Date: 27 Nov 2007

Spillover Effects of Foreclosures on Neighborhood Property Values

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Abstract

Previous studies have shown that foreclosure often results in vandalism, disinvestment and other negative spillover effects in the neighborhood. This paper extends these views into a formal theoretical model through pricing based on comparables. We project that the spillover effect of a foreclosure on neighborhood property values depends on two factors: the discount of foreclosure sale and the weight placed on the foreclosed property as a comparable in the valuation. The former is related to housing cycle and the latter varies by time of foreclosure and its distance from the subject property. Empirical results based on a 2006 sample show that this effect is significant within a radius of 0.9 km (roughly 10 blocks) and within 5 years from its liquidation. The most severe impact is an 8.7% discount on neighborhood property values, which gradually drops to anywhere between −1.2 to −1.7% for foreclosures liquidated within the past 5 years. These spillover effects vary slightly when the sample selection bias is taken into account. Based on an alternative sample of purchase transactions in 2003, the estimated spillover effects in booming years are reduced by half, confirming on the important role played by housing cycles.

We wish to thank editor C.F. Sirmans, an anonymous referee at the Journal of Real Estate Finance and Economics, and Paul Obrecht at Fannie Mae for their insightful comments and suggestions. All errors remain our own. The views expressed in this article are our own and do not necessarily represent the views of Fannie Mae. This article won a best research paper from the American Real Estate Society Foundation in 2007.