Information provided by Michael Orr of the Cromford Report in Phoenix, AZ

RealtyTrac® today is claiming that “Arizona surpassed Nevada for the most foreclosures”. Is this correct? Well, as with many things, it depends on what you are really counting. RealtyTrac® likes to count “foreclosure filings”, a concept that I think is unique to them and also extremely misleading. This is the SUM of recorded Notices of Default (NOD) or Lis Pendens (LIS), Notices of Trustee Sale (NOTS) and recorded Trustee Deed (TD) documents. So every home that completes a foreclosure is counted AT LEAST twice, once for the notice and once for the actual foreclosure auction.

In Arizona we very rarely see a NOD or a LIS. However some homes get multiple NOTS during a foreclosure process, sometimes as many as ten. RealtyTrac® eliminates multiple notices ONLY when they occur in the same reporting period. Since not all notices result in a trustee sale (many are resolved by short sales or loan modification), you can quickly see that the number of “foreclosure filings” (also referred to by RealtyTrac® as “foreclosure properties”) will far exceed the number of actual completed foreclosures. In Arizona the number of “foreclosure properties” has been typically 3 times as great as the number of completed foreclosures. RealtyTrac® then goes on to compare the number of “foreclosure properties” with the number of residences that exist within an area. They express the result as, for example, “Phoenix has 1 in 230 homes receiving a foreclosure filing”. When you read this you tend to assume that 1 in 230 homes were foreclosed. But the actual number of housing units foreclosed will be closer to 1 in 700.

If we were to add all of the numbers together we would get 6,573 total “foreclosure filings” (including all the non-residential foreclosures). RealtyTrac® reported 6,781 foreclosure filings (1 in every 242 housing units). Note the ratio of “foreclosure properties” to actual foreclosures is 3.25 to 1.

So what is the reason that RealtyTrac® reports that Arizona grabbed the number one spot from Nevada for “foreclosure filings”? It’s because it is TRUE. The state legislature of Nevada decided to implement a new law in October 2011 that made it a felony if the foreclosing lender does not have all their foreclosure documents completely in order. As a result Nevada foreclosure starts and completions have both plummeted to extremely low levels compared with 2011. This doesn’t actually improve the situation in Nevada, except for the delinquent borrowers. In fact it just means the delinquency problem will last longer. It also has NO effect on Arizona except to create bogus headlines for the media. The fact that Nevada’s numbers are down is actually BAD news for Nevada. It means they are no longer tackling their loan delinquency problem in a timely manner. This will probably slow down the state’s housing recovery.

Between 2007 and 2011 Arizona has suffered from extremely high delinquency rates. But the good news is that we have eliminated a higher percentage of our delinquencies through foreclosure and short sales than any other state in the last 2 years. It is loan delinquency that is the root cause of the housing problem, not foreclosures. Although they are painful, foreclosures are one of the cures for the problem, not the problem itself. The faster the delinquencies are processed, the faster the recovery. Short sales and loan modifications are also good, but one way or another we need to get rid of the overhang of delinquencies and get them down to normal levels.

So the fact that Arizona has had a high rate of foreclosure starts and completions is actually a GOOD sign for Arizona’s real estate market. It it is the main reason our real estate market is recovering faster than any other. Foreclosures resolve loan delinquencies and get rid of the “shadow inventory” converting it into real inventory. This is then taken back into ownership by homeowners who are not upside down and have a significant equity interest in their property, whether they are investors or owner occupiers. Once loan delinquency is back to normal levels we can stop talking about “shadow inventory”.

In a state with judicial foreclosure, the lender usually takes far longer to foreclose. This means the number of recorded foreclosures in a given period will be much lower than in a similar state with non-judicial foreclosure. So the number of foreclosures in a month is NOT a good measure of how badly a state is affected by the housing crisis. A much better measure is to determine what percentage of home loans are in some state of delinquency.  Here are a few of the most recent numbers issued by LPS for the month of February 2012, showing the percentage of first home loans that are delinquent but have NOT received a foreclosure notice:

1. Mississippi – 13.5%
2. Georgia – 10.8%
3. Nevada – 10.5%
4. Alabama – 10.1%
5. Louisiana – 9.7%
6. Tennessee -9.7%
7. Maryland – 9.5%
8. Arkansas – 9.2%
9. West Virginia – 8.9%
10. Rhode Island – 8.7%

33. Arizona – 6.6%

We can see that many of the high percentages of “shadow inventory” are in the southern states.

Note that Arizona ranks 33rd by this measure of loan delinquency, the most improved state over the last 2 years, since in February 2010 Arizona ranked 4th with 12.4%.

States with high percentages and no improving (downward) trend are likely to take much longer for their housing markets to recover. Those with low percentages and with a strongly downward trend are likely to be the first markets to recover.