A buyers are seeking good-looking homes and ignoring dilapidated foreclosures

Maybe Americans aren't avoiding buying homes right now -- maybe they're just avoiding buying ugly homes. The housing market may be splitting into two sub-sectors: well-kept, good-looking homes and run-down, torn-up homes. Could the latter group be preventing the housing market from stabilizing?

The separation of these two types of homes is mentioned in a blog post e-mailed to me on Tuesday by Jeff Lichtenstein, a North Palm Beach County, Florida realtor affiliated with the luxury-property network Christie's. He writes that demand is quite strong for nice properties; it's the ugly stuff that nobody wants. From his blog post:

The Case-Shiller Report states that there is a ton of foreclosures and short sales coming and thus see a 10-20% drop in prices. Case-Shiller is correct on the never-ending short sales and foreclosures coming. However, what Case-Shiller fails to state is that there is a huge differentiation between 'good inventory' & 'bad inventory'. When a buyer gives me their wish list, it usually goes something like this.... I want open & airy, master on the first floor, updated, nice view. The shorts sales and foreclosures tend to be dark and dreary, closed-off floorplans, dated, unpampered, and ugly views. Therefore there is an excess of 'ugly homes' but not a lot of 'good looking' homes.

One of the reasons why there are so few nice homes out there is because construction levels have been so low. Picky buyers have limited options when considering existing inventory alone.

The disparity between these two groups of homes matters, because Lichtenstein has seen prices of the good properties remain relatively strong recently, as prices of worse properties have declined. This means that it's those run-down, dilapidated foreclosed homes and short sales that will disproportionally bring down aggregate home prices, while well-kept homes should see much smaller price declines, or even appreciation.

Based on his experience, Lichtenstein asserts staging homes is more important than ever, as sellers need their house to appear as pristine as possible to appear to buyers. But his observation could have another logical conclusion: the market could be ripe for some renovate-and-flip business.

Let's continue with Florida as an example. The foreclosure discount for the state was 27% in the first quarter, according to RealtyTrac. So let's say a foreclosed home's list price is $250,000, but it sells for $182,500 due to that discount. If that buyer puts $35,000 into the home to give it a facelift and a few key upgrades, it may achieve a price close to the list price at resale, assuming that Lichtenstein's experience holds. That would provide a 15% return on investment in probably a few months work.

This doesn't mean that all foreclosures could be easily revitalized. Savvy investors would have to be able to tell apart those that have potential to be converted into more desirable homes without an excessive investment from those that don't. Floor plan and location are probably key characteristics in that determination. But more home flipping could be another part of the answer to working through some of the immense housing inventory out there.

This gives investors two options: revitalize the foreclosures that have sale potential and rent out the others. If the inventory is tackled through these strategies, then price aren't going to suddenly soar, but they could begin to stabilize sooner.

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