Regular readers know that I have a problem with those who say that the banks are sitting on thousands of homes in almost any given market — maybe tens of thousands and totalling 700,000 across the nation!– waiting for prices to improve so they take less of a loss. These houses are the so-called “Phantom Inventory.” The “facts” these experts cite are a comparison of actual foreclosures to the number of these homes that show up as REO (“Real Estate Owned“) in the local Multiple Listing Service later. Needless to say, if this is true, any possibly recovery in the housing market will be instantly crushed as all the bank asset managers decide to start unloading this inventory! 

There are a lot of innocent reasons that a bank may delay listing a home for several weeks or months: clearing the title so they can legally sell it; cleaning and repairing so it will sell for the best possible price; in some states they may have to hold it for a “redemption period” during which the foreclosed homeowner can buy it back, if he can come up with everything owed. That could delay listing for a year, depending on the state!

Further, the bank may decline to take title in the first place. 

And now the latest wrinkle. Banks are setting the auction price low, and someone other than the bank may be buying the properties at the foreclosure auction! This is not to be confused with the big real estate auctions you may see advertised; it’s the “on the courthouse steps” auction that officially takes ownership from the foreclosed homeowner. Here’s more on the problem, from somebody who saw it firsthand and then did some research: 

Only a few of the trustee sales attracted bidders, and the rest were deeded back to the bank.  Out of the 92 active sales, 25 had opening bids below the amount owed to the bank.

Why would a bank or lender set their opening bid below the amount owed?

Banks and lenders have duties to their shareholders and investors to maximize profits and minimize losses (well, at least they use to.) If opening bids are set LOWER than what’s owed, perhaps the banks have already tallied their losses, realized that if they had to take back the house, get it cleaned out and cleaned up for resale, pay a real estate agent their commission to sell it, pay for title, escrow, excise tax, utilities, and any other carrying costs,  they might as well sell it at a discount at auction.

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My theory is that banks are relying on third party information such as a mini appraisal or Broker Price Opinion (BPO) prior to auction.  If the BPO suggests that the outstanding principal balance is so high and out of range as to likely attract no bidders at auction, then the banks have nothing to lose by setting the opening bid closer to or significantly lower than the principal balance owed.  If no one bids at auction, they’re still only out the money they would have been out anyways and on the upside, if the low opening bid attracts investors, then perhaps the bidding will rise closer to the payoff.

If these properties are bought by somebody other than the bank, they will never show up as REO in the MLS system. Even if they are purchased by investors intending to “fix and flip.” They are never actually “bank owned”! How common is this? The observer reported 27% of the properties she saw auctioned — no way of knowing if that is unusual. It’s common enough that I located one such home a few blocks from me just a few days before reading this article. It’s not on the market yet, but it’s being fixed up and will be available soon.

Don’t get the idea that lots of bargains are available this way. Frankly, the foreclosure auction is a risky way to buy real estate, and should really be left to professional investors who have systems in place to determine condition, value, and the status of secondary liens. However, most of these investors will be selling or renting it in just a few months. These homes will have the “cheap” advantage of having been a foreclosure, but already fixed up, and with most of the advantages of dealing with a private owner (fast response, no long bank addendums that take away your rights, full disclosures).

The thing to remember is that while you can learn a lot from the figures, the real trick is seeing how the figures apply to what is really happening.