“Shadow Inventory” is comprised of all distressed residential properties (other than MLS listings) which will probably be coming onto the market in the not-too-distant future.

The first key question is: how many foreclosed and repossessed properties are now either in the inventory of banks or held on behalf of residential mortgage-backed securities (RMBS) investors whose loans they service.  Estimates start at about 500,000 and go up from there.  One highly reputable data provider with a huge database of first mortgage liens has been reporting an REO inventory in excess of one million since last summer.

In addition to repossessed properties held off the market, the shadow inventory includes all the homes which have been placed into default – the first stage of foreclosure proceedings.  According to Lender Processing Services’ July Mortgage Monitor report, there are now 2.02 million properties in default.  This number has not declined in the past year in spite of more than one million trial mortgage modifications.

While many of these defaulted properties throughout the nation will escape foreclosure by means of a short sale, the rest will move on to foreclosure proceedings and eventual trustee sale to a third party or repossession by the lender.

Overwhelmed by the number of defaulted properties, banks have stretched out the time between the beginning of mortgage delinquency and formal foreclosure to an incredible average of 469 days – more than 15 months. 

There is also the matter of homes which are seriously delinquent in mortgage payments.  The homeowner can cure the delinquency by paying the arrears before the home goes into default, however, the cure rate for these seriously delinquent mortgages has reduced in recent years.  Take a look at the most recent figures available. 

 

How many homeowners are now seriously delinquent by 90 days or more?  To answer that, we turn to Lender Processing Services and its massive database of roughly 34 million first mortgages.  Their monthly Mortgage Monitor provides a detailed table of non-performing first liens. Here is what the July non-performing loan count looks like.

 

At the end of July, the number of residential first mortgages that were delinquent by 90 days or more stood at 2.47 million.  While the figure has declined from a record 3.06 million in January of this year, this is due almost entirely to the mortgages which were placed in trial modification by the banks.  While in modification, they are no longer considered delinquent.  We know from the cure rate chart shown earlier that a high percentage of these seriously delinquent mortgages are headed for the resale market either through a short sale or foreclosure.

To these 90-day delinquencies we need to add first mortgages which are delinquent for at least 60 days.  The chart above reports 761,000 of these 60 day delinquencies.  The cure chart shows us that the vast majority of these delinquent properties will also end up on the resale market.

Finally, we must also include those mortgages which are newly delinquent for 30 days.    That number has been stuck at roughly 1.8 million for the last three months.  The cure rate chart shows us that only 30% of those borrowers who go into arrears by at least 30 days will cure the loan without lapsing into delinquency again and eventually falling into default.

It is important to understand that this enormous shadow inventory of distressed properties that will eventually be thrown onto the resale market is heavily concentrated in a limited number of metros.  According to data provided by Lender Processing Services, 52% of the nationwide 90 day delinquencies and 58% of the defaults are concentrated in 25 major metros.  The following table shows this concentration.

 

If you look carefully at the distressed property figures for the top four metros, you’ll see that the number of residences which will be pouring onto their housing markets in the next 1-2 years is substantial. 

(Notice Kansas City is not on this list.  Kansas City was actually in the top 5 cities in the nation regarding the fewest amounts of foreclosures and loans in default.)

Roughly 14% of the nearly 54 million first liens in the country are now either delinquent or in default.  This chart from the Calculated Risk blog shows the steady growth since 2005.

 

To come up with a total for the shadow inventory, first add the total number of loans in default to those delinquent 90 days or more.  That comes to 4.5 million properties.  Based on the cure rate for loans delinquent at least 60 days, add 95% of those 60-day delinquencies.  That is an additional 723,000 residences.  For the same reason, add 70% of those delinquent for at least 30 days – 1.25 million properties.

If you also want to figure in the REOs that have not yet been placed on MLS listings by the bank servicers, you can pick a figure from some of the estimates.  A conservative estimate is 500,000.

Adding all of these together, it totals roughly 6.97 million residences which are almost certainly going to be thrown onto the resale market as distressed properties in the next 1 to 3 years. 

These figures cannot be ignored from anyone who is in the real estate market or profession and their reality shows we still have at least a few years of adjustments ahead of us.  I believe it is important to factor in all information; however it is not meant to be doom and gloom like so many news reports sensationalize.  The market will correct itself like it always has.  Real estate, like every sector has its ebbs and flow.  The current market is needed so we can adapt accordingly, learn from our mistakes and transcend above it.  Its evidence that you must constantly adapt to the market and do your best to be ahead of the game.