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Why state laws are affecting foreclosure inventory and REITs

Brent Nyitray, CFA, MBA

Key takeaways from the May 2014 Corelogic Foreclosure Report (Part 3 of 3)

(Continued from Part 2)

State foreclosure laws vary and this affects foreclosure inventory

There are basically two different types of state foreclosure laws—judicial and non-judicial. In non-judicial states, foreclosures are handled through a streamlined process and generally take a few months. In judicial states, foreclosures can take years, as judges are often reluctant to push a delinquent borrower out of their home. As you can see from the map below, the states with the biggest foreclosure inventory are the states with judicial foreclosure processes—New York, New Jersey, and Florida.

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—you’re seeing much lower home price appreciation. In fact, you’re seeing very little residential construction at all—at least compared to some of the other states.

Implications for mortgage REITs

Real estate prices are a bigger driver of non-agency REITs, such as CYS Investments (CYS), Newcastle (NCT), and Redwood Trust (RWT), than they are of agency REITs like Annaly (NLY) and American Capital (AGNC). When prices rise, delinquencies drop. This is important because non-agency REITs face credit risk. Even for agency REITs, which invest in government mortgages, rising real estate prices can drive prepayments, which negatively affects their 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 their securities upwards. Since REITs must pay out most of their earnings as dividends, higher earnings mean higher cash flows to the investor.

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