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SURVIVAL ANALYSIS OF FORECLOSURES BY HOUSING AND NEIGHBORHOOD CHARACTERISTICS A Thesis Submitted to the Graduate Faculty of the North Dakota State University of Agriculture and Applied Science By Resha
SURVIVAL ANALYSIS OF FORECLOSURES BY HOUSING AND NEIGHBORHOOD CHARACTERISTICS A Thesis Submitted to the Graduate Faculty of the North Dakota State University of Agriculture and Applied Science By Resha Shehari Aviena Dias In Partial Fulfillment of the Requirements for the Degree of MASTER OF SCIENCE Major Department: Agribusiness and Applied Economics November 2014 Fargo, North Dakota North Dakota State University Graduate School Title Survival Analysis of Foreclosures by Housing and Neighborhood Characteristics By Resha Shehari Aviena Dias The Supervisory Committee certifies that this disquisition complies with North Dakota State University s regulations and meets the accepted standards for the degree of MASTER OF SCIENCE SUPERVISORY COMMITTEE: Dr. Lei Zhang Chair Dr. Ruilin Tian Dr. Siew Lim Approved: 11/21/14 Dr. William Nganje Date Department Chair ABSTRACT Losing a home affects not only the homeowner but the community at large. This thesis examines both housing and neighborhood characteristics to determine which characteristics have an impact on the speed of the sale of a foreclosed property. The findings from the Cox Proportional hazard model show which characteristics buyers value more when buying a foreclosed property. These characteristics can be different from the ones that are used to determine the sales price of a foreclosed property. Both financial institutions and real estate speculators can benefit from knowing which housing characteristics are preferred in a foreclosed property, allowing them to sell that property fast in the market. iii ACKNOWLEDGEMENTS First and foremost, I thank Almighty God for giving me the strength to complete another milestone in my life. I d like to thank Dr. Lei Zhang for her guidance and patience given to me when completing this step. A special thank you goes out to my committee members, Dr. Siew Hoon Lim and Dr. Ruilin Tian for giving their valuable suggestions in making this a success. I would also like to thank my parents and my uncle Mr. Anton Pulle for believing in me and being constant pillars of strength. Finally, I would like to extend my sincere thanks to Peter for supporting me in every step of the way. iv TABLE OF CONTENTS ABSTRACT... iii ACKNOWLEDGEMENTS... iv LIST OF TABLES... vii LIST OF FIGURES... viii LIST OF APPENDIX TABLES... ix LIST OF APPENDIX FIGURES... x CHAPTER 1. INTRODUCTION Problem Statement Implications... 5 CHAPTER 2. FORECLOSURES Foreclosure Definition Foreclosure Process Texas Overview Ownership Transfer Process CHAPTER 3. LITERATURE REVIEW Foreclosure Spillover Effects on Neighboring Property Values Short Sale Spillover Effects Non-Price Related Foreclosure Spillover Effects on the Neighborhood v CHAPTER 4. DATA AND METHODOLOGY Data Methodology CHAPTER 5. RESULTS AND DISCUSSION OLS Regression for Time to Resolution Cox Proportional Hazard Model Hedonic Pricing Model CHAPTER 6. CONCLUSIONS Limitations Need for Future Study REFERENCES APPENDIX vi LIST OF TABLES Table Page 2.1. List of States that Follow Judicial Foreclosure Process List of States that Follow Non-Judicial Foreclosure Process List of States that Follow both Foreclosure Processes The Summary Statistic Table for Housing Characteristics The Summary Statistics for Neighborhood Characteristics Coefficients of Time to Resolve OLS Regression Cox Proportional Hazard Model Estimates Survival Time Estimates Results for Hedonic Regression (OLS) vii LIST OF FIGURES Figure Page 1.1. Chart of U.S Annual Foreclosure Activity from Map of Dallas County Location School District Map of Dallas County Foreclosure Ownership Transfer Process Mean Sale Price of Foreclosures by Year Kaplan- Meier Survival Estimate Nelson-Aalen Cumulative Hazard Graph for Pool, Central Air Conditioning, Condition 3 and School District The Smoothed Hazard Graph from Cox Proportional Hazards Regression The Cumulative Cox Proportional Hazards Regression Graph Cox Proportional Hazards Cumulative Graphs for Variables Pool, Central Air Conditioning, Condition 3 and School District Cox-Snell Residual viii LIST OF APPENDIX TABLES Table Page A.1. Summary Statistics A.2. Time to Resolution Estimates A.3. Cox Proportional Hazard Estimates and Ratios A.4. Kaplan-Meier Survival Statistics A.5. Hedonic Model Estimates A.6. Correlation Matrix ix LIST OF APPENDIX FIGURES Figure Page A.1. Hazard Graphs x CHAPTER 1. INTRODUCTION The American Dream has become one of home ownership and recently this dream has become more attainable for many (Rohe and Watson, 2007). However, to eventually own a home, most people have to take out a mortgage, a real estate loan with property as the underlying asset. Traditionally, mortgages were 15 to 30 year loans which would be paid off gradually; mortgage coming from the French term death pledge , meaning that you had your life to pay it off. However, as home ownership started increasing in the United States of America in the beginning of 1995, the mortgages to support these ownerships became greatly customized (US Census Bureau, 2007). This increase of homeownership was in part made possible by subprime mortgages that target customers with lower credit ratings using interest rates that are above prime lending rates. The financial crisis in 2008, heightened defaults in the sub-prime mortgages category, and as a result the housing bubble burst. The number of foreclosure filings spiked by a stunning 81% between 2007 and The number of foreclosures was further increased nationally by about 22% from nearly 2.3 million in 2008 to 2.8 million in 2010 (RealtyTrac, 2014). Figure 1.1 provides the annual foreclosure filings from 2005 to While the economy has gradually recovered, the number of foreclosure filings remained above the level prior to Figure1.1. Chart of U.S Annual Foreclosure Activity from Source: RealtyTrac. One of the reasons why the financial downturn in 2008 had such a widespread effect was that these subprime and prime mortgages are important elements in the financial and the housing markets that are highly interdependent. To better understand the mutual downturn one must first understand how mortgages became traded investment assets. These debt obligations such as mortgage-backed securities are one important part of the housing bubble that burst in Mortgage-backed securities, or MBS, represent the cash flow payments that are from mortgage loans, mostly commercial and residential. Private companies, government agencies, or combinations of the two would then purchase the loans from banks and the loan originator. The next step is known as securitization, which is defined by the U.S. Securities and Exchange Commission as when the entity then issues securities that represent claims on the principal and interest payments made by borrowers on the loans in the pool (SEC, 2014). 2 Many of these securities were then issued by government organizations such as the Government National Mortgage Association (Ginnie Mae), the Federal National Mortgage Association (Fannie Mae, or the Federal Home Loan Mortgage Corporation (Freddie Mac). Others that were issued by private firms were called private-label mortgage securities. Due to the government packaging of the securities, many investors felt that these securities were all backed by the US government and therefore were not risky assets. However, only the Ginnie Mae securities were fully backed, but both Freddie Mac and Fannie Mae enjoyed the ability to borrow money from the US Treasury. Further spreading the use of mortgage-backed securities was the fact that they can exist in many different forms. What grew to be very popular with investors is a type of MBS called a collateralized mortgage obligation. These obligations, also known as mortgage derivatives, allowed different risk rated MBS to be mixed so that the investor would be exposed to a desired amount of risk (SEC, 2014). Unfortunately, a problem arose when there was an economic downturn in The downturn caused people to lose their jobs or not have the ability to pay their mortgage. This then meant that people's properties were being foreclosed. However, while a bank plans for some foreclosures, they were often times left with more properties than they had expected. To make matters worse, the sudden surge in foreclosed and for sale houses made it so that many houses were now worth less than the bank had issued a mortgage for. This meant that not only was the bank stuck with a physical asset that was worth less than they paid for it, but also home owners who were still able to make payments were sometimes stuck paying a mortgage that was higher than the actual value of their house. 3 When payments are not made on the mortgage and the property is foreclosed, the costs incur to all parties who are involved in the transaction, including the individual in default, the lender, and households living in the neighborhood. Some studies find that average costs related to foreclosures are about $27,000 for the city and $10,000 for the neighborhood of the foreclosure (Moreno, 1995). Additionally, these costs will spread to city governments, which Apgar and Duda (2005) find can cost up to $30,000 per property in most cases. These neighborhood costs are the externalities associated with property values and quality of the neighborhood. Studies conducted on different aspects of foreclosures are beneficial and lead to better enacted policies that address this issue and reduce spillover effects to the society Problem Statement Most scholars so far have discussed the foreclosure spillover effects having an impact on the neighborhood properties. Once a property is foreclosed, it needs to be transferred to a final user. This way, the property can be productive and the new owners can engage in maintaining the property which otherwise could result in vandalism (Campbell, 2011). If houses are not occupied for a long period of time it can further worsen blight and reduce the desirability of the property. For this test purposes, if a house is sold after being foreclosed, it is considered as a resolved property. An unresolved property is one that has not been sold after facing foreclosure. Not many scholars have investigated what takes place after a property is being foreclosed. In that sense the gap exists in studying resolved and unresolved foreclosures. This study aims to fill that gap by focusing on factors that are likely to help resolved and unresolved properties. To be included the foreclosed property would be one that has been unresolved during a certain period by using a similar data set used by Zhang et al. (2014) for Dallas County, Texas. The data set consists of foreclosures and sales transactions from The methodology will 4 follow a similar survival analysis framework used by Towe and Lawley (2013). By using a Cox proportional hazard model, the likelihood of a property being resolved will be calculated by taking housing and neighborhood characteristics into consideration. This study will shed light on factors that help resolve foreclosed properties faster. A closer understanding about resolved and unresolved cases would help identify where the focus should be in housing markets and allow necessary actions to be taken accordingly Implications Houses can be considered as illiquid assets if they are not occupied (Campbell et al, 2011). The liquidity of a house depends on many factors and is not limited to the price of the property alone (Kluger & Miller, 1990). When a borrower defaults, the ownership of the property is transferred to the bank/ financial institution that financed the mortgage loan. Financial institutions do not have an incentive to hold on to a vacant house and would attempt to sell it to another intermediate party or to a final user. Holding on to an unoccupied house does not bring the financial institution any revenue and this gives the motive to sell it as quickly as possible. Another drawback is the high maintenance costs associated with foreclosed properties. As discussed in previous sections, foreclosed houses are also prone to crime related activities and it brings a social disorder to the neighborhood (Immergluck & Smith, 2006). For all these reasons, financial institutions would like to transfer the ownership of a foreclosed property to another party. Investigating the types of housing characteristics that help to sell a property once it is foreclosed is useful to financial institutions that deal with mortgages. This will help them lend money to parties who are interested in properties that are desirable and easier to sell in the event of a foreclosure. For example, if a property with a detached carport has a tendency of sitting in the market for a long time, then investing money on such properties can be avoided. Real estate 5 speculators can also invest in foreclosed properties that have desirable characteristics as there is a higher chance of selling that property back in the market. In return, this identifies which housing and neighborhood characteristics are preferred by most home buyers in the Dallas County. The rest of the paper will be as follows: Chapter 2 defines foreclosures and foreclosure practices, Chapter 3 looks into the previous work done by other scholars, Chapter 4 establishes the methodology, Chapter 5 discusses the results and finally Chapter 6 explains the limitations and the summary of the study. 6 CHAPTER 2. FORECLOSURES 2.1. Foreclosure Definition A foreclosure can be defined as the process of taking possession of a mortgaged property after payments are not met, most often to be sold to recoup the loss. This process takes place once the home owner misses one or more monthly payments. Generally the foreclosure process would begin 3-6 months after missing the first mortgage payment (U. S Department of Housing and Urban Development, 2014). Once the payments have been missed, the foreclosure process begins. The laws involved in the foreclosure process and the timeline of the actions taken usually depends on the individual state. According to the U.S department of Housing and Urban Development, it should be noted that the lender usually identifies borrower s short term financial crisis. Therefore, it is important to stay in touch with the lender in the event of a missed payment. Failing to make necessary arrangements would declare the borrower to be in default and the foreclosure process begins Foreclosure Process In general the two main types of foreclosures are judicial and non-judicial. Both methods require public notices to be issued and all parties involved to be notified regarding the proceedings. One main difference between the two methods is that judicial foreclosures are mainly involved with the court. Under a judicial foreclosure, when a borrower misses one or more payments and show signs of defaulting on the mortgage, the lender can file a complaint with the court asking for permission to foreclose the property and take possession of it. The lender will record a notice in the public land records about the property that is being foreclosed, and will notify the potential buyers, creditors and other interested parties. The borrower can file a separate suit and save the property from being foreclosed. However, if the court decides that the borrower has defaulted, 7 permission to carry out a foreclosure will be granted to the borrower. This allows the borrower to recover the left over amount of the mortgage. Once permission is granted for a foreclosure, the court will authorize a sheriff s sale. This is an auction of the property which is held in a public place. It is open to anyone for bidding and the highest bidder legally becomes the owner of the property. Most of the time, the lender wins the highest bid and becomes the owner of the property. This will be transferred to a final party who will occupy the house and end the foreclosure sale. Section 2.4 of the paper discusses the process of a foreclosure sale and the ownership transfer in detail. As previously mentioned, each state has different foreclosure practices. Once a borrower defaults on his/her mortgage, a redemption period helps the borrower to reclaim the house that has been foreclosed. The redemption period happens after a foreclosure takes place, where the borrower can pay the balance of the mortgage and all costs incurred during the foreclosure process to reclaim the house from the buyer (foreclosed sale). The availability of a redemption period mostly depends on whether the foreclosure process is judicial or non-judicial. For example, Texas is one of the states that do not allow the borrowers to have a redemption period. This is especially important because this study focuses on the foreclosure activities in the Dallas County of Texas. Given below in Table 1.1 is a list of states that practice the judicial foreclosure process. Both process and redemption periods are given in number of days. 8 Table 2.1. List of States that Follow Judicial Foreclosure Process Source: RealtyTrac.com Judicial Foreclosures State Process Redemption Period Period Connecticut 62 Court Decides Delaware None Florida 135 None Illinois Indiana 261 None Kansas Kentucky Louisiana 180 None Maine Maryland 46 Court Decides Massachusetts 75 None Nebraska 142 None New jersey New Mexico New York 445 None North Dakota Ohio 217 None Pennsylvania 270 None South Carolina 150 None Vermont Unlike judicial foreclosures, the second type of foreclosure process, the non-judicial foreclosure, does not have any interventions from the court. Most cases are handled by attorneys following a state mandated process. The requirements for this process are established by state statute which varies across states. Just as discussed in the judicial foreclosures sections, once the borrower defaults on the mortgage, a default letter will be mailed out to him/her. It is then recorded in the county s recorder's office and is posted in public places. At the end of the notice period (this can differ according to the state), the foreclosure sale will take place and the highest bidder 9 becomes the owner of the property (Mortgage Bankers Association, 2014). Given below in Table 1.2 is a list of states that only follow a non-judicial foreclosure process. Table 2.2. List of States that Follow Non-Judicial Foreclosure Process State Michigan New Hampshire Tennessee Utah Washington D.C. West Virginia Non-judicial Foreclosures Comment Non-judicial Only Non-judicial Only Non-judicial Only Non-judicial Only Trustee Sale Only Trustee Sale Only Process Period Redemption Period None Court Decides 47 None None Source: RealtyTrac.com Some states are not limited to just one foreclosure process. These states follow both judicial and non-judicial foreclosure processes. However even in these states, one process is followed more often than the other. In the table given below, the comment section specifies if both methods are used or one is preferred over the other. 10 Table 2.3. List of States that Follow both Foreclosure Processes States with both Foreclosure Types State Comment Process Redemption Period Period Alabama Judicial Rarely Alaska Judicial Rarely * Arizona Judicial Rarely * Arkansas Both * California Judicial Rarely * Colorado Judicial Rarely 145 None Georgia Judicial Rarely 37 None Hawaii Both 220 None Idaho Trustee Sale Iowa Trustee Sale Voluntary Minnesota Non-judicial Mostly Mississippi Non-judicial Mostly 90 None Missouri Non-judicial Mostly Montana Trustee Sale Mostly 150 None Nevada Trustee Sale Mostly 116 None North Carolina Non-judicial Mostly 110 None Oklahoma Judicial Mostly 186 None Oregon Trustee Sale Mostly Rhode Island Non-judicial Mostly 62 None South Dakota Judicial Mostly Texas Non-judicial Mostly 27 None Virginia Trustee Sale Mostly 45 None Wisconsin Judicial Mostly Wyoming Non-judicial Mostly *these redemption periods are only for judicial foreclosure process. Source: RealtyTrac.com 11 2.3. Texas Overview Texas was the 28th state to join the United States of Am
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