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As Long as We Remember...

January 23, 2012

Shadow Inventory Lurking

Michael Kurtianyk

In comic book lure and during the Golden Age of radio, Lamont Cranston was a wealthy young man in New York City who was known as “The Shadow.” The radio broadcasts began with that famous question: "Who knows what evil lurks in the hearts of men? The Shadow knows!"


Well, these days in real estate, there’s another evil lurking, but it’s in broad daylight. It’s called the “shadow inventory.” Never heard of it? That’s okay. It’s not something a lot of people know about, but the real estate industry is worried. Shadow inventory can be broken into three distinct categories:


Real Estate Owned (REO’s).


These are properties owned by a bank after an unsuccessful attempt at a foreclosure auction. This happens quite often because most of the properties up for sale at these auctions are worth less than the total amount owed to the bank.


Properties in Process


These are properties that are about to go into foreclosure, but the paperwork hasn’t been completed. These files clog up the system and aren’t on the market yet, or haven’t gone to auction.


Delinquent Properties


These are properties wherein the owners are severely delinquent in loan payments and are headed to foreclosure. However, they haven’t begun the foreclosure process.


Figuring out how many properties are in one of the shadow inventory categories is difficult. There are, at any given time, over three million houses for sale across the country. This is about nine months’ worth of homes, as there are typically around five million homes sold in a given year. We are, however, in a sluggish economy, and inventory stays high, making it a buyer’s market. Since the economy is sluggish, things happen: some sellers can’t pay their mortgage and the bank has taken over, starting the foreclosure process.


The subprime mortgage collapse in 2007-2008 caused an unprecedented number of homeowners to go into foreclosure. The banks were left with a large number of residential real estate properties in their portfolios.


Are banks in the business of real estate? No!! However, they were stuck. Here they are, with many homes, and debating internally as to when would be a good time to put the foreclosed homes on the market. If the banks flood the market with inventory, then their profits will likely be reduced.


So, how many houses in this country are in the shadow inventory? Estimates are somewhere between four to eight million. If you add these to the current market of three to five million homes, you end up with an unhealthy market. Another way of looking at it: a healthy market is about a six month supply of homes (about 2.5 million). Having seven to 13 million homes makes for a slow housing and economic recovery.


We are also seeing lenders waiting longer before taking action against homeowners who have stopped paying their mortgages. Estimates are that about two million homeowners, who haven’t paid their mortgage in three months or more, have not received a foreclosure filing. More than half of these haven’t made a mortgage payment in over a year.


If you think about, it’s a good strategy by the banks to drag their feet with delinquent homeowners. If banks go through the foreclosure process, it would mean more paperwork and maintenance costs for the banks (because the homes are empty and not maintained by homeowners). Furthermore, the paperwork to push through the foreclosure process would add more flotsam and jetsam to an already clogged pipeline.


In this tough economy, bank-owned homes, like all other properties, aren’t selling fast enough. Once these foreclosure sales go to settlement and close there will be more properties behind them. It’s like that candy factory conveyor belt that Lucille Ball worked on in one episode – there are just too many chocolates for anyone to keep up with.


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