What is the shadow inventory and why should we be concerned about it? The term "shadow inventory" has had various meanings and has been defined in different ways over the years. The point here is not to determine which is the "correct" or "original" meaning, but to make clear how the term is commonly used, to show the implications of defining it in different ways, and to demonstrate that a knowledge of shadow inventory is an important component of our ability to understand the realities of the real estate market in any given area.
Generally, the term "shadow inventory" is used to refer to those homes that are not currently listed on the for-sale market, but that have the potential to come on as some form of so-called distressed sales (e.g. as REOs, or in the foreclosure process, or as short sales). This, of course, is different from those homes that are likely to come on the market simply because their owners have job transfers, or have decided to move up, etc.
"Shadow" is probably not an adequate metaphor. Something like the "dark cloud inventory" might be more appropriate. The build-up of potential distress sales is like a dark cloud on the horizon of a real estate market. Maybe the cloud will dissipate, leaving everything pretty much as it is. Or maybe the cloud will proceed over the market in a measured, steady way, with the attendant rain of distress sales coming and going without much damage. Or maybe it will open up like a torrential downpour, wreaking substantial havoc.
In every market, of course, there is some shadow inventory. Even in the overall best of times, foreclosures occur, some things go badly somewhere, and there are those who will fall behind in their payments. But, in normal times, these occurrences have little impact on the market. Even homes going into foreclosure are liable to have some equity, and they get sold before going back to the bank. Those with delinquencies often are able to cure their financial problems, sometimes with the help of family.
Today’s realities have been quite different from other downturns in modern times. The overall loss of equity has been enormous. Moreover, despite all the talk about a recovering economy, persistent high unemployment, among other things, has resulted in the "cure rate" for delinquent mortgages being much lower than previously experienced.
How big an issue is it? Well, that will depend in great part on your definition.
If "shadow inventory" refers to the number of foreclosed homes held by the banks and not yet on the for-sale market, then the answer is generally estimated to be somewhere between 750,000 and 1 million. However, if the term is used to refer to current REOs plus those that are in some stage of the foreclosure process, then the number is more like 2.8 million. Many would argue, though, that the most meaningful definition (that is, useful for predicting what the future may hold) would be the number of current REOs, plus those that are in some stage of the foreclosure process, plus those that are seriously delinquent (90 days or more) even though foreclosure proceedings have not been initiated. If that is the definition we use, then the size of the shadow inventory swells to something like 5.3 million. Finally, if we included all delinquencies -- not just the 90 days or more -- the total would be well over 7 million.
Treating all delinquencies as if they would eventually proceed to distress sales seems unduly pessimistic to me; but expecting such an outcome of most that are more than 90 days late seems fairly realistic. Consider this, according to Lender Processing Services (LPS), a major supplier of data in these matters, as of February, 2010, the average number of days delinquent for those mortgages that were more than 90 days was 256! The likelihood of a cure in such circumstances seems slim.
Yes, it is true that the Home Affordable Modification Program is finally beginning to show some real numbers in terms of trial and approved modifications. And, finally, someone figured out that loan modifications which actually significantly lowered payments achieved a much lower redefault rate than those that didn't. Still, the redefault rate is a serious concern, especially because, as Laurie Goodman of Amherst Securities testified before Congress, "negative equity is the most important predictor of default." Lower loan payments alone appear insufficient to stave off defaults and foreclosures.
Realistically speaking, there is currently a shadow, or "dark cloud", inventory of something more than 5 million homes in the U.S. -- roughly equal to the total number of existing homes sold in 2009. Naturally, this inventory will vary from local market to local market. Some localities will not be affected; but it is a sure bet that many will. Consumers and agents who want to keep their fingers on the pulse of their local markets need to do more than consult the MLS. They will want to track the shadow inventory as well.