The Problem with Foreclosures...

For those of you who know me it should come as no surprise that I like listening to talk radio when I'm in my car. The topic of real estate often comes up in these talk shows and one of the financial talk show hosts yesterday was asked about foreclosures and buying them. The caller was wondering if it was a good idea to buy an REO and if so what he should look for to get a good deal.

The host's answer perturbed me a little. Knowing the host to be extremely conservative when it comes to money, I loved that he said it was a very opportune time to buy real estate and that the caller would be pretty thrilled about his purchase in the future because bank owned homes are greatly discounted. However, he also told the caller to look for a foreclosed home that is 30% under fair market value. Usually, the host said, he recommends 20% under fair market value, but now he suggests going for the extra 10%

Great advice. But here's the chink in the armor - here's my point: What exactly is fair market value?

I know the definition of fair market value and I know how to get my clients a market analysis. But when every home is a foreclosure and already discounted and every sold comparative property in the neighborhood is also a foreclosure, just how is a buyer to figure out fair market value?

The value of a property falls or rises only in comparison to its neighbors'. The current market in Sacramento is replete with foreclosures. In fact, if you look at the real estate market statistics, almost 90% of the sales are foreclosed properties. So, in effect, foreclosures are making up the sold comps. To expect a property to be 30% under the recent foreclosures - already discounted - in the area would be to expect the economy to be in much worse shape than it is now. And if that happens, do we really think anyone would be buying a house?

The financial host's advice is (as in most other cases) pretty commonsensical, but only works in relatively stable markets and neighborhoods where you can compare a foreclosure to a non-distressed sale. In markets like we have today in Sacramento, that advice doesn't work as well. We need a new parameter to assess value in Sacramento REOs. Any guesses, Mr. Clark Howard?