Sizing the backlog and when it will hit the housing market is important because those distressed sales represent both opportunity and potential risk for real estate investors.
Foreclosure prevention efforts during the COVID-19 pandemic helped prevent a tsunami of distressed sales during the thick of the crisis, but it also created a backlog of distress that is beginning to clear as the world slowly returns to normal.
Sizing that backlog and when it will hit the housing market in the form of distressed sales is important for real estate investors because those distressed sales represent both opportunity (value-add acquisitions) and potential risk (discounted comparable sales that negatively impact surrounding home values).
“We make more money in a down market than we do in a market like this,” said Paul Lizell, a Florida-based real estate investor whose primary property acquisition channel historically has been bank-owned (REO) auctions. “Inventory didn’t really drop substantially on the REO side until COVID. … During the pandemic, we were using wholesalers, but now it’s going back to mostly auctions.”
A key metric in determining the size of the pandemic-triggered distressed backlog is the number of delinquent mortgages no longer protected from foreclosure by emergency programs designed to prevent a foreclosure tsunami; namely, a nationwide foreclosure moratorium on government-backed mortgages, a sweeping mortgage forbearance program with an extremely low and documentation-free barrier to entry, and an extensive loss mitigation waterfall with myriad loan modification and other options to help ease the mortgage payment burden for borrowers who exit forbearance.
Even while the overall number of seriously delinquent mortgages has been consistently falling after peaking in 2020, the number of these unprotected delinquencies has been steadily rising since the foreclosure moratorium ended in July 2021. Unprotected delinquencies increased to 420,000 as of July 2022, according to the Black Knight Mortgage Monitor report. That was up by 46,000 (12%) from the previous month and up by 198,000 (89%) from a year earlier.
Separate data from the U.S. Department of Housing and Urban Development (HUD) shows a similar trend for mortgages insured by the Federal Housing Administration (FHA). More than 30,000 seriously delinquent FHA-insured mortgages either failed or were ineligible for post-forbearance loss mitigation in July 2022. That was more than double the number in the previous month and more than double that of a year ago.
“You’ve already got an overleveraged buyer going into (an FHA) loan, compared to conventional. You’re starting off with a riskier borrower to start with,” said Lee Kearney, a Tampa-based real estate investor. “I have no doubt that the floodgates are going to open up on the post-pandemic defaults.”
If the pandemic backlog of distress can be estimated at about 420,000 delinquent loans, the next question becomes how much of that backlog will eventually reach the housing market in the form of a distressed sale—either foreclosure auction sale or bank-owned (REO) sale.
An Auction.com survey of more than 50 senior-level representatives of major mortgage servicers in June 2022 sheds some light on this question. On average, those surveyed estimated that 23% of their company’s seriously delinquent mortgages would complete the foreclosure process in the next 12 months. That is close to the historical rate of 25% based on data from Black Knight and ATTOM Data Solutions going back to 2006.
Applying the 23% rate to the 420,000 backlog of unprotected distress results in about 96,000 completed foreclosure auctions between July 2022 and June 2023. That 96,000 would represent a 43% increase compared to the roughly 67,000 completed foreclosures in the previous 12 months, between July 2021 and June 2022. That is, of course, not accounting for any “business as usual” foreclosures not flowing from the pandemic backlog.
Loosening Logjam of Distress
Increasing foreclosure starts in recent months indicate the logjam of pandemic-deferred distress is beginning to loosen. Nearly 24,000 properties started the foreclosure process in August 2022, according to ATTOM Data Solutions. That was up 12% from the previous month and up 187% from a year earlier, the eighth consecutive month with a triple-digit percentage gain.
August 2022 foreclosure starts were still 9% below the pre-pandemic level of more than 26,000 in January 2020, but the August numbers marked a new pandemic high.
Foreclosure starts are returning more quickly in some markets. August 2022 foreclosure starts were at or above the pre-pandemic levels of January 2022 in 17 states, including Florida, Texas, New York, Michigan, and South Carolina, according to the ATTOM Data.
Slowing Rising Tide of Foreclosures
That growing backlog of unprotected foreclosures is slowly making its way to foreclosure auction, as evidenced by proprietary data from Auction.com, which accounts for close to half of all foreclosure auctions nationwide.
According to the Auction.com data, completed foreclosures in August 2022 were up 1% from the previous month and up 63% from a year ago, the 17th consecutive month with a double-digit year-over-year increase.
Despite the string of double-digit increases, completed foreclosures in August 2022 were still at just 45% of the pre-pandemic level of January 2020, reflecting what has been a gradual increase in completed foreclosure activity even as pandemic foreclosure protections have lifted over the last 12 months.
The gradual increase in completed foreclosures—rather than a hockey stick-shaped increase—is likely the byproduct of extensive loss mitigation efforts by servicers and the continued backlog of borrowers still working through loss mitigation waterfalls.
Like the foreclosure start data, the completed foreclosure data pattern varies widely from state to state. Although completed foreclosures nationwide remain below half of pre-pandemic levels, 24 states posted August 2022 numbers that were above 50% of pre-pandemic levels, including Alabama, Michigan, Arkansas, Louisiana, and Indiana. Completed foreclosures in August were above pre-pandemic levels in eight states, including Colorado, Kentucky, West Virginia, and Connecticut.
“For us we are shifting too where we’re buying. … Some of your more cyclical markets may take a 20% hit,” said Lizell, the Naples, Florida, real estate investor. “(We’ve) got to be nimble in this market. Super important; otherwise we’ll be out of business.
Daren Blomquist is vice president of market economics at Auction.com. In this role, Blomquist analyzes and forecasts complex macro and microeconomic data trends within the marketplace and industry to provide value to both buyers and sellers using the Auction.com platform.