The Rise and Fall of Shadow Inventory

Since the start of the 2007 Credit Crisis, there have been alleged to be upwards of between 5 and 9 million plus homes considered to be within our country’s “Shadow Inventory.” One of the most basic definitions of a Shadow Inventory home is one in which the mortgage payments have not been made by the homeowner for at least 90 days. Understanding the nature, sources, and cause of Shadow Inventory is crucial to understanding the state of today’s real estate market.

In recent years, one of the most challenging figurative hurdles for many investors has been to find quality properties for sale from banks, mortgage loan servicing companies, or individual sellers. In spite of interest rates reaching all-time historical lows, it has been difficult for many investors to find enough quality homes to purchase in their desired regions.

Rumors of large institutions purchasing hundreds or thousands of distressed properties directly from banks or mortgage loan servicing companies have proven true over the past several years. In fact, more and more investment firms on Wall Street have openly acknowledged that they have been purchasing and holding onto large pools of distressed homes from banks. These same banks may then rent up their properties (homes or Multi-Family Apartments), and then sell of the investments in the form of Bonds, REITs, or even by way of Equity Crowdfunding options.

Many banks were reluctant to begin the foreclosure process on many homes over the years partly since these same financial institutions did not want to readily acknowledge how bad their mortgage and financial portfolios were to their investors. Unhappy investors who held stock, bond, or various forms of derivatives investments in these same financial institutions could then later drive down the prices of these financial entities by unloading their bank’s stockholdings. As such, many “Shadow Inventory” homeowners were able to go 1, 2, 3, or even 5+ years without making any mortgage payments since these same banks were very hesitant to begin the foreclosure process with either a Notice of Default foreclosure filing in a Trust Deed state like California, or by filing court actions in Judicial Foreclosure states like in New York.

Shadow Inventory by the Numbers

According to Core Logic (a global real estate and financial data firm) in April 2014, their study entitled “2014 National Foreclosure Report” made note of these eye-opening statistics and housing trends:

There were 4.9 million completed foreclosures between September 2008 and the 1^st Quarter of 2014. They also report that there were approximately 752,000 homes in various stages of foreclosure in February of 2014 as compared with 1.2 million homes in the “Foreclosure Inventory” one year prior back in February of 2013. The total numbers for the end of February of 2014, which includes delinquent mortgage loans and bank owned REO (Real Estate Owned) properties, reached 1.9 million properties, per Core Logic’s same study.

Core Logic reported there were 43,000 completed foreclosures in the United States in February 2014, down from 51,000 in February 2013, a year-over-year decrease of 15 percent. On a month-over-month basis, completed foreclosures decreased 13.1 percent from 50,000 in January 2014. National residential shadow inventory was 1.7 million homes as of January 2014 compared to 2.2 million in January 2013, a year-over-year decrease of 23 percent.

Shadow Inventory by location. The five states with the highest number of completed foreclosures between February 2013 and February 2014 were as follows: #1 – Florida (118,000), #2 – Michigan (50,000), #3 – Texas (39,000), #4 – California (37,000), and #5 – Georgia (34,000). As a group, these 5 states accounted for almost 50% of all completed foreclosures nationwide. On the other hand, the five states with the lowest number of foreclosure completions were as follows: #1 – Washington D.C. (60), #2 – North Dakota (421), #3 – Hawaii (519), #4 – West Virginia (571), and #5 – Wyoming (705).

Shadow Inventory by dollar amounts. The total combined value of “Shadow Inventory” reached $254 billion back in January of 2014. This number rapidly declined from the previous combined “Shadow Inventory” dollar amount, which had hit a high of $324 billion. Between January of 2014 and January of 2013, the overall “Shadow Inventory” fell 22%. During this same time span, “Shadow Inventory” homes declined by a monthly average unit rate of 41,000 homes per month.

Potential Causes for Shadow Inventory Swings

Between the 1^st quarter of 2012 and the 1^st quarter of 2013, home listing inventory levels rapidly fell anywhere between 30% and 70% in various regions across the USA. Why? It was due to a combination of many Big Banks holding onto their large supply of non-performing assets or homes and waiting for asset values to move much higher, and a more aggressive and motivated investor base (both individuals and large multi-billion dollar firms such as Hedge Funds, REITs, Investment Banks, Equity Crowdfunding companies) buying larger quantities of properties in bulk.

In many regions, home prices have moved upward between 10% and 35%+ per year over the past few years due to record low interest rates and rapidly declining listed home inventories. As most of us learned in our High School or College Economics or Business classes, when the demand for a product exceeds the supply of that same product, then the price for that same product typically will move much higher too.

Another contributing factor to Shadow Inventory was the MERS (Mortgage Electronic Registration Systems) scandal which potentially affected upwards of 60 million+ residential homes nationwide. In this situation, many banks were very hesitant to start their foreclosure process or sell their “Shadow Inventory” homes to the General Public due to potential litigation issues involved with the questionable or valid Deeds of Trust or Promissory Notes associated with these home mortgages. In many cases, the current mortgage loan servicing company did not have a valid Promissory Note (the “IOU” for the mortgage debt) in the file. So, many savvy homeowners told the banks that “No Promissory Note = No Valid Mortgage Ownership”, and were able to defeat many banks and mortgage loan service companies from foreclosing on them.

As the MERS Scandal began to subside, Banks were able to begin releasing their “Shadow Inventory” properties more efficiently. Due to the combination of record low interest rates allowing borrowers to qualify for much larger loan amounts in recent years, then home prices began to rapidly accelerate once again. The improving assets values for the banks then allowed them to release more of their Shadow Inventory.

Additionally, the recovering net worth of investors who held stock and other financial assets encouraged many investors to purchase more real estate after many portfolios almost doubled or tripled in value since 2009. The increasing demand for real estate from wealthier investors fueld by near record Dow Jones index highs, in turn, then drove prices higher for both the Banks and Sellers in somewhat of a “Win / Win” scenario for most parties involved. And as home prices have moved higher in recent years, the number of “upside down” homes nationally has also declined, further shrinking future potential Shadow Inventory.

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