Much has been written about the so-called "shadow inventory" since the term was first coined a few years ago. Some analysts and commentators have argued about whether it even exists. Let's take an in-depth look at this shadow inventory and see whether it really is a threat to housing markets around the country.
Shadow Inventory Defined
Rather than joining the dispute about what the term actually means, I will simply define it in this way: The "Shadow Inventory" is comprised of all those distressed residential properties (other than MLS listings) which we know will almost certainly be coming onto the market in the not-to-distant future.
MLS Foreclosures - Only the Tip of the Iceberg
The starting point in discussing the shadow inventory has to be homes actually on MLS listings around the country. With the plunge in home sales starting in July, the number of listings has risen substantially since the spring. For example, California listings are up 25% since April.
The percentage of total listings that are bank-owned properties has declined over the last year, while the percentage which are short-sale listings has risen tremendously during the same period. For example, short sales comprised 40% of all active listings in Sacramento County in August. The following table from data supplied by ZipRealty shows this soaring number of short sale listings.
Because of the sharp climb in short-sale listings, roughly 30% of all July home sales in California, Arizona and Nevada were short sales according to Inside Mortgage Finance. It also reported that nationwide, closed short sales have climbed from roughly 45,000 in January 2010 to nearly 100,000 in June.
With regard to shadow inventory, the key question is how many foreclosed and repossessed properties are now either in the inventory of banks or held on behalf of residential mortgage-backed securities (RMBS) investors whose loans they service. Estimates start at about 500,000 and go up from there. One highly reputable data provider with a huge database of first mortgage liens has been reporting an REO inventory in excess of one million since last summer. Whatever the number is, it seems clear that the vast majority of these properties are not currently on the market.
Defaulted Properties Heading for the Resale Market
In addition to repossessed properties held off the market, the shadow inventory includes all the homes which have been placed into default - the first stage of foreclosure proceedings. According to Lender Processing Services' July Mortgage Monitor report, there are now 2.02 million properties in default. This number has not declined in the past year in spite of more than one million trial mortgage modifications.
In many of the worst bubble metros, the number of homes in default has been climbing in the last year. Take a look at the soaring number of defaults in the Las Vegas metro area in this graph from ForeclosureRadar.
In spite of the huge number of foreclosed homes that have been sold by the banks in the Las Vegas area, the volume of new foreclosure actions continues to rise.
While many of these defaulted properties throughout the nation will escape foreclosure by means of a short sale, the rest will move on to foreclosure proceedings and eventual trustee sale to a third party or repossession by the lender.
Overwhelmed by the number of defaulted properties, banks have stretched out the time between the beginning of mortgage delinquency and formal foreclosure to an incredible average of 469 days - more than 15 months. Since these homeowners in default are living in their house without making mortgage payments, that is a way to build up a sizeable pile of cash.
Delinquent Homeowners - The Number Just Keeps Growing
You could argue that the shadow inventory is the total of repossessed homes not yet on the market and defaulted homes that will move into foreclosure. However, there is also the matter of homes which are seriously delinquent in mortgage payments. Why? you may ask. The homeowner can cure the delinquency by paying the arrears before the home goes into default.
The problem is that the cure rate for these seriously delinquent mortgages is almost zero. Let's take a look at the following chart.
If this were early 2005, one could claim that 40% of homeowners who were delinquent 90 days or longer would eventually bring the mortgage current. But the cure rate has plunged along with home prices. As early as one year ago, the cure rate had dropped to almost zero. A delinquency of 90+ days now means almost certain foreclosure or short sale.
How many homeowners are now seriously delinquent by 90 days or more? To answer that, we turn to Lender Processing Services and its massive database of roughly 34 million first mortgages. Their monthly Mortgage Monitor provides a detailed table of non-performing first liens. Here is what the July non-performing loan count looks like.
At the end of July, the number of residential first mortgages that were delinquent by 90 days or more stood at 2.47 million. While the figure has declined from a record 3.06 million in January of this year, this is due almost entirely to the mortgages which were placed in trial modification by the banks. While in modification, they are no longer considered delinquent. We know from the cure rate chart shown earlier that nearly all of these seriously delinquent mortgages are headed for the resale market either through a short sale or foreclosure.
To these 90-day delinquencies we need to add first mortgages which are delinquent for at least 60 days. The chart above reports 761,000 of these 60 day delinquencies. The cure chart shows us that the vast majority of these delinquent properties will also end up on the resale market.
Finally, we must also include those mortgages which are newly delinquent for 30 days. That number has been stuck at roughly 1.8 million for the last three months. Now you may question the inclusion of these newly delinquent loans. Keep in mind, though, that the vast majority of those homeowners who become 30 days delinquent have been delinquent before according to Lender Processing Services figures. The cure rate chart shows us that only 30% of those borrowers who go into arrears by at least 30 days will cure the loan without lapsing into delinquency again and eventually falling into default.
Concentration of the Shadow Inventory in 25 Major Metros
It is very important to understand that this enormous shadow inventory of distressed properties that will eventually be thrown onto the resale market is heavily concentrated in a limited number of metros. According to data provided by Lender Processing Services, 52% of the nationwide 90 day delinquencies and 58% of the defaults are concentrated in 25 major metros. The following table shows this concentration.
If you look carefully at the distressed property figures for the top four metros, you'll see that the number of residences which will be pouring onto their housing markets in the next 1-2 years is enormous. Anyone who thinks that prices have bottomed in the Miami, New York, Los Angeles or Chicago metro areas had better take a good, hard look at these statistics.
Tallying Up the Shadow Inventory
An incredible 14% of the nearly 54 million first liens in the country are now either delinquent or in default. This chart from the Calculated Risk blog shows the steady growth since 2005.
To come up with a total for the shadow inventory, let's first add the total number of loans in default to those delinquent 90 days or more since we know that these loans are headed for foreclosure or a short sale. That comes to 4.5 million properties. Based on the cure rate for loans delinquent at least 60 days, we will add 95% of those 60-day delinquencies. That is an additional 723,000 residences. For the same reason, we will add 70% of those delinquent for at least 30 days - 1.25 million properties.
And, of course, let's not forget the REOs that have not yet been placed on MLS listings by the bank servicers. We'll be conservative and estimate them at 500,000.
Adding all of these together, we come up with a total of roughly 6.97 million residences which are almost certainly going to be thrown onto the resale market as distressed properties at some point in the not-too-distant future. This massive number of homes will put enormous downward pressure on sale prices. To believe that prices are firming now is to completely ignore this shadow inventory. Ignore it at your own risk.