How will shadow inventory affect home prices?

By Kevin Fritz
Fritz Capital Group 

Housing prices may be bottoming: As a mortgage professional, people often ask me if the real estate market and home prices have bottomed out. What they are really asking is: “Is this the right time to buy?” Five years ago I hated this question because the answer was clearly “NO.” Due to many factors, however, the climate is very different today. Home prices are the most affordable they have been in the past 40 years, rates are at their lowest point in our recognizable history, investors are able to cash-flow on their rentals, and first-time homebuyers are able to purchase for less than it costs to rent.

With all this good news, why is there still concern? Probably the largest elephant in the room these days is the looming shadow inventory. In almost every conversation about real estate, the question of shadow inventory will come up as a concern because of the misconception of what it really is, how much of it there really is, exactly what the banks are going to do with it, or when they will distribute it.

What is shadow inventory? If you have been in one of these conversations, you may have wondered what is meant by shadow inventory. In a nutshell, it includes all homes that are delinquent 90 days or more, in foreclosure or already owned by the lender but are not yet listed on the Multiple Listing Service. These homes are not yet on the market, but they are coming. The way people talk about shadow inventory makes it sound like a mystical new concept that arrived over the past few years with this current negative market cycle.

The truth is shadow inventory has always been around. In a “hot market” one month of  shadow inventory is normal and considered the amount that can be absorbed without impact to home prices. The hottest market in decades, 2006, still had a recorded one month of shadow inventory.

Why does shadow inventory matter? As we are trying to gauge where we are in the process of a real estate recovery, supply and demand is a big deal. Generally speaking, more supply equals lower home prices and more demand equals higher home prices. The concern is that if the banks dump inventory onto the market, then home prices will plummet. As a result, the important question is “Do the banks have inventory to dump?”

What do the numbers say? At the worst level in 2010, nationally there was approximately eight to 11 months of shadow inventory. Recently S&P Case-Schiller reported that shadow inventory has reduced down to as little as 3.1 months of inventory as of March of 2012. In addition there has been a significant decrease of mortgages newly 90-plus days late by about 37 percent. This drop in new lates is the best that it has been in five years.

While certain states, including Nevada, Florida, and Michigan, have much higher levels of shadow inventory, many states are seeing very low levels of shadow inventory. In California, some depressed cities have higher levels such as Stockton, Merced, San Bernardino, and Modesto. However, California has several areas with extremely low levels of shadow inventory including Sacramento, Placer, El Dorado, Contra Costa, San Francisco and Los Angeles County. Coupled with the fact that these areas have very little regular inventory, prices have shown an increase for the first time since 2006.

Is shadow inventory a threat? There are many things to consider when determining if the housing market has really hit the bottom. However, as we consider the impact of shadow inventory, it appears that this is not a major risk factor. With very little shadow inventory waiting in the wings, new significant lates on existing mortgages on the decrease, limited regular inventory in the market, extremely low mortgage rates and prices at some of their most affordable since the 1970’s, it is our opinion that we may have already seen the bottom.

With the current limited inventory, the bigger issue may be “How does one get their offer accepted?” That is another conversation for a future article.

Located in Roseville, Fritz Capital Group helps families get the right mortgage to help them in their home buying journey. For more information visit fritzcapital.com.