Hat tip to pemeliza for sending this along from WSJ/Marketwatch:

Recent research suggests that properties near foreclosures normally suffer falling home prices, but a new paper from the Federal Reserve Bank of Atlanta challenges the claim.

It’s the condition of the distressed property progressing through the foreclosure process that weighs most heavily on home prices in the area, not the finality of foreclosure itself, the study found. The negative effect on nearby home prices actually peaks before the distressed property even completes the foreclosure process.

After foreclosure, when a lender-owned property is in below-average condition, nearby houses will trade at lower prices; when it’s above average condition, nearby homes will trade at higher prices.

But even then, if there’s a delinquency or foreclosure down the street, there’s not a huge economic effect on the prices of nearby homes.

The study found that a property in serious delinquency for less than a year or a property foreclosed on and now owned by the bank reduces values of homes within a tenth of a mile by about 0.5% to 1%, “an amount that would most likely go unnoticed by the typical seller who does not have many distressed homeowners living nearby,” according to the report. Researchers analyzed housing information, including public records in 15 metropolitan areas, with a focus on single-family homes.

“We find that while properties in virtually all stages of distress have statistically significant, negative effects on nearby home values, the magnitudes are economically small, peak before the distressed properties complete the foreclosure process, and go to zero about a year after the bank sells the property to a new homeowner,” the authors wrote in the report.

“The estimates are very sensitive to the condition of the distressed property, with a positive correlation existing between house price growth and foreclosed properties identified as being in ‘above average’ condition.”

It’s assumed that the owners of the distressed properties aren’t making as much investment in their properties or are doing as much general upkeep as foreclosure looms. And that’s what’s impacting nearby prices.

“The most important take-away is the effect [on nearby home prices] starts when the property is delinquent. It’s not the foreclosure itself that is the problem,” said Paul S. Willen, an economist at the Federal Reserve Bank of Boston and co-author of the report, in an interview.

In order to minimize the effects that foreclosures have on the surrounding area, it’s best to minimize the time that a property spends in serious delinquency and in bank-owned status, the authors concluded. To do that means accelerating the foreclosure process and putting pressure on lenders to sell bank-owned properties more quickly.

Moreover, policies that delay foreclosures, slowing down the transition from delinquency to foreclosure, don’t protect the neighbors, Willen said. These policies are exacerbating the effect of distressed properties.

“When you talk with community groups… they’re aware that long, drawn-out foreclosures are not good for the community,” Willen said. “The first choice is for the foreclosure to be prevented in a way that is good for the investor and the homeowner. Failing that, it’s good to get this process done it a faster, more humane way.”

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