The ‘Shadow Inventory’ Darkening Housing


Reducing inventory in the real estate market these days is like trying to shovel your driveway clean in the middle of a blizzard. No matter how fast you work, new falling snow just keeps covering over any progress you have made.

And housing’s biggest problem continues to be a blizzard of backlogged foreclosures, aka “shadow inventory,” which before the recent agreement with the 50 state attorneys general were backed up in the pipelines of the major banks.

Even so, Friday’s new-home sales report from the Commerce Department was surprisingly negative. New-home sales fell 1.6% in February, to a seasonally adjusted annual rate of 313,000, after they were expected to show an increase to an annual rate of 325,000. Homebuilder stocks were all selling off in early trading, with laggard KB Homes (NYSE:KBH) down over 12% following a disappointing earnings report. But even recently resilient homebuilders, such as Hovarian Enterprises (NYSE:HOV), were down over 6%.

On Wednesday of this week, Corel Logic reported that as of January 2012, the U.S. had approximately 1.6 million units of residential shadow inventory. This is a little more than half of the 3 million total properties that are currently seriously delinquent, in foreclosure status or bank-owned properties (known as REOs, for real estate owned).

That 1.6 million units equate with a about a six-month supply, and the good news is that’s a two-month reduction from the levels seen in January 2011. The bad news is the level of shadow inventory remains the same as it was six months ago. As fast as  investors and cash purchasers snatch up these properties, new shadow inventory is released.

This is the frustrating Catch-22 of today’s real estate market. Prices can’t rise until inventory declines, and inventory can’t decline until prices rise. Let’s take a closer look at why this is the case.

Sellers Can’t Sell

Imagine you need to sell your home due to a change in job or family situation. But the problem is that you bought your home with a 30-year mortgage less than eight years ago, and you’re upside-down on your mortgage. If you sold your home, you would have to bring $30,000 or $40,000 to the closing, and that’s money you just don’t have.

One solution is to short-sell your home (sell for less than what’s owed on the mortgage). But if you do that (assuming your bank even agrees), it hurts your credit, could take up to eight months to get lender approval — and it ultimately brings down the value of the surrounding homes in your neighborhood.

Another solution is to rent your home, but depending on when you bought your home, your mortgage payment could be several hundred dollars a month more than your potential rental income.

Faced with this dilemma, many homeowners have chosen to simply walk away from their mortgage, a practice known as “strategic default.” But doing this has ruined their credit and now prevents them from buying another home for as long as seven years. The ongoing strategic defaults have continued to feed the shadow inventory levels, which eventually trickle down into the inventories of the local Multiple Listing Services (MLS).

Inventory rises and prices decline or remain low.

Buyers Can’t Buy

Some buyers can’t buy due to poor credit or high debt loads. Lenders are demanding better credit and lower debt-to-income levels than they did several years ago. Another obstacle for would-be buyers is higher down payment requirements and an increase in loan fees, especially on FHA loans.

Other buyers can’t buy because of their recent foreclosures or bankruptcies, thanks to that hit to their credit ratings.

Along with the buyers who can’t buy are those who “won’t” buy, either because the recent downturn in real estate has left a sour taste in their mouths or because they fear further decline is probable. These buyers won’t move until they see evidence that prices are rising again.

Since inventory is showing few signs of diminishing, prices are stagnant in many areas of the country, and buyers in those areas continue to hold off. By doing so, they perpetuate the cycle in which inventories remain abnormally high.


As I have noted in a recent InvestorPlace article on homebuilder stocks, employment and the real estate market remain inexorably linked: Each relies on the other for growth. New construction creates thousands of jobs, and each re-sale provides additional revenue for dozens of independent contractors and service providers, who can then afford to hire more help.

So the key to a better real estate market remains an employment rate that will give more first-time buyers the wherewithal to qualify for loans. Additionally, the government needs to stop hindering the market with the kinds of programs now in force, including new FHA loan fees, excessive environmental regulations on older homes and a centralized appraisal system that’s destroying market values.

Another solution is for the government to give real estate investors incentives to purchase homes — without destroying property values, which is what happens when thousands of homes get sold in bulk to hedge funds. Incentives such as tax breaks or the ability to roll the cost of needed repairs into conventional home loans would help reduce the inventory of the foreclosures more quickly and would not hinder property values.

Until and unless we break through the stalemate that simply replaces one sold foreclosure with another from the pipeline, the housing market will continue to muddle along at the bottom for several more years.

Article printed from InvestorPlace Media,

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