The Shadow Inventory (You Haven't Been H...

shadow For months, I have mentioned in passing the potential impact the so-called “shadow” inventory might have on (i) the housing recovery and (ii) residential investors in general.

While everyone knew this inventory (comprised of homes with loans more than 90 days past due that have not been foreclosed and are not on the market) existed, it was unclear as to its size...

...until now.

Now, thanks to the Inspectors General of the Federal Housing Finance Agency (FHFA) and the Department of Housing and Urban Development (HUD), we have some idea as to the size of the shadow inventory and the threat it poses to the soundness of Fannie, Freddie and HUD.

According to their joint report, 2.7 million homes comprise the shadow inventory. For every REO property in the Fannie/Freddie portfolio, there are more than six homes in the shadow inventory. For HUD, the ratio is 20 to 1 in favor of shadow properties.

What Lies Beneath the Data?

Before drawing any sweeping conclusions, it will be prudent to learn more about these shadow properties. Why are the occupants not paying their mortgage? The explanations could be job loss, reduction in salary, or the fact that they are so underwater they have made the decision to simply stop paying. Obviously there may be other factors as well. Also, what types of homes are these? Knowing the average value of each shadow inventory property will be important to know so that the threat to the overall economy can be gauged.

I spent the latter half of the week speaking with agency officials, Congressional staff and friends on Wall Street to determine what logical conclusions could be drawn from this recent revelation. I did come across some statements by an economist from a well-known association for real estate agents that I found stunning. The economist engaged in some hand-wringing about the current lack of inventory and ensuing rising home prices, and suggested the sensible steps forward should be to build more homes to expand inventory.

A Few Sensible Conclusions

holmes Perhaps it does make sense to keep these homes in the shadows, because were they to be foreclosed tomorrow it is likely the housing market would take a sudden and substantial downturn. While I never claim to be right about everything, I am growing increasingly concerned with the cheerleading from the media and interest groups with a financial stake in higher home valuations that the housing recovery is underway.

With that, here are some sensible conclusions that can be drawn based on the data released by FHFA and HUD:

The housing recovery is not sound. We have sounded the bell on inflated valuations of distressed assets and the danger of the shadow inventory. Much of the premise of the “recovery” is based on reduced inventories (higher demand) that have driven prices up. But the lack of inventory appears to be a lie given the fact that there are 2.7 million distressed properties sitting on the sidelines. The recovery appears to be engineered, and until these properties hit the market, no one will know whether the recovery is genuine or a product of shrewd policies and a shell game at Fannie and Freddie.
The effort to reform Fannie and Freddie has been revitalized. Recently the Senate began working on a bipartisan piece of language and introduction is expected this month. Developments in the House have been less optimistic in recent weeks as the committee chair wants to focus more on “messaging” rather than legislating. Hopefully, the recent report will galvanize both chambers into action during the second half of the year. Every office I spoke with last week voiced concerns over the shadow inventory numbers, but now it is my job to convert concern into action.
The shadow inventory numbers are good news for investors. This year, some investors have expressed concerns about the impact of institutional buyers in their respective markets. The fact that there are 2.7 million distressed properties floating in space means that short sale and REO opportunities are available to investors. Investors may want to approach these delinquent borrowers before government action is taken. Our meetings during the month of June will focus on free market solutions to unwind this inventory.

As a lobbyist fighting on your behalf, I will continue to work on reforming Fannie and Freddie and recommend solutions to unwind the shadow inventory. This is a critical time for investors and my clients, and we intend to remain at the forefront of these debates.