Toxic Neighbors: Foreclosures and Short-Sales Spillover Effects from the Current Housing-Market Crash

Article excerpt

I. INTRODUCTION

As the national mortgage crisis continues, governments at all levels are considering undertaking ways to design homeowner-rescue and foreclosure-prevention policies. Justifications for such policies are based on the fact that foreclosures' negative impact goes beyond hurting those who are losing their homes. In addition to foreclosed homes being sold at a significant discount, they impose negative spillover effects on the values of the nearby properties. First, they cause physical blight. Delinquent mortgage and foreclosure process reduce the incentive of homeowners to invest in the interior and/or exterior of the property, thus reducing the attractiveness of the neighborhood to potential buyers. In addition, properties undergoing foreclosure most probably experience neglect, abandonment, and vandalism, which further alters a property's exterior. Second, homeowners' valuation of their own home is influenced by the price of neighboring homes. Thus, a decline in neighborhood home values due to foreclosure reduces the reservation and transaction price of non-foreclosed homes. Finally, an increase in foreclosures increases the total supply of available homes in the affected segment of the market. Given stable demand, prices of all properties will be lower in that segment of the market.

Over the past several years, a number of studies estimated the impact of foreclosure status on house price. This literature shows that mortgage defaults and resulting property foreclosures generate a selling price discount of about 7%-24%, depending on location within the United States. (1) More recently, a handful of studies concentrated on the spillover effects of foreclosed residential properties on the sales price of nearby nonforeclosure properties during stable housing markets. (2)

This study advances the knowledge of the short-term spillover effects for foreclosures and short sales during a severely "thin" market period. The study includes data of all single-family detached home transactions from January 2008 to the end of June 2009 in Las Vegas, Nevada. We find estimates of foreclosure spillover effects that are twice the size of previous estimates of the same market, from 1.1% to 2.9% per foreclosed home. Controlling for the overall market trend in prices, the neighborhood average price, and unobserved neighborhood characteristics significantly reduce the size of the effects. We find no additional spillover effects from short sales.

II. LITERATURE REVIEW

As mentioned earlier, only a handful of studies have looked at spillover effects of foreclosures. Immergluck and Smith (2006) examined the effect of 1997-1998 foreclosed properties on a sample of 9,600 homes that were sold in Chicago in 1999. They concluded that, on average, for each foreclosed property within 600 feet there was a 0.9% negative spillover effect on the values of nondistressed properties. Lin, Rosenblatt, and Yao (2009) estimated the spillover effect of foreclosed properties on the neighboring properties for Chicago. Using data on 1990-2006 foreclosed properties and year 2006 nondistressed sales, they found the spillover effect as large as 8.7% for foreclosures within 300 feet and 2 years of liquidation. The effect declined sharply within a distance of 2,700 feet and 5 years of liquidation. Schuetz, Been, and Ellen (2008) used data from 2000 to 2005 from New York and found a spillover effect of about 0.2% to 0.4% within 250 feet caused by neighbors filing for foreclosure. Leonard and Murdoch (2009) used 2005-2007 home transaction data in Dallas to estimate the effect of properties in some stage of default process (not sales of foreclosed homes) on nearby sales. They found a 0.5% effect within 250 feet.

The above papers estimate hedonic models that include the number of, or indicators for, foreclosed properties as additional independent variables. They do not control for spatial and time interdependence and/or for overall market trend in prices. …