The Shadow Inventory Debate

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I’ve been tracking what people are saying about the shadow real estate inventory that many economists, real estate professionals, and bankers are frightened of.  Seems there’s some debate if the shadow inventory, will stymie the housing recovery.

First the definition of shadow inventory is up for debate.  Depending on who you’re listening to it can mean many different things.  The different definitions are some of what’s causing people to debate the subject.

What is Shadow Inventory?

Definition 1 – Foreclosed but not listed.  Some analysts say the “shadow inventory” is the homes which the has bank foreclosed on but not sold.  These are homes that are not on the market but owned by the bank (REOs not listed on the market).

Definition 2 – Homes in the foreclosure process as well as delinquent mortgages where foreclosure proceedings are imminent.

Definition 3 – All homes delinquent, short sales not on the market, REOs not on the market, and anything in the foreclosure process.

Definition 4 – All of the above plus modified loans (as they have a large percentage of failing anyway, pay option-arms about to be reset, and lots sitting idle with builders in trouble.

I’m going to go with Standards & Poor’s definition which most similar to Definition 3, all delinquent loans, not just REO’s.

If you go with this definition, then naturally your focus is to look at delinquency rates which are widely published.  So to say we have no way of knowing the true size of the shadow inventory is false.  The mortgage banker’s recent survey with data ending in the 4th quarter shows that 9.47% of all loans are delinquent.  Yikes!  That’s a scary number; however the number was down slightly when seasonally adjusted.  Also according to this recent survey 50% of all past –due mortgages were 90 days or further past due.  This is the highest number in the history of the mortgage banker survey.  Usually you’d see a large glut of 30-day past-due balances, which becomes smaller at the 60-day mark, and there would be smaller yet number of 90-day balances (assuming homes were being liquidated with efficiency).

With fewer loans at the 30-day mark, it seems the glut of sub-prime loans is being flushed through the system but only so slowly that it is creating the large inventory (the 90-day past due loans).  The government and banks are trying loan modifications, short sales, and foreclosure work outs to reduce these properties flooding the market.  Unfortunately distressed assets are distressed assets, especially when they have negative equity.

Standard & Poors sees this shift in lender strategy as temporary as lenders will realize that these toxic assets are unredeemable in most cases.   Therefore these homes, estimated at 33 month’s supply or 5-7 million, will eventually hit the market.   If they do, home prices could head lower because of increased inventories.  The saving grace for the market could the limited new home construction, recent loss in builder confidence, a growing economy, and continued political pressure on banks to keep foreclosure as a tool of last resort.

Nothing to Worry About?

Some believe the shadow inventory isn’t a big concern.  Steve Cook of Real Estate Economy Watch points out that total housing inventory is at a 7.8-month supply, slightly up, but overall way down over 1 year ago.  “The huge shadow inventory of 1.7 to 7million properties first forecast more than a year ago has yet to materialize-and may be a myth,” said Cook recently in blog post challenging the shadow inventory concerns.  I tend to agree.  Although my credentials aren’t as serious as Standard & Poor’s rating system, there is great pressure on the banks to work with owners to work out, modify, short sell, or salvage these loans in some way.  Side note; a friend of mine recently modified his loan from 7% to 2% for the next 5 years and had his payment sliced in half.  The odds of him paying this back are good.  Market absorption is continuing to happen as well.  In my market, Memphis, inventories are down 30% from the peak, so it’s hard to comprehend prices dropping much further.

New Delinquencies Waning

I think inventories are set to rise in the upcoming months because foreclosures are expected to peak this winter .  I’m looking closely at mortgages headed into delinquency for the first time to gage how much time the crisis has left.  Those and past-due loans headed into serious delinquency are in decline.  This summer will be critical for the market as the government intervention is nearly over.  If the builders continue to hold off building, the market should absorb much of the shadow.  Some markets have further to correct of course, but I think we’re unlikely to see home prices drop more than another 5% nationally.  My last caveat is this; banks are getting smarter.  They were dumping properties for next to nothing a year ago and now that they’ve used their free passes for Wall Street, they’ll be making more prudent pricing decisions for the homes they’re marketing.  Shadow inventory yes.  Should we dig bomb shelters and buy survival seeds?  NO.  Continue to accumulate real estate (today) at or near the bottom.

Photo: Hannah J.

About Author

Ryan Hinricher is a Real Estate Entrepreneur, Blogger, Change Advocate and Founder of Investor Nation, a concierge realty and real estate investment company focused on the needs of the residential investment home community.


  1. Craig Grella on

    I agree, this shadow inventory is an interesting one to track, and something for investors to think about before jumping into the current market on a speculative level.

    US Census and HUD report shows supply closer to 9.1 months, down from this time last year when it was over 12 months.

    The MBA’s survey of loans also shows the number of foreclosures increasing slightly, along with loans 60+ and 90+ days delinquent, though both at a slower pace than previous quarters, which is positive.

    While there is some evidence that banks are becoming more efficient at removing property from their balance sheets through short sales, foreclosures, and other means, there will still be additional foreclosures in the coming months.

    These foreclosures will continue to be a problem for developers and builders because they cannot price their properties to be competitive. On one hand that is good, because building will continue to slow, decreasing supply, which can help the market. On the other hand, it hurts the building trade, which removes construction jobs, and continues the economic strife we’ve been seeing.

  2. Yeah Craig, sort of a double-edged sword with the slow housing construction. We’re clearing out inventory but not the sign of a healthy economy.

    Inventories are definitely set to creep up. This is a good sign for investors looking to accumulate but not for homeowners underwater trying to sell.

    We are further along in this stabilization/recovery process than 6 months ago. For that I am glad.

  3. One thing this article fails to note is that of those homes encompassed in the “7.8 month supply” how many have been sitting empty for a year or two? Has their condition deteriorated without getting any care or maintenance? Or worse, have they been vandalize, since no one is looking out for them? In other words, have they lost even more value than has been lost since the Real Estate bubble burst? I’m not trying to be a Chicken Little, here, but I believe that things are a little more dire than most people think they are.

    • That’s a tough metric as it seems the stats are a bit fragmented out there. Even the most reliable sources available for data on this subject are conflicting to some extent. There certainly are a lot of homes out there vacant 1 Year+. My question is why are they sitting there? The 203k loans are for getting these properties improved. Those need to be on the market.

      • Some areas have a huge backlog of vacant properties – whole neighbors deserted – that is why they are ‘just sitting there’. Too many properties to be sold in a timely fashion and almost no one wants to move into a largely empty building or neighborhood; especially if the homes have not been kept up and the place looks like a neglected ghost town. Friends and relatives of mine in Florida have used exactly that term to describe certain places, but I’m sure that’s true in other states, too. Poor Florida; after two severe Hurricane seasons in 2004-2005 where they were hit by nine major hurricanes in 18 months, suffered through years of devastating drought, agricultural blights and now freezes; even if the rest of the Country sees some improvement, I don’t think that Florida’s economy and housing market will recover for many years. Just my two cents’ worth. 🙂

  4. Your article is very informative….unless the credit markets free up how do we turn around housing prices by generating sales. the real estate markets cannot continue to be driven solely by cash buyers. We need real investment in real estate to #1 remove inventory from the books, #2 stabilize house prices and set them on a solid foundation once again, and #3 to create opportunity for investment once again.

    This huge hidden market exists to in the commercial and land portfolio’s held out there as well. The crisis in commercial paper has not yet peaked.

    Opportunities exist that also remove inventories pre foreclosure as more and more lenders are also selling off their notes pre-foreclosure in both performing and non-performing categories. This has a huge impact on the banks as these sales are at significant discounts, but attractive as it takes a loan off their books before they incur the added costs of foreclosure and before they need to write it down in their inventory.

    Great article….

    • Thanks for the feedback. Good point on the notes being sold off. There is a surprising demand for non-performing notes. I learned that last week.

      A lot of banks would rather buy non-performing and delinquent notes instead of make new loans with their new found cash reserves many are sitting on.

  5. Craig Grella on


    As a follow up on this great post, just wanted to let those who commented known that NAR recently posted their existing home sales data, which confirms supply higher than expected, and, I think, suggests a lag due to distressed property sales, possible shadow inventory, and the beautiful winter weather the East Coast has been having. I wrote a quick blog post on biggerpockets here.

  6. The size of the ” shadow inventory” under the definitions described in this article is significantly understated.

    In April of 2009 the U.S. Congress, under pressure from the banking industry, persuaded the FASB to delay implementation of mark-to -market accounting for mortgage related assets.* This delay allows banks to carry mortgage assets at origination value rather than at their current market value. The conditions that would force the revaluation of mortgage assets would be completing a foreclosure or taking the property in as a REO. It seems banks and mortgage investors are delaying foreclosure proceeding and resisting taking back properties to avoid having to reprice their mortgage assets (which would show the true state of their balance sheets and force banks to add to reserves).

    Many mortgage borrowers are far in arrears on their mortgage payments, well beyond 90 days. The banks do not want to take possesion of the properties and thereby have to deal with the costs of owning these homes.

    • Bill, excellent input. I have a friend at the FDIC who mentioned the banks skirting the rule as well. The banks should have already taken possession of much of these assets. I’m seeing estimates of the shadow inventory rising as well.

      Barclay’s estimates the number at 4.5million.


      • Fore more on the issue of the shadow inventory do a key word search on:
        3 Underground Real Estate Practices Moving the Market – Short Sale Fraud, Squatter Simulus, and Buying Before Foreclosing at the My Budget360 blog

        Banks don’t want have the property become their property. As long as they don’t foreclose they carry the mortgage at origination value and they don’t have the costs of ownership. In Japan they called it the lost decade.

  7. The most recent report from National Asociation of Realtors is that the shadow inventory is roughly 2.4 mil. which possibly could be low in my opinion as there are more than 130 mil. households in the U.S. If this data is correct it might not be as bad as it sounds as it is only about 2% of the nations properties.

  8. The American fact finder website will be updated in mid January with the census 2010 results and that will tell us the housing breakdown, which should make this shadow inventory debate even more interesting. We’ll find out a more accurate count of investment property or rental property vs. Owner occupied homes, as well as population migration statistics down to a neighborhood level. That will play unto redistricting, which will have an effect on new legislation, which will in turn effect how the banks handle this inventory. Very interesting times.

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