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Real Estate Article: "Shadow" or "Black Cloud" Inventory? That's the Question
Written by article default Tuesday, 08 June 2010 10:29
There is a term that I often use when conducting workshops and classes related to the real estate market, "shadow inventory." A student asked me the other day what that term meant and why they should be concerned about it. I realized that maybe I needed to spend a little time explaining what "shadow inventory" is and why it's something we have to consider in today's market.The term "shadow inventory" is used to refer to those properties that are not currently listed for sale, but have the potential to come on the market as distressed property (for example, short sales, foreclosure or REOs). Distressed properties are different from what I refer to as equity sales. Equity sales are homes that come on the market simply because their owners decide to sell maybe because of a job transfer, or have decided to move up or down size, etc.
We use the metaphor "shadow," but many think it's something more like a "black cloud inventory." The build-up of potential distress sales is like a "black cloud" that sits out on the horizon of the real estate market. Maybe the cloud will dissipate, leaving the sky blue and our market healthy; maybe the cloud will proceed in a measured manner and just rain steadily and long, but won't leave much damage in its wake; or maybe the "black cloud" will just open the floodgates creating a downpour and reeking havoc on the real estate market.
There is always a "shadow" inventory no matter the condition of the market. Even in the best of times, foreclosures occur and things will be bad somewhere. I remember in the mid-eighties when real estate was on an up swing in most of the country, the market in Houston, TX was, sad to say, the least; and now when real estate is in bad shape in most of the sand states, TX is booming. During normal times, foreclosures have little impact on inventory and the market, but these are not normal times. Often the properties that go into foreclosure in normal times have some equity and they get sold through Pre-Foreclosure before they even go back to the bank. There isn't usually a concern that these foreclosed properties are sitting out there affecting inventory and prices.
The reality today is much different; in fact, it's different from any downturn we've seen in modern times. The loss of equity has been enormous. That, along with the high unemployment rate, has resulted in fewer numbers of delinquent mortgages that can be brought current.
In today's market, if we consider the "shadow inventory," the number of foreclosed homes held by banks, commonly know as REOs and not yet on the market for sale, it's estimated to be somewhere between 750,000 and 1 million properties. However, if we consider the "shadow inventory" to be the current REOs and those properties that are in some stage of the foreclosure process, the number would be more like 2.8 million. There are experts out there that consider the "shadow inventory" to be the REOs, properties in some stage of foreclosure and properties where the mortgages are seriously delinquent (90 days or more); that number would be close to 5.3 million. In my opinion, the second scenario is the most accurate, 2.8 million. My reasoning behind this is that treating all delinquencies as if they will proceed to foreclosure is fairly unrealistic.
Last year, there were roughly 5 million properties sold in the U.S.; its realistic to think that the "shadow inventory" (or Black Cloud) is about half that number, so one out of every two properties sold is distressed. This does vary from market to market.
You may ask what happened to the Making Homes Affordable Act, which created the loan modification program. Well, that program hasn't been as successful as was hoped for, but has recently started to have more of an impact. However, it's not loan payments that are the predictor of default. As Laurie Goodman of Amherst Securities testified before Congress, "Negative equity is the most important predictor." The MHAA didn't address the issue of negative equity and principal reduction. Some experts think that without this issued addressed, foreclosures will continue for a while.