 2006, 2007 and even 2008. The rate of change, however, is slowing. Notably, in December 2008, OER rose just 0.08% from November, breaking from the rest of the year’s trend.

And while 1 month does not a trend make, the data support stories from Manhattan to Los Angeles of landlords giving in to thrifty tenants shopping for the best deal. With mounting job losses and weak economic conditions persisting, this will be an important trend to watch in coming months. Property liquidations by big banks like Wells Fargo (WFC), Bank of America (BAC) and Citigroup (C) will add to housing supply, further pressuring rents.

CPI data matter, despite their myriad of potential problems, because of their effect on inflation expectations - or in this case, deflation expectations.

Federal Reserve officials, including Chairman Ben Bernanke, are wary of these expectations because they represent future consumer behavior. In a speech last summer, as energy prices rose to all-time highs, Bernanke said “Some indicators of longer-term inflation expectations have risen in recent months, which is a significant concern for the Federal Reserve.”

Fearful of higher prices in the future, consumers increase buying now, spurring demand and pushing prices up even further. The same is true the other way. If the public thinks prices will keep falling, they will delay purchases, waiting for a better deal down the road. This weakens aggregate demand, accelerating price declines.

So as rents, the largest component of the CPI, continue to fall, pricing measurements are likely to signal deflation, even as conventional wisdom calls for hyperinflation. And as a deflationist attitude gains currency, social mood continues to darken, and consumerism is shunned, lower prices will ultimately become a self-fulfilling prophecy.

By ANDREW JEFFERY

This post first appeared on Minyanville.

Foreclosure: It’s not just for those “subprime” people anymore.

Besieged by collapsing home prices and frightened banks scrounging for cash, even the real-estate industry’s brightest stars are finding there’s no place to hide. According to the New York Times, small and mid-size homebuilders who thrived during the housing boom are seeing credit lines pulled even before they miss a payment.

Banks like JPMorgan (JPM) and GMAC, the financing arm of General Motors (GM), loaned builders hundreds of billions of dollars — even as the housing market began to falter — to buy up vacant land. Now that demand for new homes has plunged (and buyers in some areas can pick up previously constructed homes for less than it costs to build a new one), builders’ ability to turn a profit has been effectively eliminated.

It’s estimated that over 20% of the nation’s homebuilders have closed their doors, even as big builders like D.R. Horton (DHI), Lennar (LEN) and Toll Brothers (TOL) limp along, bleeding cash and fighting for survival.

Lenders, for their part, are scrambling to mitigate risk.

Collateral, the term used to describe the assets against which loans are given out, protects lenders in the event of borrower default. As the value of collateral rises, banks become better protected since their loans are now backed up by a more valuable asset. In a downturn, however, falling collateral values means risk increases with each passing day.

In response, banks may ask borrowers to send in cash to make up for the lost value of their investment. These margin calls, as they’re known, can quickly force small firms into insolvency.

Such was the case for Brown Family Communities, a well-known builder in the Phoenix area. The Times reports the firm’s lender, JPMorgan, demanded millions in cash for land on the outskirts of town that had fallen in value. Brown balked, since he was yet to miss a payment and had been a longstanding client of the bank with an impeccable record. Ultimately, Brown lost the property and closed his doors, complaining “The real estate market is gone.”

Other builders have suffered a similar fate, proving that despite extensive government-led efforts to minimize losses from investments gone awry, the fundamental tenets of capitalism remain intact.

Bad investments should yield losses, period. Savvy new buyers, able to handle the risk inherent in buying distressed properties, can make bets that have the potential to reap huge rewards. This cycle of profits and losses fuels economic expansion. By forestalling losses, intervention delays recovery.

The speculative buying of vacant desert land on the edges of the Phoenix city limits in 2005 and 2006 certainly qualifies as a poor use of borrowed money. That builders are being asked for cash to cover banks’ potential losses should be seen as nothing more than prudent lending – something builders and other real-estate investors spent the boom years conveniently forgetting.

By RYAN TAYLOR

In this two part series, Cirios’ Valuation Guru Ryan Taylor offers an insider’s look into the nuances of investing in foreclosed homes. Please click here for Part 1.

As potential buyers embark on their search for a new home or a prospective investment, they are very likely to see at least one REO property. These buyers need to educate themselves on what an REO property has in store for them because avoiding an REO is often times unwarranted.

One of the first things a prospective buyer needs when looking at a property is imagination. In the case of owner-occupied sales, most buyers can visualize themselves in the property because someone lives in the home. Homebuilders like Centex, Lennar, Toll Brothers and KB Home have made their fortunes by staging homes with swanky furniture so it’s easy to envision life in their new home.

On the opposite end of the spectrum, REO properties are often times neglected by the bank that owns them and they are not nearly as welcoming.

Do not let weeds and trash in the yard, the lack of furniture or a pink bedroom distract you from seeing the property as your potential home.

Another attractive aspect of purchasing an REO is the ability to negotiate with the bank. This fact has become, and will continue to be, a big part of any REO transaction. In the early part of 2008, most banks were unwilling to negotiate for a variety of reasons, but as losses have continued to mount, the fear of the housing market falling further have forced banks to the negotiating table.

Any prospective buyer should ask to be compensated for closing costs and request money for needed repairs. While banks may not give you everything you ask for, with a little negotiating and the recognition that you, the buyer, are in the position of power, buying an REO can save you thousands of dollars.

Probably the most beneficial aspect of purchasing an REO is that the buyer has an opportunity to buy a home that they can turn into their perfect home. Adding your personal touch will not only add personal value to the property, but also monetary value.

In a market where there are very few willing and qualified buyers, most homes that are purchased are turnkey or move-in ready. The majority of buyers are not interested and/or do not have the time to work on a “project”. While these people are getting a very nice home, they could have saved money by seriously looking at an REO property. The money they saved on the purchase price could have helped them upgrade the home to their own taste. Let’s face it – everyone has their own taste and would like nothing more than to have a home that has their own personal touches.

One of the biggest deterrents from an REO purchase is the potential work that needs to be done on the property. You name it and it could be broken, destroyed or missing. REOs come in all levels of disrepair, which makes having a trusted inspector (and a contractor in most cases) go through the home with you crucial to knowing that you are getting what you paid for. There is nothing like saving a few thousand dollars at the closing table and then having to turn around and pay for a new roof and new plumbing system. It can almost always be assumed that the property has been neglected by the bank so be sure all aspects of property repair have been thoroughly reviewed and included in any offer.

The other big risk is the supply of REOs in the property’s immediate neighborhood. The general rule is the more REOs, the worse the potential value declines could be in the near (if not long) term. As unsold homes sit on the market, buyers demand lower prices and neighborhoods become less desirable.

Just because you have found an REO that is in good shape and priced at or around your budget doesn’t mean it is a good buy right now. As you have read numerous times on this site, the real estate market is in for more pain. One of the main reasons for this is that banks are facing increased pressure to liquidate these properties and raise cash, so they are listing their REOs for less than anything else on the market.

This practice is one of the biggest drivers of the declines infecting most of the country, and the primary reason foreclosure prevention efforts are such a high priority in Washington.

Buying a home in a declining market can be a very risky financial decision and everyone needs to be aware that property values could decline by another 25%, if not more, depending on the area. At the very least, prospective buyers have to see themselves living in the home for 5 years. Even though living in the same house for a long time sounds like a great idea now, if you have a 5 year old and a 7 year old and are considering a one bathroom house, do you really to want to share a bathroom with them when they are 10 and 12? And maybe more importantly, are they really going to want to share that bathroom with you?

The final piece of advice I will offer regarding an REO purchase is you should always have an understanding of the true value the home. This is of course, no easy task to figure out.

If there are quite a few REOs on the market listed at $100,000 above their real value, even receiving a discount of $30,000 on the list price means you could still be overpaying by $70,000. List prices are simply what a seller wants, and often bears little resemblance to the actual market price.

On the flip-side of that coin, many banks will drop the list price of their REOs dramatically after they have been on the market for 30 or more days. If you see a home listed for $500,000 and your property valuation provider tells you it is worth $450,000, you should not be afraid to offer $450,000 for the property. If you wait for the list price to come closer to $450,000, you may miss out on the opportunity. When sellers drop their list price, the home immediately jumps on the radar screens of Realtors and investors — this can often create a bidding war that may drive the price up above your target. In addition, it’s hard to argue for closing cost incentives if you’re willing to pay more than the list price.

The supply of REOs is only increasing so do your homework and do not be afraid to make an offer on one of these homes. You never know when you could get a great deal.