Shadow inventory dictates direction of housing market

by Dan Krell © 2010

Housing markets are not out of the woods yet. To know where housing is headed, you need to follow the “shadow inventory.” It is estimated that the shadow inventory will be dictating the direction of the housing market for the next twelve to thirty-six months; and contrary to some recent optimistic reports, it could get ugly.

“Shadow inventory,” simply put, is the term used to describe properties that are not yet for sale, but is expected to be listed for sale. The term is loosely used and generally refers to homes that are already owned by banks as well as homes in the process of foreclosure. However, some analysts broaden the scope of the term to also include homes that have seriously delinquent mortgages and/or in the process of a short sale.

Alarms about a threatened housing recovery due to the nationwide shadow inventory have been ringing since early 2010. Although recent reports of increased sales have been undeniably due to home buyer tax credits, economists doubt that any gains in the housing market will carry into July (one qualification for the home buyer tax credit is to close by June 30th). Even Lawrence Yun, Chief Economist for the National Association of Realtors, stated in a May 24th NAR press release (Realtor.org) that although there was an expected increase in existing home sales in April, sales will “temporarily fall back” when the home buyer tax credit expires.

Although it is expected that home buyer demand will diminish in the absence of a home buyer tax credit, a sudden exponential growth of home inventory has the potential to erode not only home buyer confidence but home values as well. It is clear that such an inventory surge can wreak havoc, as evidenced by the foreclosure surge of 2007-2008; but analysts cannot agree on the extent of the problem. Estimates of shadow inventory range from a conservative 1 million units to an astounding 6 million units.

A Standard and Poors analysis published February 16, 2010 (The Shadow Inventory Of Troubled Mortgages Could Undo U.S. Housing Price Gains) made clear the correlation between property liquidation and home value depreciation. And although the reduced number of foreclosures in the past year was due in part to attempts in assisting home owners to keep their homes (through mortgage modification programs), the inevitability of liquidating $473.4 billion in loans (which is equated to 1.75 million homes) was temporarily delayed. It is possible that home prices may again begin to depreciate as these troubled loans are liquidated (standardandpoors.com).

First American Corelogic appears to concur (Home Price Index Report – April 2010) with the premise of the S&P’s report. Although Corelogic’s Loan Performance Home Price Index (HPI) revealed an increase from February 2009 to February 2010, the report states that market stabilization has been widely due to government intervention through foreclosure prevention programs, Federal Reserve purchases of mortgage backed securities, and home buyer tax credits. Due in part to the expected conclusion of Federal Reserve purchases of MBS and home buyer tax credits, the HPI forecast from February 2010 to February 2011 is projecting a decline (corelogic.com).

Housing will undoubtedly be affected by shadow inventory. However, the affects of shadow inventory disposition may largely depend on other economic factors and government intervention; which includes (but is not limited to) employment, interest rates and foreclosure prevention programs.

This article is not intended to provide nor should it be relied upon for legal and financial advice. This article was originally published in the Montgomery County Sentinel the week of May 24, 2010. Using this article without permission is a violation of copyright laws. Copyright © 2010 Dan Krell.