We explore several different explanations of the effect of foreclosures on neighboring properties using a dataset of transactions in Boston, for which we have rich data on the size and location of condominium associations. There is compelling evidence against a supply effect—nearby condo foreclosures in different associations, and even those within the same association but at different physical addresses, have little impact on condo sale prices. However, condos transact at average discounts of 2.4 percent when a foreclosure shares the same physical address. We view the results as indicating that investment externalities drive foreclosures’ impacts on neighboring house prices. In this paper, we shed light on these different explanations of the effect of foreclosures on neighboring properties using a dataset of condominium transactions in Boston over the years 1987 to 2012, for which we have rich data on the size and location of condo associations. Starting with Immergluck and Smith (2006), researchers have documented that properties that sell near foreclosures transact at a discount relative to otherwise identical properties that have no foreclosures nearby.

We extend this literature by focusing on a sample of Boston condominiums that allows us to identify the precise mechanism that generates these price effects. In particular, we aim to distinguish between two popular theories, the first being that foreclosures cause price declines through a “supply effect,” resulting from the fact that a foreclosed property is a close substitute for nearby properties. An alternative and not mutually exclusive explanation is that an owner has no incentive to invest in his property during the foreclosure process, and so the property deteriorates, generating a physical externality. Our results have important implications for policy.