Understanding Your Assessment: June 2008

Foreclosures and the Assessment Process

Much has been reported in the news media about foreclosures and the impact that they are having on residential real estate markets.  The focal point of these reports has often centered on national and regional statistics, but occasionally, the spotlight has focused on state and local figures, too.  The information offered in these explanations is proof that the foreclosure problem has weakened the marketplace for residential properties.  However, the data shows that the magnitude of this problem and its effect on both sale prices and real estate valuations differs significantly throughout the United States, Minnesota, and even within Stearns County. 

What is a foreclosure?

A foreclosure is a legal process that allows a lender to gain possession of and sell a property when an owner fails to make payments on a loan that is secured by that property.  The process begins when the lender files a notice of default against the owner in the county where the property is located.  If the owner fails to make arrangements to address the non-payment of the loan, a notice of a pending Sheriff Sale is published six weeks before the sale.  The sheriff also serves notice to the owner four weeks prior to the sale.  At the sale, the lender usually opens the bid with the exact amount due, and other participants are given a chance to bid at higher amounts.  The successful bidder receives a Sheriff’s Certificate of Sale, resulting in the foreclosure of the loan.  The time period from the notice of default filing to the Sheriff Sale is about four months.  After the sale, the original owner has the right to redeem the property by paying the successful bidder the amount of the final offer plus interest and fees.  Usually the redemption period for residential property extends over six months, but it may be shorter if the property is abandoned.  During the redemption period, the original owner may continue to live at the property.  After six months, the original owner must vacate the property, and the successful bidder becomes the new owner.                       

What should be considered when reviewing foreclosure statistics and sales information reported by the news media?

When reviewing foreclosure statistics and sales information, this data should be considered in its context relative to the identified area because residential real estate markets are highly localized and always changing.  The facts presented are usually based upon a specified time period and vary according to population characteristics, the job market, sub-prime lending issues, financing, and the economy of that area.  Another major factor to consider is that some statistics are based on the number of properties going into default rather than on the properties that have completed the foreclosure process.  These figures, according to some real estate experts, tend to adversely influence housing indices and overstate the problem.  Last of all, it must be noted that some companies who have supplied information to the media, the Federal Reserve Bank, and Congress have been questioned, and certain firms chastised for their methods of counting the number of foreclosure properties.   

Since foreclosure statistics seem to fall into two categories, which set of numbers best describes the residential housing market for an area---foreclosure filings or properties sold at a Sheriff Sale?

To accurately evaluate the impact that foreclosures have on the marketplace, both foreclosure filings and properties sold at auction should be considered.  The number of foreclosure filings describes the potential for foreclosure and may have a bearing on sale prices and property values, but a truer measure of the vitality of the housing market is the number of properties sold at a Sheriff Sale.  Thus, if one set of numbers is viewed, only part of the story is being told.    
  
How do foreclosure filings and foreclosed properties affect sale prices and property values?

The influence that foreclosure filings and foreclosed properties have on sale prices and property values is extensive and infects every community at varying degrees.  Since all markets pass through phases of the real estate cycle, they are impacted either positively or negatively by the forces of supply and demand.  Liquidity in the markets is also affected by the availability of credit, the condition of the economy, and demographic changes.  Additionally, knowledge and experience together with news reports describing specific market conditions shape public opinion and have an effect on the confidence displayed among home buyers and sellers.  Therefore, both the number of properties in default and sold at auction can disrupt markets by causing an increase in supply, a sense of uncertainty and insecurity, as well as a decrease in sale prices that may result in lower property values. 

What types of sales occur before, during, and after the foreclosure process and how do they influence the market?

Properties selling before, during, and after the foreclosure process fall into three categories based on the time when they are sold.  They are labeled pre-foreclosure, foreclosure, or post-foreclosure sales. 

• Pre-foreclosure sales are usually open market, arm’s length sales unless there is evidence that there is duress or a lack of market exposure.  They are known as a normal third party sale, a short sale, and a soft sale.  First, the third party sale is a sale where the loan against the property is in some stage of default and the amount owed is less than the value of the property.  This sale usually takes place before the published Sheriff Sale.  The owner is selling the property to avoid the foreclosure process and losing equity.  It happens often and goes unnoticed because the property has been listed for sale at or near a price commanded by similar properties.  A short sale is the second type of pre-foreclosure sale that is in default.  It is a sale involving a discounted payoff that requires lender or third party approval.  The total purchase price of the property is less than the total amount owed against it but not necessarily less than the value that it would receive in the open market.  The owner is selling to avoid foreclosure and to reduce a potential loss.  Like the third party sale, it may be overlooked because there is no indication of lender involvement and the sale price falls within the predominant value range for properties in that neighborhood.  The third kind of pre-foreclosure sale is a soft sale or a deed in lieu of foreclosure.  This sale is not considered an open market, arm’s length transaction for ratio study purposes because it is completed to avoid the foreclosure process.  It occurs when the owner and lender have agreed that in lieu of being foreclosed upon that the property deed is given back to the lender in order to eliminate or lessen the time and costs associated with foreclosure proceedings.  The property is conveyed by a warranty deed and the total purchase price is the amount of the loan in default plus fees.                      

• Foreclosure sales typically involve legal action and are sold at auction.  The sheriff is selling the property to the highest bidder.  In most instances, the successful bidder is the lender who obtains the property by offering the amount of the unpaid loan plus interests and fees.  The price paid for a foreclosure property under this circumstance is generally not a good representation of the marketplace.

• Properties that sell and close before the end of the redemption period are post-foreclosure sales.  They are very rare and somewhat akin to a short sale because lender approval is required.  In this scenario, the property’s purchase price is usually at or near the amount paid at the Sheriff Sale.  Other post-foreclosure sales include bank sales and auction sales.  All property acquired through foreclosure by a lender is considered to be real estate owned by a bank.  When it is sold by the lender on an individual basis, it is acknowledged as a bank sale.    If the lender chooses to sell a property at auction as one or with a group of properties through either open or reserved bids, it is called an auction sale.  Both bank and auction sales are not deemed to be an accurate reflection of market value due to the motivation of the seller and limited time exposure.  Yet, there are occasions when these kinds of sales are valid if they meet the market value criteria used in the sales confirmation process.                

Does the assessor use foreclosure sales or the sales of properties that sell during or after the foreclosure process when setting values for tax purposes?

Generally, properties that sell during the foreclosure process, at the Sheriff Sale, and after foreclosure do not meet the definition of an open market, arm’s length transaction and are not used when setting values for tax purposes.  Ratio study standards and published guidelines followed by the assessor prohibit the use of certain sales related to foreclosures.  The types of transactions that are regularly rejected by policy include: (1) sales involving financial institutions (i.e. the lien holder is the buyer and the sale price equals the loan balance in the case of a judgment or a deed given in lieu of foreclosure); (2) forced sales (i.e. a sale resulting from a judicial order when the seller is a sheriff, appointed receiver, or court officer); (3) sales to avoid foreclosure (i.e. legal action is being taken such as in the case of foreclosures, divorces, and bankruptcies); (4) bank sales (i.e. lending institution sales not exposed to the market and the resale of repossessed property if they do not meet the open market, arm’s length test because the lender is only trying to recover its investment in the property; and (5) sales of doubtful title or other non-arm’s length transactions that are atypical (i.e. sales that are not listed, advertised, or promoted to potential buyers).  Still, it must be said that if foreclosure related sales become the norm for a market area, then these sales could be included in the ratio study and used to establish property values.  In this case, a more detailed sales confirmation is performed by the assessor to validate that the use of this data is acceptable.  This review includes a verification of the property attributes and condition on both the date of assessment and the date of sale to ensure that they are the same.  Properties with significant differences in the described physical characteristics are excluded from the ratio study while properties considered similar are used when verified with and approved by the assessor’s Department of Revenue Regional Representative.      

Does Stearns County have a foreclosure problem?  What areas of the county have been impacted the most by foreclosures?

The amount of residential properties in default within Stearns County has been difficult to quantify based on the resources available.  However, the actual number of reported foreclosures has been much easier to track because the Land Records Division of the Auditor’s Office routinely processes all Sheriff Sales after the loss of title and occupancy.  Based upon these records, the total number of residential/seasonal recreational residential (Res/SRR) properties sold in 2007 at auction was 0.75% of the total parcel count, or say, 373 foreclosed parcels out of 49,748 Res/SRR parcels.  In 2006, this figure was 0.47% (i.e. 231 foreclosed parcels out of 49,159 Res/SRR parcels) representing an increase from 0.26% (124 foreclosed parcels out of 47,510 Res/SRR parcels) in 2005 and 0.17% (76 foreclosed parcels out of 45,919 Res/SRR parcels) in 2004.  Currently, for the first quarter of 2008, the amount of properties that have completed the foreclosure process is 116 or approximately 0.23% of the total Res/SRR parcel count.  This statistic would indicate that the number of foreclosures is likely to increase for 2008 should projections be based on historical tendencies over the last four years.  It would also suggest that there may be a few more properties in default compared to a year ago.

The patterns of foreclosure appear to be greatest in the cities rather than the townships of Stearns County.  In 2007, 0.92% of the total parcel count for the cities, or say 321 foreclosed properties out of 34,992 Res/SRR parcels were sold at a Sheriff Sale compared to 0.35% or say, 52 foreclosed properties out of 14,756 Res/SRR parcels in the townships.  In 2006, this number was 0.53% (185 foreclosed parcels out of 34,653 Res/SRR parcels) in the cities and 0.32% (46 foreclosed parcels out of 14,506 Res/SRR parcels) in the townships, indicating a slight growth from 0.31% (104 foreclosed parcels out of 33,177 Res/SRR parcels) in the cities and 0.14% (20 foreclosed parcels out of 14,333 Res/SRR parcels) in the townships during 2005 and 0.20% (63 foreclosed parcels out of 31,860 Res/SRR parcels) in the cities and 0.09% (13 foreclosed parcels out of 14,059 Res/SRR parcels) in the townships in 2004.  For the first quarter of 2008, the numbers indicate that this relationship is still evident with the cities reporting a foreclosure rate of 0.29% (103 foreclosures) compared to 0.09% (13 foreclosures) in the townships. 

In 2007, the cities having the most foreclosures were:

St. Cloud (126 = 0.86%),
Sartell (42 = 0.87%),
St. Joseph (36 = 2.11%),
Sauk Centre (23 = 1.39%),
St. Augusta (13 = 0.87%),
Cold Spring (10 = 0.70%),
and Paynesville (10 = 1.05%). 

From 2004 through 2008, the sale price range for foreclosures in Stearns County was from $3,736 to $914,832, reflecting all types of foreclosed properties---unimproved land and entry level, custom, and lake homes.  During 2007, the reported sale price range was $3,736 to $667,314 with a mean sale price of $161,154 and a median sale price of $140,250.  This data, like the three previous years, demonstrated that the majority of all foreclosures was typically an entry level home sited in some of the newer neighborhoods of cities primarily located on the east end of the county.

In summary, Stearns County is a diverse area comprised of rural, recreational, suburban, and urban properties.  Its housing market has experienced some softening, but not to the same extent as other areas of the country and state.  The number of foreclosures has increased during the past year, but these figures are not horrific when compared to the statistics reported on the coasts or in and around the Twin Cities where sub-prime financing was more common and speculative buying more prevalent.  The total number of open market, arm’s length transactions (excluding St. Cloud City) was down largely due to tightened lending standards and lower buyer confidence.  It has decreased by about 15.0% between the 2007 and 2006 study periods (i.e. each period covers 12 months starting on October 1st of a given year and ending on September 30th of the following year), making it more challenging for assessors to set market values.  In 2007, there were 909 sales compared to 1,069 in 2006.  The year 2005 produced the largest number of sales with a total of 1,227, followed by 2004 with 1,168 sales.  Finally, the aggregate changes in the 2008 residential/seasonal recreational residential assessment indicated that the market was fairly stable in most areas of the county.  Based on the 2007 ratio study, market value changes ranged from a decrease of around 4.00% in Holdingford City to an increase of about 7.00% in Sauk Centre Township with most districts showing only modest changes.  There were 18 cities/12 townships with decreases reported in their overall value and 12 cities/22 townships with little or no total market value increases, resulting in an aggregate increase of 0.10% in the county.  Thus, in spite of the changing market conditions, sale prices and market valuations appeared to either increase or hold up slightly better in most rural and lake areas when compared to the urban parts of the county.

If you have any questions regarding this information, or topic suggestions for a future column, please contact us.

Stearns County Assessor's Office
Administration Center, Room 37
705 Courthouse Square
St. Cloud MN 56303

Phone 320.656.3680

or e-mail the Assessor: gary.grossinger@co.stearns.mn.us