U.S. Markets open in 3 hrs 34 mins

State Foreclosure Laws Are Affecting Home Price Appreciation

Brent Nyitray, CFA, MBA

Foreclosures Continue to Drop in April: Good News for Builders

(Continued from Prior Part)

State foreclosure laws affect foreclosure inventory

There are two basic types of state foreclosure laws: judicial and nonjudicial. In nonjudicial states, foreclosures are handled through a streamlined process and generally take a few months. In judicial states, foreclosures can take years, since judges are often reluctant to push delinquent borrowers out of their homes.

As you can see from the above map, the states with the largest foreclosure inventories—New York, New Jersey, and Florida—are the states with judicial foreclosure processes.

Foreclosure inventory affects home price appreciation

We’ve seen that home price appreciation varies widely by location. In California, the foreclosure pipeline has been worked through, and we’re seeing price appreciation and bidding wars reminiscent of the peak of the bubble years. In the judicial states, particularly New York, New Jersey, and Connecticut, we’re seeing much lower home price appreciation. In fact, there’s very little residential construction, at least compared to some other states.

New York State has started to examine the issue of zombie homes, or homes no longer occupied by borrowers and for which responsibility hasn’t transferred to the bank. These homes become decrepit and can affect the value of real estate in the neighborhood. Streamlining the foreclosure process for non-owner–occupied homes in New York would go a long way toward fixing this issue.

Implications for mortgage REITs

Real estate prices are a bigger driver of non-agency REITs such as Two Harbors Investment (TWO) than they are for agency REITs such as Annaly Capital Management (NLY) and American Capital Agency (AGNC). They also help originators like PennyMac (PMT) and Redwood Trust (RWT). Investors interested in trading in the mortgage REIT sector should look at the iShares Mortgage Real Estate ETF (REM).

When prices rise, delinquencies drop. This is important because non-agency REITs face credit risk. Even for agency REITs that invest in government mortgages, rising real estate prices can drive prepayments, which negatively affect returns.

Rising real estate prices also help reduce stress on the financial system. This makes securitization easier and lowers the cost of borrowing. Finally, those REITs with large legacy portfolios of securities from the bubble years are able to stop taking mark-to-market write-downs and may revalue securities upwards.

Browse this series on Market Realist: