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 seriously 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.
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. It is being offset by improved demand, particularly from investors. 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.
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.
There are a wide range of estimates of shadow inventory. A common measure are loans that are either in the foreclosure process or that are three months or more delinquent. These are mortgages that are among the most likely to ultimately become bank-owned properties.
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.
But it is down from a peak of 4.25 million in February 2010. And unless mortgage delinquencies begin to accelerate sharply, the shadow inventory won’t be growing. Barclays estimates that at the current rate, this figure could fall to around 2.4 million loans.
“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.
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.”
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. Tomorrow, we’ll offer a deeper look at how demand factors into this equation, and how the shadow is being disposed.
This is the first of three posts examining the shadow inventory.
Tomorrow: Monitor Banks’ Speed, Not Just Volume
For more on this subject, see Joshua Brown’s The Reformed Broker.
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