Putting shadow inventory under the light

September 27, 2010, 9:59 PM UTC

No one really knows what exactly it is, or how big it is. Shadow inventory is certainly a problem, but it’s a surmountable one.

Not a happy sight

Plenty of terms have been coined during this financial crisis, but none sounds scarier than “shadow inventory.” That’s the glut of foreclosures and delinquent mortgages that threatens to keep a housing rebound at bay until it’s been cleared.

But how much should we really worry about the shadow inventory, given that it’s a term loosely defined and even more loosely quantified? The bundle of potential forthcoming foreclosures poses a huge problem to the overall economy, but some of those worries have to do with the unknown.

Estimates of the size of the shadow inventory range anywhere from 1 million to as high as around 8 million units, which a Morgan Stanley analyst recently claimed is the number of bank-owned and foreclosure-bound homes that have yet to hit the market. That’s quite a range — the impact from adding 1 million units to a troubled housing market is far different from another 8 million units.

But as ABC News’ Dalia Fahmy points out, the definition of shadow inventory ranges even wider. Some say it encompasses units that have already been repossessed by banks and are awaiting distressed sales while others include delinquent mortgages. Some estimates of shadow inventory even include homeowners eager to sell their units who are waiting for market conditions to improve.

The scale of this excess inventory is anyone’s guess. But a few factors could keep at least a portion of it from pushing the housing market into another terrible tailspin.

Cluster foreclosures

For one, a fair number of units are simply too dilapidated to repair and will likely be bulldozed, turned into parks or open space. They’ll never be added to the inventory for sale. And other units sit in neighborhoods so undesirable they resemble ghost towns, and they might never be worth putting onto the market.

Blighted neighborhoods have long been a problem in urban areas, but this housing crisis doesn’t discriminate. Richard Florida, an expert on social and economic trends, told the St. Petersburg Times that the abandonment of single-family homes and the decline of suburbs will be a big problem in the coming years. In a story highlighting how foreclosures in the Tampa Bay area have turned neighborhoods into a haven for crime, Florida says “Who would’ve thought that it’s the big cities that have become more vital and less dangerous (while) the suburbs are the ones that have become less vital and more dangerous?”

Another factor keeping the shadow market somewhat under control is that even though some homeowners may technically be in foreclosure, banks are having a hard time repossessing properties because of the laxity of boom-era mortgages. Last month, Bloomberg reported that Ally Financial’s GMAC Mortgage unit told brokers and agents in a memo to halt evictions tied to foreclosures on homeowners in more than 20 states including New York and Florida as lawmakers and lenders try to slow foreclosures and keep people in their homes amid record U.S. seizures.

Realistically, properties that will ultimately make it to market as distressed inventory will likely will be around 3 million to 3.5 million units, says Rick Sharga, senior vice president at RealtyTrac, an Irvine, CA-based data provider. Sharga counts the shadow inventory as distressed properties that have been repossessed by the lender,  are delinquent on payments and in the foreclosure process. This is no small number, but it’s nowhere as big as the 8 million some predict. The current housing market is absorbing about 1 million units per year, and at that rate, it will probably take about 3.5 years for the shadow inventory to be bought, occupied or otherwise absorbed. This is more or less consistent with predictions made by other experts, including economist Bill Wheaton at Massachusetts Institute of Technology’s Center for Real Estate. S&P puts the estimate at 40 months.

Shadow inventory is certainly significant, especially for the millions of homeowners under water on their mortgages. Forty months sounds like an eternity. But if you see the excess inventory for what it really is, it takes shape as a difficult but surmountable problem. And the shadowy fears might ease, if only a little.

See also:

A housing rebound? Yes, it’s possible

Housing quagmire: Is it time to remove relief?

Rise of the renting class