Shadow Inventory: A New Wave of Foreclosures in the Cards?

A big issue currently being debated in economic and real estate circles is the question of a "shadow inventory" of homes that could hamper any recovery effort.

This shadow inventory arises from two sources. One is the supposedly growing number of potential homesellers who have taken to the sidelines to await a more stable market and stronger prices, and who are likely to emerge at the first solid sign of improvement. The other is a possible surge of homes coming to market from sizable existing REO portfolios of unsold foreclosure homes already held by banks, investors and lenders, accompanied by a new wave of foreclosures, as large (some say larger) than that we've already experienced.

This spectre of rising foreclosures is a widely held belief among many in the industry and government, and is worth keeping in focus. Whereas the bulk of prior foreclosure activity was blamed on poorly qualified buyers, and resetting ARM's, the next go round is said to arise out of Option ARM's and Alt-A loans, possibly running to millions of foreclosed properties over the next few years. And many of these homes will be in a higher price range than the majority of distress sales currently coming to market.

There is hope that being aware is a step in the right direction to address the problem, but with the declines in property values, high listing inventory in many areas, increased unemployment, and questionable success in resolving current issues, it's hard to know from where any relief will come. More and more sellers are upside down on their loans, and even when they are able to find a buyer, actually closing the transaction becomes an iffy prospect that can be blown apart at any point by tougher (and very changeable) lending standards, unpredictable appraisals, and, more and more of late, the vagaries of dealing with short sale / loss mitigation departments of the seller's lender.

I have blogged elsewhere that remedial efforts thus far may have unintended consequences, causing them to backfire, while only a small percentage of homeowners have actually been able to take advantage of them. Lenders appear to have become more amenable to considering short sales and negotiating on foreclosures they hold, but as the number of failed banks climbs, it also becomes a question how much more banks can continue to suffer these kinds of losses . . . particularly when the equally ugly likelihood of growing commercial foreclosures approaches.

So, if all the indicators hold true, we're not quite out of the woods. This suggested shadow inventory of increased foreclosure numbers and "try-it-again" sellers could swell inventory and reign in any upward pressure on prices that might otherwise occur, even if the increased buyer activity we have been seeing were to continue.

That's a great many "ifs" and "buts", when none of us has a crystal ball -- a subject I will pick up in part 2 of this blog post . . .