The arguments about whether there is or is not a shadow inventory have gotten silly. There is a shadow inventory, and there are certain facts we can establish about it. First, there are millions of delinquent mortgage squatters who will not be given free homes. The exact number is impossible to ascertain because no accurate records are kept outside the banks who aren’t accurately sharing this information. Since the banks aren’t disseminating accurate information (why would they?), CoreLogic, who relies on voluntary information, consistently under reports the problem. Second, the disposition of these properties will require a sale on the MLS. This may be as an REO after a foreclosure, or it may be as a short sale in lieu of foreclosure. The only way these sales bypass the MLS is if a loan modification succeeds, which is rare, or if the property is purchased by a hedge fund and held as a rental. But even then the property will be resold, it’s only a matter of when the hedge fund wants to exit the business. Most will be out in five to ten years.
The two facts which aren’t in dispute together means there will be several million property sales on the MLS, and most of these sales would not have occurred if these borrowers were not in such dire financial distress. In other words, these are additional MLS sales above and beyond ordinary sales volumes. So how does a market absorb excess supply without causing prices to fall? It is possible, but it requires carefully managing absorption rates.
Ever since the housing bust began to overwhelm the banks with REO, asset managers have tried to sell homes at a rate the market could absorb without forcing prices to move lower. This was not successful when prices were extremely elevated and unaffordable and supply was overly abundant. But since house prices dropped, rents rose, and mortgage interest rates fell, affordability improved significantly. Now what the market needs is a healthy supply of borrowers with good jobs and good credit. Unfortunately, those people are in short supply, so lenders respond by reducing MLS inventory until such time those buyers are available.
Prices may go up or they may go down depending on how well bank asset managers control the flow. The bottom callers are all placing their faith in the skills of these asset managers rather than in the forces of the market. Right now, these asset managers overly constricted the supply in the Southwest, and prices are rising. However, this also means lenders aren’t clearing out the existing shadow inventory and are actually adding to it. This will likely prompt lenders to increase foreclosure processing rates to take advantage of the higher prices. It’s also possible lenders will become overly exuberant about regaining their non-performing capital and process too many. The cycle of real estate often proceeds from periods of scarcity to periods of excess.
Unfortunately, there is no way to know how orderly the liquidation of shadow inventory will be. We are not talking about a natural market subject to ordinary laws of supply and demand. In a normal market, millions of individual owners control the supply, and they don’t act with any coordinated effort. Today, a cartel of a few major banks control the bulk of our housing inventory. These banks openly collude on prices with the blessing of our government. Since cartel arrangement are inherently unstable, there is not telling how this plays out. Caution is advised. I recommend buying properties below rental parity so you have a viable plan B if prices were to go south.
August 14, 2012, 9:55 AM
The chart above is similar to mine on delinquencies, but it does contain a fair amount of guesswork and wishful thinking.
The housing market is improving because there are more buyers chasing fewer homes. Skeptics of a housing bottom, however, often point to a scary set of numbers: the “shadow inventory” of potential foreclosures—the millions of mortgages that are either in foreclosure or in default.
It’s true that home prices are unlikely to see brisk gains once they do hit bottom because it will take years to absorb this glut. But will this phantom inventory derail the incipient housing bottom? Maybe not, say a number of housing analysts.
What follows is a load of opinions not supported by much data. Basically, the reporter found everyone who was willing to say the huge overhang of supply won’t be a problem.
There are several reasons why the shadow inventory isn’t as scary as it sounds: It’s concentrated in a handful of markets—it isn’t inherently a national phenomenon.
So that means certain markets will get crushed, right?
It is being offset by improved demand, particularly from investors.
This improved demand is concentrated in a handful of markets, and it’s only focused on low-end properties.
And the housing vacancy rate is low, a product of very little new home construction over the past few years that could counterbalance continued high inventories of foreclosed homes.
Vacancy rates are only declining in select markets, and the rate is still much higher than historic norms.
We’ll address each of those in subsequent posts. But first, let’s examine the actual size of the shadow inventory. While the shadow is very large, one often-overlooked fact is that the shadow isn’t nearly as large as it was two years ago.
… Barclays Capital estimates that at the end of May there were around 1.8 million mortgages in the foreclosure process and another 1.45 million where borrowers have missed at least three payments. That puts the total number of properties that could be repossessed and resold by banks at around 3.25 million mortgages.
If those homes hit the market all at once, housing would be in deep trouble. Last year, for example, there were 4.4 million sales of previously owned homes. The figure is still higher than any time before June 2009.
Total sales was 4.4 million last year, and even at that rate, prices fell. So what happens if you add 500,000 properties a year for the next six years in order to clear out the 3,000,000+ homes in shadow inventory?
… “The concept of a huge shadow inventory is preposterous,” says Christopher Thornberg, a housing economist with Beacon Economics in Los Angeles. “The number of mortgages in distress is way down from one year ago. It’s clear there are fewer distressed properties out there.”
Housing analyst Ivy Zelman has a slightly larger estimate of shadow inventory—around 6.3 million homes at the end of last year—that includes more newly delinquent mortgages and potential re-defaults. She says that in a normal market, there’s a comparable shadow inventory of 2.9 million homes. So the key figure—the excess level above the historical trend—is around 3.4 million homes.
She uses a different measure but comes up with the same estimate of excess units.
Ms. Zelman published an in-depth research note earlier with the title: “Shining a bright light on the shadow: Why what’s lurking doesn’t concern us.” In it, she explains how it’s more important to focus on the pace at which foreclosures are being liquidated, and not the absolute number.
“Just like the Wizard of Oz, shadow inventory is not very intimidating once you pull back the curtain,” the report said. That isn’t to dismiss the magnitude of the problem and headwind it will continue to pose for any housing recovery, she wrote. “The bathtub is almost full, but the water has stopped rising, and we are most concerned with how fast it drains.”
Absorption is the key metric. The absolute number of shadow inventory homes dictates how long it will take to clean up the mess. The slower the absorption rate and the larger the inventory, the longer the overhang will hinder appreciation. It’s really that simple.
Certainly, there are many other risks to housing. There are at least 11 million homeowners that are underwater, owing more than their homes are worth. There are even more than that who don’t have enough equity to make a 10% down payment on their next home, plus pay a real-estate broker’s sales commission, in order to trade up to a bigger home or downsize to a smaller one. And it’s still very difficult to get a mortgage.
But the shadow inventory is often the big trump card used to quiet any housing-happy talk. …
That’s because shadow inventory is the defining problem of the housing bust. Shadow inventory is a result of the can-kicking lenders began four years ago to deal with the precipitous decline in house prices caused by the first flood of foreclosures. Every problem which added to delinquencies was solved by adding to shadow inventory. Like sweeping dust under the rug, the buildup of shadow inventory created a mound the market is sure to trip over.
What’s more worrisome than the actual “shadow inventory” is how banks dispose of it—and whether there are enough buyers willing to purchase the homes when they do.
It’s increasingly clear that banks—whether by design or not—aren’t going to foreclose quickly and relist all of these homes for sale.
It is clearly by design, and it’s working. Banks will continue to manage their disposition of shadow inventory until they are done with their task. The question is whether or not they will be able to manage this disposition effectively or if it will get out of control.
… The number of bank-owned homes is down from a peak of nearly 700,000 in September 2008. After that, changes to accounting rules and the introduction of government loan-modification programs prompted banks to slow down the process and led to a drop in the volume of bank-owned properties throughout 2009.
Bank-owned foreclosures began rising again in 2010, peaking at around 600,000 that September, when banks again slowed down foreclosures, this time amid the “robo-signing” scandal. Since then, banks have been very slow to process foreclosures, particularly in judicial states, where courts are overwhelmed by the volume cases and banks have struggled to properly document their ownership of mortgages.
Notice that projections for bank-owned homes are expected to rise significantly throughout 2013.
…“If you don’t understand the shadow inventory, it’s very ominous and concerning,” says Ivy Zelman, chief executive of Zelman & Associates. “But if you understand the flows and how it is brought to market” it looks less intimidating, she says.
I don’t know. I understand it, and it looks pretty daunting to me.
…“What most of the bears aren’t focused on is understanding demand,” says Ms. Zelman. This is one reason she’s turned bullish. Her most recent forecast calls for a 5% increase in home prices this year, a change from her initial forecast of a 1% decline when the year began. Getting a handle on demand “allows us to have a complete picture of the housing market.”
I understand demand. Investors are buying up below-median properties in select markets. This will stabilize prices in those areas — and only in those areas — but these investors are not prone to chasing prices higher. Owner occupant demand is still in the doldrums and showing no signs of improvement.
Finally, shadow inventory isn’t a national phenomenon. Instead, it is heavily concentrated in particular markets—and within those, in particular submarkets. To the extent banks to ramp up the foreclosure process, the shadow is more likely to resemble a “tornado” than a “flood,” as it will strike particular communities while bypassing others, says Jeffrey Otteau, president of Otteau Valuation Group, an East Brunswick, N.J., appraisal firm.
So which communities will see this flood? Will we see a triple dip in Riverside County while Orange County prices head to the moon?
Housing markets are not that compartmentalized. If prices crash in one market, the substitution effect will draw buyers in from another nearby market. We may not see a national decline in house prices as shadow inventory is liquidated, but we will see disruptions in many markets. And this process will continue for quite some time.
That Option ARM was a bad idea
It only takes one mistake to lose your home. The former owners of today’s featured property paid $182,000 back on 5/14/1998. They used a $145,600 first mortgage and a $36,400 down payment. Their only refinance was a $357,000 Option ARM with a 1.25% teaser rate. It proved to be more than they could handle. They extracted $212,400 in mortgage equity withdrawal, so it’s hard to feel too sorry for them, but they did lose their home, and now they are living in a rental. Let’s hope they have some of that $200K to comfort them.
Wouldn't you be embarrassed to overpay by $100,000? Only fools buy houses without knowing neighborhood values. Don't be a fool. Don't suffer the pain of an underwater mortgage. The surest way to lose your house is to overpay for it. Our reports identify overvalued and undervalued neighborhoods. Use it to broaden or narrow your search area. Savvy buyers work with us to find bargains. We've saved thousands from financial ruin. Let us save you too. If you want peace of mind while shopping for your next home, sign up for our monthly market newsletter.
We're sorry, but we couldn't find MLS # P832706 in our database. This property may be a new listing or possibly taken off the market. Please check back again.
Proprietary OC Housing News home purchase analysis
$399,900 …….. Asking Price
$182,000 ………. Purchase Price
5/14/1998 ………. Purchase Date
$217,900 ………. Gross Gain (Loss)
($14,560) ………… Commissions and Costs at 8%
$203,340 ………. Net Gain (Loss)
119.7% ………. Gross Percent Change
111.7% ………. Net Percent Change
5.5% ………… Annual Appreciation
Cost of Home Ownership
$399,900 …….. Asking Price
$13,997 ………… 3.5% Down FHA Financing
3.55% …………. Mortgage Interest Rate
30 ……………… Number of Years
$385,904 …….. Mortgage
$111,105 ………. Income Requirement
$1,744 ………… Monthly Mortgage Payment
$347 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$100 ………… Homeowners Insurance at 0.3%
$402 ………… Private Mortgage Insurance
$278 ………… Homeowners Association Fees
$2,870 ………. Monthly Cash Outlays
($260) ………. Tax Savings
($602) ………. Equity Hidden in Payment
$16 ………….. Lost Income to Down Payment
$70 ………….. Maintenance and Replacement Reserves
$2,094 ………. Monthly Cost of Ownership
Cash Acquisition Demands
$5,499 ………… Furnishing and Move In at 1% + $1,500
$5,499 ………… Closing Costs at 1% + $1,500
$3,859 ………… Interest Points
$13,997 ………… Down Payment
$28,854 ………. Total Cash Costs
$32,000 ………. Emergency Cash Reserves
$60,854 ………. Total Savings Needed
The property above is available for sale on the MLS.Contact us for a comparative market analysis, a cost of ownership analysis, or information on how you can make an offer today!
1299 PHILLIPS Dr
2 bd / 2 ba
1,364 Sq. Ft.
36 PRESTON Ln
4 bd / 2.5 ba
1,825 Sq. Ft.
26 PRESTON Ln
4 bd / 2.5 ba
1,825 Sq. Ft.