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Residential Department: BackSpace: July 2014

 

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Detecting signs of vanishing shadow inventory

For years, the threat of the shadow inventory felt like the recession was adding insult to injury. In the wake of the housing bubble bursting, home values dropped, origination volumes fizzled and unemployment climbed. As if that wasn’t bad enough, then there was the shadow inventory — a looming mass of delinquent and foreclosed-upon homes that threatened to destabilize the market even more.

Typically defined as properties that have yet to appear on multiple-listing services and are more than 90 days delinquent, in foreclosure or held as real estate owned (REO) properties, the shadow inventory has long been a major concern among economists and even the general public. Suddenly, however, the big bad shadow inventory doesn’t seem so scary. Defaults, auctions and REOs have been dropping all over the country, and the shadow inventory has been dropping with them.

Reduction in Shadow Inventory From Peak Levels

“It’s manageable,” says Rick Sharga, a mortgage-industry veteran and executive vice president of Auction.com. “It will continue to decline to where it becomes less and less of a potential issue.”

Nonetheless, after enduring so much market turmoil in the past few years, some originators may be understandably incredulous about a sustained foreclosure recovery. Just how much has the shadow shortened, and what lingering factors may threaten its resurgence?

The decline

This past April, CoreLogic released its most recent figures on the shadow inventory, statistics that were included as a supplement in its February National Foreclosure Report. For many originators and industry analysts, the findings painted an encouraging — and perhaps even surprising — picture of the shadow inventory’s current state. A few figures stood out:

  • The national residential shadow inventory declined 23 percent year over year this past January, dropping to 1.7 million homes.
  • The inventory has experienced double-digit, year-over-year declines for each of the past 16 consecutive months.
  • The inventory’s value was $254 billion this past January, a year-over-year decline of $70 billion.

To frame this improvement in another way, between January 2013 and this past January, the shadow inventory decreased at an average monthly rate of 41,000 properties, according to CoreLogic. Current inventory figures represent a supply of just 5.2 months, a far cry from where supply levels were at the height of the recession.

Sharga says that there are numerous explanations for the shadow inventory’s rapid decline, not the least of which is the current health of the housing market.

“The first [explanation] is the most obvious: Prices have been going up on homes pretty steadily,” Sharga says. “We’ve seen a huge swing from negative equity to positive equity or at least a neutral position, simply due to home prices increasing over the last few years.”

An abundance of loan modifications and short sales also are at the heart of the shadow inventory’s decline, as many lenders have become increasingly inclined to find solutions for troubled homeowners in lieu of going forward with a foreclosure. Additionally, investors often turn to the shadow inventory for their needs.

“The homes typically fit into that first-time buyer [mold] — they’re smaller-sized homes. But what we have seen is: It’s really the investors who have been snapping them up,” says Lawrence Yun, chief economist and senior vice president of research at the National Association of Realtors (NAR). “It’s a combination of institutional investors and also just your normal, mom-and-pop investors who are buying one or two properties. They see a good rental income potential.”

Caveats

The shadow inventory’s recent decline comes with a few caveats, however. The inventory’s contraction has hardly been uniform, for instance, and certain housing markets continue to find the shadow looming over them in almost full effect.

“This is principally the tri-state region right along the northeast: New Jersey, New York and Connecticut,” Lawrence says. “In these three states, we have not seen any meaningful decline in the pipeline of distressed homes that will sooner or later turn into foreclosed properties but that have not yet been released to the market because of various reasons.”

As of this past January, New York’s shadow inventory has declined by just 5 percent from its recession-era peak, according to NAR. New Jersey, meanwhile, has seen its inventory shrink by 8 percent, and Connecticut’s inventory has declined by 11 percent.

Of course, any decline is cause for celebration, but originators in New York, New Jersey and Connecticut may feel less upbeat when they consider how other states have fared. For comparison, California’s shadow inventory dropped by 71 percent from its peak, while Arizona’s inventory declined by 78 percent, according to NAR.

In considering the market-wide threat that foreclosure and shadow inventories may still pose, originators should bear in mind the relative fragility of the housing market. One cause for concern may be the slew of prerecession home-equity lines of credit (HELOCs) that began amortizing earlier this year. If these borrowers struggle to adequately manage their HELOCs once their amortization periods begin, the housing market — and the shadow inventory with it — could suffer. Many within the industry, however, remain optimistic that the market will avoid significant upheaval in this respect.

“Lenders won’t let those loans go into default,” Sharga says. “As home prices have gone up, there’s the opportunity to bundle those HELOCs into the primary mortgage and do a refi. We’ve learned a lot coming through the last foreclosure cycle, and I really don’t think we’re going to see a massive fallout.”


 

Raymond Fleischmann was editor of Scotsman Guide's Residential Edition. For questions about this article, call (800) 297-6061 or e-mail articles@scotsmanguide.com.

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