Banks turn to demolition of foreclosed properties to ease housing-market pressures

The Washington Post ^ | 12 Oct 2011 | Brady Dennis

[CowboyJay]

"Yeah, but isn't that what they've been trying to avoid, because of the hits to earnings and equity?"

What they're really trying to avoid is the loss in overall value to their portfolio if they have to attach realistic valuations. They'd rather write off a loss at face value than sell at half that value. So perversely, turning what used to be a functional dwelling into a hole in the ground is preferable to selling it to someone for whom it would have utility. I predicted this behaviour 3-4 years ago. Frustrating waste of resources.

[Pearls Before Swine]

They'd rather write off a loss at face value than sell at half that value.

How so? The hit to tangible equity is twice as big for the writeoff.

In the short term, I can see why they would want to keep the property alive rather than sell it, because they could carry it in OREO (other real estate owned), and not realize the loss until it is dumped--whether at half-price or at zero. But, this is marking to fantasy, not to reality.

The whole problem for the banks is that the loans they made aren't worth what they are carried on the books for--and the homes backing the loans have shrunk in value. If they "realize" this by getting rid of the property, they take a hit to equity and earnings.

Now, it is true that some properties have become so decrepit that the cost of keeping them exceeds the cost of destroying them. That's what motivates this behavior--but I don't know how they account for the value of the residual lot left after demolition.

[CowboyJay]

It’s mostly due to the way valuations are calculated through comparable sales (comps). If the structure is demolished, it’s not used as a comp. If a property is dumped for 25-50% of the value of the note, they not only have to write that down, but it also effects the value of any other nearby properties they hold title to. You’re partly right that they’re demolishing because it’s cheaper than just sitting on the property, but the net that they’re after is to avoid selling at current market prices.

In the end, the banks would rather outright demolish 10% of their holdings than take a 20% writedown across their entire portfolio due to dropping valuations. If values are dropping because of surplus supply - eliminate the surplus. Too busy at the moment to post up graphs of why the math works out the way it does, but trust me, it does. It’s financially in their best interest to either let a good number of properties collapse and turn to dust, or demolish them outright, rather than take another 20% beating on the Case-Shiller.

[Pearls Before Swine]

If I understand you correctly (post 23), you’re saying that sales from OREO trigger a revaluation of all unsold properties, but that demolition is a one-off writedown. So, that would mean that sales are leveraged, but demolitions aren’t. Is that a decent summary?

[CowboyJay]

Bingo. If they condemn and demolish, they take a loss, but only on THAT property. If banks start letting standing houses go for $0.25 on the dollar, they take a hit across their whole portfolio due to dropping comp values.

I would expect quite a few houses with plenty life left in them to quietly (or not so quietly) be destroyed until values start heading upward again. Frustrating as hell to watch from a macro standpoint, because it represents a huge waste of economic resources, but not sure what besides an actual act of congress will prevent it.