There are plenty of non-financial reasons why people purchase homes.  The wealthy may not care about cost.  Many families decide that the benefits of homeownership outweigh the potential risk of falling prices.  Others attach some value premium to a specific property or neighborhood and pursue ownership regardless of price.     

But most potential buyers are concerned about the financial impact of buying a home.  This risk is heightened by an environment where many houses continue to be overvalued, overleveraged and experiencing price depreciation.

According to First American CoreLogic, over the 12 month period ending January 2010 the average sales price for the Distressed (defined as REOs and Short-Sales) and Non-Distressed housing segments were as follows:

Obvious Limitations on the Usefulness of “Averages”

Average sales price discounts are exaggerated in that the data represents pools of properties which are not identical.   

For example, subprime mortgages (which have a higher likelihood of defaulting) were disproportionately used to finance lower priced properties.  As such, one would expect the average REO sale to be at a lower price than Non-Distressed transactions. 

Regardless of our ability to isolate precise discounts using the CoreLogic data, Distressed properties do sell at large discounts to Non-Distressed transactions.  This phenomenon is conceptually appealing, consistent with other asset classes, freely observable in the housing market, confirmed by the data above, and one of the primary forces driving national home prices lower.

So Why Buy A Non-Distressed Property?

If homebuyers can capture material discounts on the purchase of Short-Sales ($32,400 on the average transaction), why wouldn’t they access this option instead of buying a Non-Distressed property?  If homebuyers can save an even greater amount on the purchase of a REO ($105,800 on the average transaction), why wouldn’t they buy bank-owned properties instead of individually owned, Non-Distressed houses?

Personal preference and cultural stigma are obvious explanations for paying more for equivalent, Non-Distressed homes.  Additionally, there are risks associated with purchasing Short-Sales and REOs which partially explain their relative discounts. 

But as we have seen since 2006 there are material risks attached to buying overvalued homes as well.  In fact, buying a Distressed property at substantial discount reduces the risk of further price depreciation.

More Questions to Ponder

Given the correlation between Distressed property sales and falling prices, why buy a home today in any market characterized by a high and/or rising share of REO and Short-Sale transactions?

Given the highly visible source of Distressed transactions (resulting from Affordable Mortgages) that will continue through 2012, why not wait to buy such a property?  Since Distressed transactions will continue to force market prices lower, REOs and Short-Sales available in 2012 are likely to be cheaper than those on the market today.