ORLANDO, Fla. – Oct. 22, 2011 – When you drive down the street, you can see a “for sale” sign on nearly every road. The supply of homes may seem overwhelming at times, and we are definitely in a buyers’ market. But in August, the National Association of Realtors (NAR) reported an 8.5-month inventory level, close to the six-month level that historically signals a balanced market. Even so, there’s a general feeling of uneasiness about the market.
The reason for this anxiety, notes Erica Cross, research analyst with the Florida Realtors, is likely due to “shadow inventory” – homes placed in foreclosure or owned by lenders, and loans overdue by at least one payment. We feel their looming presence, even though a “for sale” sign hasn’t appeared in the front yard.
But how much shadow inventory is out there? The amount depends on its definition. How delinquent must a property be to include it in shadow inventory – 1 day, 90 days? Is it assumed that any of the delinquencies will improve? Are foreclosure properties included?
With all of these different questions, estimates of shadow inventory in March 2010 ranged from 1.7 million to 7 million, according to NAR. The number of homes in shadow inventory is uncertain; more importantly, so is the timing of their exact release to the market.
Shadow inventory going to market
Let’s imagine two scenarios. First, think of a situation where banks slowly release shadow inventory to the market. Foreclosures are currently weighing down home prices, so this trend would continue. But if a balance between those foreclosures coming on the market and those being sold is maintained, market stability will continue. The supply of homes would be restricted.
Now picture a more drastic case. What if banks dumped all of the homes they own on the market all at once? The increase of supply would cause a decline in price, a drop most likely affecting home prices negatively across the board. Since demand cannot respond quickly, the price drop would have a tremendous impact on the market.
In turn, a drop in home prices would have a harmful impact on home equity and consumer confidence, leading to less consumer spending and more of the economic issues we are currently trying to resolve.
Can it be managed?
Banks aren’t the only players in the “disposing of homes” game. Homeowners also control the number of homes in shadow inventory. A homeowner in trouble can decide whether to pay the mortgage, seek mitigation or walk away. Think of it like a bathtub. Currently, the amount of bank-owned homes fills part of the tub. The disposing of homes into the market is like letting the drain open. Homeowners going into foreclosure can add more homes to the shadow inventory – like opening a faucet into the tub. If there is more water (homes) being added by the faucet than there is water (homes) being drained (or sold), the bathtub will fill and overflow. The flooding of the bathtub means that banks can only hold so many homes or they will need to dump homes on the market.
The government affects the supply of shadow inventory through the Home Affordable Modification Program (HAMP). HAMP allows homeowners to modify their mortgage payments to 31 percent of their pre-tax income to make them more affordable. If homeowners meet the HAMP criteria and can reduce the amount of their mortgage payments, they are less likely to default. Stricter eligibility or removal of HAMP would cause more delinquencies and foreclosures. Easier eligibility could prevent delinquencies and foreclosures and lower the shadow inventory count.
What to do
Banks, homeowners and the government can modify their actions to speed up or slow down the amount of inventory added to the current supply. With each player making different moves, the moral of the story is that the timing and number of distressed properties in the market can’t be predicted. We do know it will affect your business, so monitor your local market closely. Communicate with lenders so you know the business decisions they are making, and work with distressed homeowners to help mitigate their debt burdens.