Is it real?  When will it come? How will it affect the market? These are all questions many people have about shadow inventory. Many people believe that shadow inventory is an idea made up by investors and consumers who are wondering why housing prices and default notices are consistently increasing while foreclosed inventory decreases as the months go by.

Others believe that shadow inventory is certainly real in the gist that there are foreclosed homes out there in numbers that are not yet for sale but would have a considerable impact on the county's housing supply if they were to arrive on the market. While prices may not return to the levels seen in 2007, it is hard to deny the fact that declines in many neighborhoods have slowed down or stopped completely and home prices are indeed rising in some regional markets.

Amherst Security Group recently released a research report that stated “The single largest impediment to a recovery in the housing market is the large number of loans that are either in delinquent status or in foreclosure that are destined to liquidate. This creates a huge shadow inventory. We estimate this housing overhang at 7 million units, 135 percent of a full year of existing home sales.”

According to many sources including Lender Processing Services, Inc., the amount of home loans inching closer to delinquent status now outweighs the number of foreclosure stats. This may indicate another wave of troubled loans already in the bottlenecked loan pipeline. Nearly one-third of foreclosed homes remain off the market in pre-sale status even up to 12 months, this is twice as many as in previous years. 

Pete Flint, CEO of Trulia.com said, "With mortgage rates still low and the expansion of the tax credit  to trade-up buyers, we could see significant inventory — both new and  'shadow inventory' — hit the market during the next four to six months. Inventory levels this quarter are poised to be atypical of a normal real estate market, which could create tremendous pressure on sellers to price their homes competitively and move their property before the tax credit expires on April 30th.”
   
Many people indeed believe that the shadow inventory situation will last longer because of programs like President Obama's Home Affordable Modification Program. However, banks are in the difficult situation of trying to figure out what to do when the shadow inventory hits the market to prevent real estate prices from plummeting. 

Jim Saccacio, Chairman and CEO at RealtyTrac.com, the nation's biggest source of foreclosure listings and information said, “If lenders sell off their inventory over time on a controlled basis then local home prices will be supported. However, if lenders suddenly dump massive numbers of foreclosed properties then the result will be substantially reduced home values for everyone.”
   
While a sizeable and growing amount of shadow inventory is troublesome, it is very possible that the situation is not as threatening as it appears to be.

Lenders have and logically would keep large shadow inventories simply because it's to their advantage to hold depressed assets as opposed to selling them at bargain-basement prices. A mortgage that is formally valued at $400,000 is far greater from a company’s management and shareholder perspective than a foreclosure sale that produces an actual price of $325,000 or yet $395,000 and highlighted as a complete loss.

Because lenders, mortgage insurers and investors have huge financial motivation to keep any shadow inventory off the market, many companies are developing foreclosure alternatives. For example, Fannie Mae has initiated a new program that permits homeowners in the hole to transfer their title back to their lenders, evade foreclosure and stay in their homes as renters.

Under what is termed the “Deed for Lease” program troubled homes do not show up as foreclosures on Fannie Mae’s books while owners avoid the financial and psychological damages of a forced move. Because Fannie Mae is still gets a monthly income even if these homes are not foreclosed and there are no maintenance or insurance costs for a vacant house this provides even less incentive to sell rented properties at a loss.

Thanks to new sale and lease-back deals the company can wait months sometimes even years for local markets to return to satisfactory levels and therefore these homes will never reach the shadow inventory market.

RealtyTrac‘s Jim Saccacio feels “The Fannie Mae concept may well be adopted by other lenders. If so it will be possible to have both an expanding shadow inventory and yet not materially increase the supply of distressed properties actively for sale. That's an approach which is very much in the public interest.” Whether or not that will truly happen is another matter entirely.  

Thus far, foreclosed homes are only being filtered into the market.  The underlying principle that banks are too flooded and financially depressed to process foreclosures seemed believable at first, but this justification has been exploited so long that many people are increasingly skeptical of it, especially with numerous signs that home prices have long ago reached their bottom and are consistently rising. 

Like many other facets of the housing industry, this has developed into a largely political issue and as a result is difficult to predict. So one can only presume that the foreclosures are purposely being held off the market by some combination of government bailout programs, "extend and pretend" (in which lenders postpone foreclosures attempting to support the printed value of their properties), and other political pressures.

Many experts are saying at the same time banks are waiting on the government to conjure up more money to modify programs to deal with even more borrowers who are unemployed and those who have negative equity to allow them to remain in their properties. This is very well within the realm of possibility, but again another not for sure thing.  There is no doubt that the shadow inventory is out there somewhere and in large quantities. 

In spite of whether prices are rising at the moment, until the future steps are clearer on all fronts, shadow inventory is a factor that should not be taken lightly as the dam may break one way or another.