Shadow Inventory-Threat or Non-Threat?

Realtor.com is reporting that shadow inventory which once was a major threat to housing recovery is receding.  According to a Lender Processing Services report from their August Mortgage Monitor, shadow inventories have now fallen to its lowest point in 4.5 years.

What is Shadow Inventory?

Shadow inventory refers to real estate properties with mortgages held by banks that are either in the foreclosure process but have not yet been foreclosed upon or that have been foreclosed on and sold back to the banks but that have not been resold as an REO (real estate owned) property yet.

Shadow inventory in the past years has been listed as an uncertain number and different reports have placed the numbers anywhere from 2 million to over 7 million properties.  The fear was that the banks would release their shadow inventory into the market all at once which would flood the local markets and further cause prices to fall due to a massive amount of inventory without equivalent buyer demand.

Shadow inventory can make it difficult for a depressed market to figure out when they will have a full recovery.  Banks were holding onto their shadow inventory because they did not want to resell these homes in a depressed market as it would affect their ROI (return on investment). Now that prices have increased the fear of course remains that the banks may try to capitalize on the recent increase in prices, especially in certain areas, by releasing their shadow inventory.  This would create a surge in inventory and without the appropriate amount of buyer demand would then push prices back down.

Shadow Inventory Down

LPS reports that shadow inventory now represents 2.66% of all homes with a mortgage in the country, compared to 4.04% a year ago.  Mortgages that are 30 days or more delinquent on their mortgages but not yet technically in “foreclosure” was at 6.20% in August which is a decline of nearly 10% since August 2012.

The states with the highest percentage of non-current loans were; Florida with 16%, Mississippi 15%, New Jersey 14.9%, New York 12.7% and Maine 12%.

However, Report Doesn’t Address Shadow Inventory of Already Foreclosed Upon Homes

However this report appears to only address shadow inventory as homes that are late on payments but have not yet been foreclosed upon and not the shadow inventory of homes that have already foreclosed but the banks are still holding onto and have not released into the market to sell yet.  This number still seems to be unknown and a potential threat.

In a June 2013 article in US News’s Money section, Michael Jacobs, a Certified Financial Planner reported that housing’s shadow inventory is still haunting banks.

He quotes a statistic by the National Association of Realtors which states that only 15-20% of the homes that were actually foreclosed upon during the real estate downturn made their way to the market in 2008 and 2009.  The remaining 80-85% of these homes that were foreclosed upon and are now owned by banks have not yet made their way to market.

The theory for the reasoning behind this is that the reason the banks have not resold the properties is because current bank regulations do not require the banks to bring to market their real estate holdings right away.  They are able to then continue to book an inflated real estate value and pay the debt service and management costs to hold these properties in their inventory rather than sell the properties and book the losses.

Mr. Jacobs cites this as the reason why some markets have no inventory, why banks are still hesitant to lend money and why we have issues in the U.S. and internationally due to overextending our leverage.

He quotes statistics that show an overall general decline of shadow inventory of about 35% from the peak in 2010, however last quarter saw an increase of 9%, which is fairly large.  The theory is that with the finalization of the national mortgage settlement it clarified foreclosure processing procedures and timelines and gave banks a better ability to foreclose efficiently and avoid lengthy court processes (for those states who are judicial foreclosure).   He gives a statistic of a rise from $175 billion to $205 billion in the estimated value of the shadow inventory.

Shadow Inventory Appears to Still Be a Threat

In short it appears that shadow inventory is still a very real threat especially if regulators force the banks to market their holdings and sell in the market today.   While some of the numbers look promising there are still very large issues here and depending on how these issues are navigated, they could cause real damage to the real estate market and affect stabilization.

Sources: Lender Processing Services and “One-third of Shadow Inventory Cleared in Last Year,” Mortgage News Daily (Sept. 26, 2013) and Housing’s “Shadow Inventory” Still Haunts Banks, US News (June 28, 2013). 

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Sarah Litchney

Sarah Litchney is a licensed California Attorney, Sacramento Realtor and co-founder of StoneCrest Realty. StoneCrest Realty is a full service residential and commercial real estate brokerage. In addition to the brokerage, Sarah is the founding attorney of Litchney Law Firm, P.C.

Her practice centers on transactional real estate work. She represents developers, investors, and individual buyers and sellers and their funds in a wide range of matters including acquisitions, dispositions, development, leasing, financing, short sales, general real estate transactions and foreclosures. Her clients range from individuals, investors, corporations, and institutions across all asset classes of real estate, including residential, multi-family and commercial.

Contact Sarah Litchney by calling 916.757.6000. Attorney at Litchney Law Firm, Broker at StoneCrest Realty. DRE License # 01704912.

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