Distressed properties often bring home values down.  Everyday in the news, you see something about distressed properties, foreclosure rates and falling home prices, but lets just boil this down the simplest question: How exactly do “Distressed Properties” bring down property values?

First, lets define what a distressed property is.  A distressed property, for the sake of this argument, is a property that has been foreclosed on (meaning the bank has repossessed the house and now owns the house), or the home is in some stage of “Pre-Foreclosure” (meaning home owner has fallen behind on making their mortgage payments and now it is only a matter of time before the bank forecloses on the home-owner and repossesses the home). Pre-Foreclosure sales are usually conducted as short sales.

Short sales occur when a home owner puts their home up for sale but the market is not willing to give them enough for the Seller to pay off the mortgage(s) on the property.  If the seller owes more than their home is worth, and agrees to sell the home to the buyer contingent on the seller’s bank for less than what it’s worth, it’s considered a short sale.

So distressed sales are foreclosure sales and short sales.  Both of these types of sale put an emphasis on getting the home sold as quickly as possible. But, in order to sell a home quickly, you need to market the home as a deal.  What’s a deal in today’s market?  A great price, a low price.  If you price a house low enough, you can sell it in a day, regardless of the market you are in, and banks know this.  Typically, the bank or a seller trying to short sell their home, will put a price on a house and continue to lower the price systematically and rather rapidly until the home sells.

So how do these low sales bring down the values of the homes that are not foreclosures or short sales?

Traditionally, Market Value is defined as whatever a ready, willing and able buyer is willing to pay for a home.  The way that buyers judge value in most cases is by comparison.  If someone paid $100k for a house last month, in the same neighborhood, that is roughly the same size and has roughly the same amenities and features as this house, than the buyer can conclude that the market value of this house is around $100k.  Maybe this house had an updated kitchen though and brand new hardwood floors which the other comparable property did not have when it sold. Perhaps, in this situation, it’s worth an extra $20k to the buyer so they are willing to pay $120k.

Now-a-days, what a buyer is willing to pay is not the only consideration.  The Appraiser is the person hired by the buyer’s lender to determine whether the house is worth what this buyer has agreed to pay, based on a comparative market analysis.  The main component of the appraiser’s comparative market analysis is “comparable sales” which means homes like the home in question that have sold recently.  To boil down, for simplicity’s sake, what the appraiser looks at to determine what a comparable sale is, here are the three main criteria that determine whether a sold property is “Comparable” to the subject property and can be used to help determine value:

Based on these three main criteria, plus of course a series of adjustments that the appraiser makes, the appraiser determines whether the home is worth what the buyer is agreeing to pay for it.  If the appraised value comes in under the agreed upon price, the bank will refuse to do the loan for the buyer and the deal falls apart unless the seller is willing to come down on the price. Then either the buyer agrees to bring the difference in cash to put down on the property, or the buyer and seller meet somewhere in the middle.

To sum it all up, if the properties that are considered comparable to yours in your neighborhood are selling for lower prices, and those are the only sales, than the amount you would be able to get for your home is lower too, thus your property value has fallen. So for example, if the only homes that have sold in your neighborhood in the last 6 months are low priced foreclosures or short sales (sold for less than is owed on them), than these “Distressed” properties are the only comparable data points that a buyer or an appraiser can use to value your house.