Following on the discussion from yesterday, there’s another topic you’re going to start hearing more about soon: shadow inventory.
What is Shadow Inventory?
Before we talk about shadow inventory, we have to first figure out what inventory is. Inventory in this case in the number of homes currently for sale in the US. Inventory can be measured in a couple of ways. The National Association of Realtors likes to express it in months of inventory, so there is an 8.4 month supply of inventory of existing home (it excludes new ones). Generally speaking, an ideal supply is closer to 6 months; this means that if no new homes went on sale, the existing supply would run out in 6 months.
The shadow inventory is the inventory of homes that are probably going to be for sale real soon. For example, foreclosed homes that haven’t been listed are a part of shadow inventory. Calculated Risk mentions unlisted condos by builders that have decided not to sell yet are also a part of the shadow inventory. The exact definition of shadow inventory depends on who you ask. Someone might say it only includes homes that have been taken over by the bank. Another might say it could include any home that is more than 6 months late on a mortgage.
What Impact Does Shadow Inventory have On Real Estate?
Regardless of what you say shadow inventory is, there’s a lot of it. Estimates vary between 2 million and 8 million homes in the US. With sales expected to be 5.5 million this year, that’s a lot of inventory. The effects of such inventory will be to depress home prices. As soon as sales pick up people and banks will list homes to try to sell them. This will depress prices as there will again be more sellers than buyers. It could take years before all the shadow inventory is sold off, which means prices will be lower than what they could be.
And It Gets Worse
I wish I could find the source, but I’ve seen it so many times I know it to be legitimate. There are a lot of mortgages that are going to be reset in 2011. Imagine people with 5 years of locked in rates having their mortgages reset in 2011 because they bought at the peak of the bubble in 2006. Right now, these people can still afford their mortgages. But what will happen when rates reset? It’s already expected that interest rates will rise in 2011, so these people could be in trouble. Will these release a flurry more shadow inventory on the market? I hope not. Let’s all hope people start to get jobs again throughout this year and can refinance these mortgages. But then again, I may be in the market for a house next year, so I might not hope too hard.
Photo: BSL MMRS
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The size of the ” shadow inventory” under the definition described in this article creates a significant understatement of the problem of excesss supply of housing as compared to the paucity of demand for housing at the current prices of mortgages and homes (particularly considering the state of the economy, unemployment and the new “risk aversion” mortgage lenders and banks are exhibiting.
In April of 2009 the U.S. Congress, under pressure from the banking industry, persuaded the Financial Accounting Standards Board (FASB) to delay implementation of mark-to-market accounting for mortgage related assets.* This delay provides banks with the opportunity to continue carry mortgage assets at origination value rather than at their current market value. The conditions that would force the revaluation of mortgage assets would be completing a foreclosure or taking the property in as a REO. It seems banks and mortgage investors are delaying foreclosure proceeding and resisting taking back properties in order to avoid having to reprice their mortgage assets (which would show the true state of their balance sheets and force banks to add to reserves).
Many mortgage borrowers are far in arrears on their mortgage payments, well beyond 90 days. The banks do not want to take possession of the properties and thereby have to deal with the costs (property taxes, security, HOA fees, and municipal assessments) of owning these homes.
* http://online.wsj.com/article/SB124396078596677535.html