“Strategic” Defaults…Media Hype or Serious Issue?

Westcoe Realtors, Riverside California…So…one of our regular readers wrote in and wanted to know if Strategic Defaults (where a homeowner simply walks away from their home because it has dropped in value, not because they cannot afford it) were a large part of the real estate landscape in the Riverside area.  Seems the media has popularized this term with stories about the wealthy and the prevalence of this phenomena, and our loyal reader wants to know about our region.  Is this happening right here in Rivercity?

Good question…and while it’s hard to get much actual data in this area (for reasons we will describe), we’ll give you the best answer we can.

To begin, everyone should understand that there are generally only two ways for a real estate company such as ours to get involved with a “distressed” property….either through a short sale (while the seller still owns the home) or as a REO/repo once the bank has foreclosed on the property.

In a short sale, in order for the bank to actually allow the sale to take place (remember, the bank must agree to accept less than what is owed on the property) the seller must have a defined and demonstrated hardship that can be documented to the bank.  This hardship could be loss of job, transfer, divorce, etc…and it must be something that can be documented to the bank.  It’s not enough for the seller to just plead hardship…they must actually show the hardship on paper.  Also, even if there is a verifiable hardship, if the seller has a boatload of cash sitting in a bank somewhere, the existing lender will not exactly be in the mood to lose thousands of dollars while the seller keeps their thousands of dollars.  Bottom line…the seller has to show they can no longer afford the payments and has basically run out of money in the bank in order to get most lenders to agree to the short sale.

So…in this case, it would be almost impossible for a Strategic Default to take place, since the existing lender would just say “no” to the short sale and move on from there.

That leaves us the second way a real estate company gets involved in a distress sale…as a bank repo that needs to be sold.

In this case, since the real estate company only gets involved at the tail end of the foreclosure process, we have no idea why the seller lost the home.  It could have been a true economic hardship brought on through no fault of the seller, or they could have had hundreds of thousands of dollars in the bank and simply elected to walk away from the home because the equity was so low.  We don’t know.  We rarely meet the homeowner, and when we do, it is only on their way out of the home.

So…to answer our readers question, we simply do not have the data to give you a factual answer…but that doesn’t mean we don’t have an opinion, or “gut level” response to the question of Strategic Defaults.

As an opinion, I would think that in the Riverside area, we probably have very little of this happening.

Our real estate market exploded from 2000-2007 like almost everywhere else, but mostly it was carried on the wings of first time buyers.  Riverside real estate has always been far more affordable than our neighboring counties of Orange and Los Angeles.  We have usually attracted the families who may work in those areas, but needed to buy an affordable home in Riverside…and since first time buyers are generally not the “uber wealthy” with massive amounts of savings, one could assume that Strategic Defaults are not part of our distressed pattern.

Riverside did indeed have its share of “trade-up” purchases where the $300,000 seller moved up to the $500,000 home, and the $500,000 seller moved up to the $1,000,000 home etc.  However,  our experience was that the more expensive homes used a very large down payment from the equity of the buyers previous home, which would act as a buffer against Strategic Defaults.  In this example, the million dollar home has taken an equity hit like everyone else, but they still have equity…just not as much as when they bought the home.

Therefore, while I am sure we have had some Strategic Defaults in the Riverside area, my best guess is that they represent a very low proportion of the foreclosures.  I would think that this would be a far greater issue in areas where the entry level housing price was far above the level reached in Riverside, and where buyers had very high incomes and could qualify for the very low down payment loans available at that time.  I have no data, but this sounds like Orange County and parts of Los Angeles County to me, not Riverside.

Anyway, sorry for the lack of factual data on this subject, and I hope I haven’t irritated too many of those residents of our neighboring counties (although they bag on the IE often enough that “what goes around comes around” might fit here)…but for once, we will be happy to let those areas take the real estate lead on this topic.

Take care, and thanks for reading what I write, and writing about what you want to read.