RealEstateEconomyWatch.com

For a year or so, rumors of a “shadow inventory” of foreclosed homes have captivated the real estate industry. Over the months bloggers have grown the idea into a huge, sinister phenomenon that is distorting our understanding of the foreclosure picture and threatening to swamp local markets like a bursting dam.  Is the shadow inventory real? Is it really as bad as people say?

Like most foreclosure developments, the shadow inventory was born in California a year ago. It first hit the big time when Peter Viles wrote in the LA Times blog on August 8 that “there’s a theory floating around various blogs that listed inventory is deceptive because banks and lenders are quietly sitting on large and growing piles of foreclosed houses — so-called shadow inventory. The theory continues that banks fear that putting the entire inventory on the market at once would put even more downward pressure on prices.”

(Note: The shadow inventory caused by banks allegedly withholding REOs from the market is different from the shadow inventory caused by homeowners who would like to sell but are waiting for better prices. We prefer to refer to the latter as “pent-up supply.”)

In many West Coast markets last fall, concern grew over discrepancies between the number of listings reported by MLSs and foreclosures reported banks. In LA, for example, Deutsche Bank reported the inventory of foreclosed homes in Greater Los Angeles to be 88,843 units; far higher than the entire MLS-listed inventory for the metro area, 62,379.

In the Bay Area, a San Francisco Chronicle analysis of data from San Diego’s MDA DataQuick shows that more than one-third of foreclosures are in shadow territory - that is, they are not registering in county records as having been resold.

For the next eight months, the shadow inventory was largely a West Coast phenomenon until Rick Sharga, vice president of RealtyTrac, took the shadow national in a widely republished April 8 article in the Chronicle by Carolyn Said:

“We believe there are in the neighborhood of 600,000 properties nationwide that banks have repossessed but not put on the market,” said Rick Sharga, vice president of RealtyTrac, which compiles nationwide statistics on foreclosures. “California probably represents 80,000 of those homes. It could be disastrous if the banks suddenly flooded the market with those distressed properties. You’d have further depreciation and carnage.”

The Shadow Inventory was off to the races. In the past two months bloggers have written that banks across the nation are “gaming the system” to keep prices artificially high so that they can get more for their REOs, that the Obama administration may have leaned on banks not to release the entire foreclosure inventory at once in order to preserve neighborhood values, that neighborhoods suffer greatly from shadow inventory-unused houses tend to attract vandals, squatters and a host of other troubles;

The Calculated Risk blog even shared a Realtor’s tour of “shadow inventory” homes, http://www.calculatedriskblog.com/2009/06/jim-realtor-tour-of-shadow-inventory.html

Here’s the latest. San Diego is currently suffering a “reverse shadow inventory.” More properties are listed on the Sandicor MLS than are really available because a number of short sales are “sitting around” in limbo with offers from buyers that banks take a month or more to approve. Find out more at Voice of San Diego, http://www.voiceofsandiego.org/articles/2009/06/15/toscano/703reverseshadowinventory061509.txt

Some thoughts about the Shadow Inventory:

1. It’s not likely that banks would withhold properties from the market today in the hope of better prices tomorrow. Virtually every respected housing economist expects existing home prices on a national level to drop farther. When they will stabilize is anyone’s guess. Local values also are extremely difficult to judge. With foreclosures continuing to rise in the markets supposedly with shadow inventories, withholding properties may take owners into a worse market than the one they are in.

2. The volume of foreclosures hitting many markets is unprecedented. Banks were unprepared. Processing REOs takes staff time many don’t have. Cleaning and preparing properties for sale is a major undertaking and there are few vendors available. In major foreclosure markets like Las Vegas, where 75 percent of the listings are REOs, the strain on resources is immense.

3. The California moratorium on foreclosures may be contributing to the Shadow Inventory. Default filings over the past six months did not translate into foreclosures until the moratorium was lifted May 22.

4. Most banks today are focused on short-term results. They are not inclined to move quickly and spend resources to realize losses such as REO sales and short sales.

There’s no question that swome lenders take an extraordinary amount of time to process REOs, especially in the heaviest foreclosure markets where their resources are stretched thin. Oversupply and understaffing may be more at fault than any systematic strategy to game the market. Whether by intent or inadvertently, delaying the marketing of foreclosed properties postpones the day that the oversupply of distressed and discounted properties will be absorbed by the market and prices will stabilize.

When all is said and done, though, is the Shadow Inventory worth losing sleep over?  Not according to Sean O’Toole, founder and CEO of Foreclosure Radar.  “I think it is largely a non-issue at this point, at least in CA. Through September of last year banks were adding more foreclosures to their inventory then they were selling, but since then they have been selling more. We think at most there are 100k homes in bank inventory in CA at the moment. Many of those will be listed or in escrow. A good chunk of the remainder will be working through eviction and cleanup. Still with foreclosure resales around 20k units a month in the state, I think it is a manageable number, and overall no longer an issue,” he told Real Estate Economy Watch.

 Below, graphic from the San Francisco Chronicle, April 8.