How The Shadow Inventory Is Forcing Home Prices Higher

In recent weeks we’ve seen reports suggesting that real estate prices have begun to stabilize. What’s being said is not that prices are returning to the  levels seen in 2007, but instead that declines in many communities have now slowed or stopped. Indeed, home prices are actually rising in some local markets.

  • “The decline in the national median price has moderated recently, and a shrinking supply of unsold inventory suggests we are getting closer to price stabilization in many areas,” says Lawrence Yun, chief economist with the National Association of Realtors. NAR reports that “during the third quarter, 123 out of 153 metropolitan statistical areas reported lower median existing single-family home prices in comparison with the third quarter of 2008, while  30 areas had price gains.”


  • “The percent of American single-family homes with mortgages in negative equity,” says, “fell to 21 percent in the third quarter, down from 23 percent in the second.” Rising equity, of course, reflects higher values and rising prices.
  • U.S. home prices fell 0.7 percent in the second quarter of 2009 from the first quarter of 2009, according to the Federal    Housing Finance Agency’s house price index (HPI). “For the second consecutive quarter we are seeing much slower rates of depreciation in the HPI than in 2008,” said FHFA’s Edward J. DeMarco. “This is further evidence that prices may be stabilizing for the nation as a whole.”


  • “Broadly speaking, the rate of annual decline in home price values continues to improve,” says David M. Blitzer with Standard  & Poor’s. The latest S&P/Case-Shiller report    for August shows that 17 of 20 major metro areas saw rising home values when compared with July.

These reports are good news, but many people wonder: How is it possible for home values to stabilize while our vast “shadow inventory” of distressed and unsold real estate continues to grow?

The Shadow Inventory
Today we have a marketplace where potential losses are so great in some areas that many owners cannot offer their homes for sale. In terms of distressed real estate we have huge numbers of properties entering the foreclosure system — but far fewer that are leaving because lenders want to avoid losses. The result is a massive backlog of unsold distressed properties, homes at the center of the shadow inventory.

The slow release of foreclosed homes pushes prices higher by limiting supply — perhaps  accounting for some or even all of the price increases that are being reported.  Right now, says NAR, 30  percent of all existing home sales involve foreclosures and short-sales.

The worry raised by the shadow inventory is that the insurance and maintenance  costs required to retain growing lender inventories cannot be sustained, forcing  lenders to quickly release more and more distressed homes into local markets. The direct result would be more homes for sale, increased supply and lower real estate prices.

But while the worry is real, the reality is that lenders are unlikely to quickly  unload foreclosed inventory because accounting rules and the potential for  current losses and future profits are too powerful to ignore.

How Big?
A recent research report from the Amherst Security Group says “the single  largest impediment to a recovery in the housing market is the large number  of loans that are either in delinquent status or in foreclosure that are destined  to liquidate. This creates a huge shadow inventory. We estimate this housing  overhang at 7 million units, 135 percent of a full year of existing home sales.”

In comparison, says Amherst, the shadow inventory amounted to just 1.27 million  units in early 2005.

According to Lender  Processing Services, Inc., “the number of loans deteriorating further  into delinquent status is now more than twice the number of foreclosure starts,  indicating another major wave of troubled loans in an already clogged loan  pipeline. Nearly one-third of foreclosures remain in pre-sale status after  12 months —  twice as many as the year prior.”
The numbers from Amherst and LPS are plainly visible in the marketplace. Lindy  Clarke Hall, with HTown Realty in  Houston, says “I’ve been surprised that many of the drive-by BPOs I’ve  done, as much as a year ago, have NOT gone into foreclosure… I’m glad to  see that somehow those people managed to stay in their homes.” (A BPO  is a broker’s price opinion, an estimate of value from a local real  estate professional.)

“With mortgage rates still low and the expansion of the tax credit  to trade-up buyers, we could see significant inventory — both new and  ‘shadow inventory’ — hit the market during the next four to six months,” says  Pete Flint, CEO at “Inventory  levels this quarter are poised to be atypical of a normal real estate market,  which could create tremendous pressure on sellers to price their homes competitively and move their property before the tax credit expires on April 30th.”
“The real concern is not that a shadow inventory exists, instead the  question is what will be done with these millions of homes,” says Jim  Saccacio, Chairman and CEO at, the nation’s biggest source of foreclosure listings and information. “If  lenders sell off their inventory over time on a controlled basis then local  home prices will be supported. However, if lenders suddenly dump massive numbers  of foreclosed properties then the result will be substantially reduced home  values for everyone.”
The shadow inventory is generally seen as including delinquent and foreclosed  properties, but the definition should be expanded to include other real estate  as well.

Option ARMs typically have five- to 10-year “start” periods during which time borrowers can make monthly payments that do not even cover interest  costs. Those unpaid interest costs — so-called “negative amortization” — are  added to the loan balance. When the loan balance reaches 110 percent to 125  percent of the original mortgage amount, the loan is then immediately “re-cast” so  that monthly payments increase to a level where the mortgage becomes self-amortizing  over the remaining loan term. In many cases re-casting will happen in less  than five years and will increase monthly mortgage costs by 50 percent or more.

Many option ARMs which are now current will be re-cast in 2010 and 2011, a process which will increase the total number of delinquent and foreclosed homes — and  thus the shadow inventory.

In addition to option ARM borrowers, the shadow inventory will also grow as unemployment levels rise. Borrowers who today are solvent and on time with  their mortgage payments could soon be at risk of foreclosure if they lose their jobs.The official unemployment rate now hovers close to 10 percent, a rate which is likely to increase in 2010.

Take the usual definition of the shadow inventory, add to it option ARM borrowers  and those who face unemployment, and then we’re looking at large numbers of  additional homes that can reasonably be seen as both distressed and unsold — if  not now, then during the next year or two.

How Bad?
While a large and growing shadow inventory is troubling, it may be that the situation is less threatening then it seems.

Lenders have large shadow inventories precisely because it’s to their advantage  to hold impaired assets rather than sell at bargain-basement prices. A mortgage  officially valued with an accounting wink at $300,000 is far better from a  management and shareholder perspective than a foreclosure sale that produces  a real price of $225,000 or even $295,000 and shows up in company ledgers as an outright loss.

Because lenders, mortgage insurers and investors have big financial incentives to keep excess inventory off the market, they’re developing alternatives to selling. For instance, Fannie Mae has introduced a program that allows troubled homeowners to transfer title back to the company, avoid foreclosure and then remain at the property as renters.

Under the “deed for lease” program distressed homes do not show  up as foreclosures on Fannie Mae books while owners avoid the financial and  psychological damage of a forced move. Because Fannie Mae is getting a monthly income and has no maintenance or insurance costs for an empty house it also  has no incentive to sell rented properties at a loss. With sale and lease-back deals the company can wait months and years for local economies to return.

“The Fannie Mae concept may well be adopted by other lenders,” says  RealtyTrac’s Saccacio. “If so it will be possible to have both an expanding  shadow inventory and yet not materially increase the supply of distressed properties actively for sale. That’s an approach which is very much in the public interest.”
  Peter G. Miller is syndicated in more than 100 newspapers and operates the  consumer real estate site,

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