Can a foreclosure or short sale be used as a comp in California?

A bank-owned sale is still a sale

Two kinds of sales make agents nervous. A foreclosure sale, often called an REO (real estate owned), is a home the lender took back and is now selling. A short sale is a home where the seller owes the lender more than the price, so the lender has to approve the deal.

Neither one is banned from the grid. The question is the same one I ask about every sale: what does this price tell me about what buyers pay for a house like yours?

The federal definition of market value helps here. It describes a sale where buyer and seller are typically motivated, both are well informed, the home gets a reasonable time on the open market, and the price is not affected by undue stimulus. A distressed sale can strain some of those conditions. A bank with a whole portfolio of houses on its books is motivated in a very different way than a family that wants to move closer to the grandkids.

That does not make the price fake. It makes the price something to study before it gets used. A bank-owned house is a little like a rental car. Plenty of people drive it, but nobody washes it before they sell it.

What Fannie Mae's rules actually say

Fannie Mae's Selling Guide (B4-1.3-08, Comparable Sales) speaks to this directly. Here is what it requires:

• They are allowed. It is acceptable to use foreclosures and short sales as comparables when the market data shows they are the best and most appropriate sales available.
• Say how common they are. The appraiser must address the prevalence of these sales in the subject's neighborhood.
• No assuming. The appraiser cannot assume a distressed sale is equal to the subject. Differences such as condition, and whether any stigma is attached to the property, must be identified and considered.
• Watch the condition gap. The guide notes a foreclosure or short sale may be in worse condition than the subject, especially when the subject is new or recently renovated.
• Label it. On a UAD report, the appraiser must identify the sale as an REO sale or a short sale.

The usual comp rules still apply too. Fannie Mae wants at least three closed comparables, and sales that closed within the last 12 months should be used, with older sales allowed when they are the best indicator of value.

Other loan programs and private lenders can have their own rules, so check the guide that fits the loan.

Two adjustments people mix up

A distressed sale can differ from your house in two separate ways, and each belongs on its own line.

Condition is physical. The REO had no carpet, a dead furnace and a backyard that looked like a hay field. That goes on the condition line, measured from what the market pays between condition levels. In my view, an adjustment goes on the row that names it, so the reader is never confused about why.

Conditions of sale is about the deal itself. Did the bank sell as-is with a short marketing time? Did the short sale sit for months waiting on lender approval while buyers walked away? If the terms pushed the price away from market, that gets its own adjustment.

Here is the trap. If you put the whole price gap on one line, you double count or you miss something. Say an REO sold low because it needed $60,000 of work. Take out the condition difference first. Whatever is left, if anything, is the sale terms talking.

Fannie Mae says adjustments must reflect the market's reaction, not a rule of thumb. So there is no automatic "take 10% off for REO" in my files. Some months the leftover gap is real. Some months it is zero. The sales decide.

A hypothetical: one tract, three sales

Say the subject is a remodeled 1960s ranch in a Hayward tract, rated C3. These sales are made up for the example, but the method is the real one.

Sale B looks like a bargain next to Sale A. A lazy read says "REO discount, $145,000." But Sale C is a regular sale in the same rough condition, and it sold for nearly the same price as the REO.

That tells me most of the gap is condition, not the bank. Before I trust that, I check more pairs in the tract and the wider market, and I test the most recent window the data supports. If the pattern holds, Sale B gets its condition adjustment and no conditions-of-sale adjustment at all. And that zero gets explained in the report, because a zero has to be earned like any other number.

What I see in the field: when distressed sales are the market

The label is never the whole story. I have seen bank-owned homes that sold to a crowd of bidders, and standard sales that were quiet deals between neighbors. Most of the gap I measure between an REO and a regular sale turns out to be condition. Buyers are pricing the new roof they will need, not the bank's name on the deed.

Sometimes the distressed sales are not the odd ones out. If half the recent sales in a neighborhood are bank-owned or short sales, buyers shopping there are comparing your house to those homes. Ignoring them would describe a market that does not exist. That is why Fannie Mae makes the appraiser address how common they are.

In that kind of market, I still separate condition from terms. A wave of REOs can pull prices down because there are more sellers than buyers, and that pressure lands on the standard sales too. In that case the distressed sales are not a special category. They are setting the price, and the time adjustment has to show it.

The other direction matters just as much. One stray short sale in a strong market does not set the value for a whole street. One sale is a story. Several sales that agree are evidence.

Either way, the value comes from the evidence, not from the contract price on your file. If the distressed sales show the market moved, the report should say so plainly, even when nobody at the closing table wants to hear it. Facts over feelings, including the feeling that "that one doesn't count."

How to spot a distressed sale in the MLS

Agents and loan officers can catch these before the appraiser does. Here is my checklist:

1. Read the Special Listing Conditions field. California's CRMLS defines values such as Real Estate Owned, Short Sale, Notice of Default, HUD Owned, Auction, Bankruptcy and Third Party Approval. Other MLSs use similar fields.
2. Read the remarks. "Sold as-is," "cash or rehab loan only," "subject to lender approval" and "no repairs" are clues.
3. Check the timeline. A long gap between contract and close can point to a short sale waiting on approval.
4. Look at the seller. Public records may show a bank or a trustee as the grantor on the deed.
5. Look at the photos. Missing appliances and stickers on the door tell you a lot.
6. Watch for the resale. A cheap REO followed months later by a remodeled resale gives you a natural condition pair.
7. Verify before you rely on it. Confirm price, terms and condition with a disinterested source.

A probate listing is not the same as a distressed sale. Estates can sell at full market value, so do not lump them in without reading the facts.