One question which comes up with some frequency is why foreclosure numbers are so important. After all, isn't it a fact that foreclosures are actually rare when we look at the entire housing stock?

According to the Census Bureau there were 128 million housing units in the U.S. at the end of 2007. Of these units, 75.2 million were owner-occupied. In comparison, says RealtyTrac.com, nearly 1.3 million households received one or more foreclosure notices during 2007.

You could say foreclosures represent just 1.72 percent of all owner-occupied homes. This is a mathematical fact that is both true and irrelevant. Why is this percentage irrelevant? Because most homes are not for sale today. This is why real estate brokers, appraisers and tax assessors all base fair market values on homes for sale now and homes that have recently sold -- but not homes that merely exist.

The relevant fact is this: The National Association of Realtors says that in 2007 there were 5,652,000 existing-home sales.

Now the math is different: Foreclosures in 2007 equaled 23 percent of the existing homes which were actually sold.

In strong markets foreclosures can sell without any price reduction. Also, a certain number of foreclosures each year are natural and normal and have little marketplace impact.

However, as the percentage of foreclosed properties increases relative to the number of homes for sale in a local market, a distinct "foreclosure discount" begins to appear. This discount impacts not just the valuation of homes being foreclosed, but the valuation of all homes for sale.

The reason home prices are falling in many markets is not because of some bizarre media plot to "do in" real estate brokers, home builders or mortgage lenders with "negative reporting," it's because buyers will not pay more than necessary to acquire property in markets flush with inventory. This is hardly illogical: If you were buying a house today would you pay more than fair market value? Of course not -- and neither would any thinking person.

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Published: March 4, 2008

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