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2010-01-29 16:24:57

The Truth About “Shadow” Inventory


The housing crash will resume early this year, according to a story published recently.  
Quoting analysts at Amherst Securities, the reporter wrote that 7 million properties “likely to be seized by lenders have yet to hit the market” creating a “huge shadow inventory” of homes. That could have a disastrous effect on inventories, 1.35 years worth, if not another home was added to the market. High inventories would collapse prices, knocking another 8% off homeowner equity, with a domino effect on the struggling economy.
The analysts told Bloomberg that the shadow inventory is likely to only be reduced by about 1 million homes through “cures” such as homeowners getting their loans refinanced, finding jobs, selling their homes before seizure, etc.
But the foreclosure threat, while very real, could be way overblown.
Foreclosures could have a much higher cure rate, due to increased government homebuyer incentives. The first-time homebuyer tax credit, which has now been extended to April 2010 and also includes a new program for qualified move-up buyers.  
Add to that, inventories are diminishing. Existing home inventories have been reduced from a glut of over 11 months on hand, to about 7.8-month supply in September, down from 9.3-months on hand in August. Six months on hand is widely considered to be a balanced market.
Lawrence Yun, chief economist for the National Association of REALTORS® predicts that the tax incentives will invite as many as 2.3 to 2.4 million first-time homebuyers to the market this year, which should help to stabilize prices.
First-time homebuyers were 47% of the market in 2009, according to the National Association of REALTORS® 2009 Profile of Home Buyers and Sellers, up sharply from 41% in 2008’s survey
Next, foreclosures aren’t pandemic. Four states accounted for 52% of foreclosure activity in October - California, Florida, Illinois and Michigan, according to RealtyTrac. Some of the hardest hit states are showing significant reductions in foreclosure filings. Nevada is down 26% from the previous month, California down 1%, and Florida down 6%. 
Last, foreclosures appear to be declining as job losses bottom.
According to RealtyTrac® chief executive James J. Saccacio, the number of foreclosures declined for three months in a row through October 2009, but filings are up nearly 19% from October 2008. 
“However, the fundamental forces driving foreclosure activity in this housing downturn — high-risk mortgages, negative equity, and unemployment — continue to loom over any nascent recovery,” said Saccacio in a statement. “And despite all the efforts and resources directed at helping homeowners avoid foreclosure, we continue to see foreclosure activity levels that are substantially higher than a year ago.”
And that’s why shadow inventory remains worrisome. Explains Rick Sharga, senior vice president of RealtyTrac Inc., “Essentially, the 7 million ‘shadow inventory’ number consists of all the properties currently in foreclosure (about 1.2 million), all the loans that are delinquent (about 5.5 million), and some of the REOs (about 900,000 in our database).” However, he says, “it appears that the analyst is working on the assumption that 100% of everything that's delinquent or in default will ultimately go back to the banks as REOs. That's never happened, and is unlikely to happen this time.”

A more likely scenario, says Sharga, is that many of the loans that are only modestly delinquent will be cured or re-financed. “Of the loans that go into foreclosure, probably 50-60% will either be sold at foreclosure sale or taken back by the banks,” forecasts Sharga.
In addition, Sharga says that 20% of that number is already on the market, and are therefore not “shadow” inventory.
So what’s the real number of shadow inventories? “The only shadow inventory we can really be certain of is that which has already been repossessed by the banks, and isn’t yet listed for sale,” explains Sharga. “We estimate between 400,000 and 500,000 such properties. Everything else is pure speculation.”
The worst case? “If you were to assume that 50% of loans in all stages of delinquency would enter foreclosure and that 50% of those (as well as 50% of the homes currently in foreclosure) would ultimately wind up as REOs, and add these to the current off-market REOs, that would give you potentially 3.7 million homes in the pipeline.
“If 20% of those are currently listed, you come down to 2.96 million properties. Given processing timelines, which range from 3 weeks to 600+ days, and other delays in the system, predicting when these homes become REOs and hit the market is virtually impossible right now.
“And it doesn’t factor in two other important variables: how many loans are yet likely to go into default during this cycle, and how rapidly will buying activity increase? At the end of the day, we’re not looking at 7 million properties that are likely to flood the market all at once; but we will have several million properties go through foreclosure over the next 3 years and ultimately keep market prices from recovering as quickly as everyone would like.”
That could mean a long, slow recovery through 2013, predicts Sharga, rather than another precipitous drop in home prices. The foreclosure pipeline will continue to be slow, but what will hold the finger in the dyke is sheer volume, accounting and strategy. 
“Even with the current slowdown, foreclosure activity is running at 6 times what it was four years ago, and REO activity at 10 times,” says Sharga. “Secondly, there are financial reasons to slow down foreclosures and subsequent resales.
“When the “mark to market” accounting rules were relaxed last year, it meant that lenders didn’t need to write down the value of their real estate assets until the assets were re-sold. This allows lenders to repossess properties at full loan value (on their books) and defer the losses for months or even quarters. Finally, now that we’ve reached “critical mass” – a point where releasing all of the REOs onto the market would probably drive prices down – lenders realize that it’s a better strategy to gradually release the properties back onto the market, and may even benefit from a small bounce in prices which will minimize some of their losses.”
Actually, the housing market in many areas such as California, could use more inventory, so lenders would do well to release some foreclosures for resale. In some recovering areas of Southern California, for example, there is less than one month’s inventory for sale on hand.
Says Walt Molony, spokesperson for the NAR, “At the end of Sept. we were showing 3,630,000 homes on the market, down 7.5% from Aug. and 15.0% below a year earlier.  That works out to a 7.8-month supply.

“Census is showing a 251,000 new home inventory, down 3.8% from August and 36.5% below a year ago.  That represents a 7.5-month supply, so it's headed in the right direction.”
Blanche Evans is CEO of Evans Emedia, Inc. and publisher of The Evans Ezine. As an award-winning journalist, Blanche has been named one of the "25 Most Influential People In Real Estate" by REALTOR Magazine, and twice recognized as one of the industry's most "Notables."  

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