After a sharp decline in home values as a result of the Great Recession, millions of homeowners were underwater. Unable to maintain their expensive mortgage or uninterested in paying a mortgage worth sometimes double the property's value, short sales became a popular way for distressed homeowners to avoid foreclosure. With 3.57 million homeowners becoming past due on their mortgage in 2020 and 2.74 million loans in forbearance, it's understandable that real estate investors are wondering if there will be a boom in short sales in 2021. Here's why it's unlikely.
More equity means less short sales
Equity is one of the biggest determinants as to whether a lender will enter and accept a short sale. Since a short sale requires the lender to accept a short payoff, or a lower amount than what's actually owed, there needs to be a good cause for the lender to take a loss -- namely, being underwater. Prior to the Great Recession, short sales were few and far between because real estate traditionally held their values, even during economic downturns.
As of the third quarter 2020, only 3% of all mortgaged homes are considered underwater with negative equity according to a CoreLogic (NYSE: CLGX) report. Home equity has actually improved 10.8% year over year, with roughly 63% of all borrowers seeing an increase in their home equity over the past year.
Real estate appreciation has gone through the roof, as record low supply is unable to keep up with current demand. The Zillow (NASDAQ: Z) Home Value Index found the average home value increased 9.1% over the past year and expects the average home value will increase another 10.1% in 2021.
Prices could come down, but dramatic price reductions are unlikely
A flood of properties hitting the market all at once could drive real estate prices down, which may be the eventual outcome as foreclosure moratoriums and forbearance plans expire in 2021. But it's unlikely real estate values would drop enough to deflate the equity captured over the past few years. With the exception of the few cities experiencing a mass exodus of inhabitants pushing real estate values down, most markets will only see improvement in home equity over the next year.
The Millionacres bottom line
This means investors should be prepared for a competitive real estate market in 2021. Arkansas, Connecticut, Delaware, Illinois, Iowa, Oklahoma, and Louisiana are the only states with high levels of negative equity. Investors looking for a discounted buy as a result of a distressed sale may want to start their search there. However, I think the short sale opportunities will be few and far between for 2021.