Foreclosures, Shadow Inventory, Banks Balance sheets and how it all affects the real estate marketplace.
Foreclosures affect the pricing of homes in the marketplace. The average foreclosure sells for a discount of over 30%. In the past two years we had a boom of foreclosed real estate hit the market. This is part of the reason prices continued to fall, even after some had predicted that the worst was over, it’s far from over. It is estimated that only 10 to 15% of foreclosed properties are hitting the market. These are properties that have gone through the entire foreclosure process, are owned by the banks and sitting on their books. So what is going on with the other 85 or 90%, where are they?
Those properties are sitting in the Banks/Lenders inventory, they are on their balance sheets, showing up as real estate assets. What? how is a foreclosed home an asset to the bank? Well the bank can list the foreclosed property on their balance sheet at a value that they bought the property back for at the foreclosure auction. They had to show a loss on the loan balance but now they have this wonderful piece of real estate to show stockholders and auditors as an asset. If they were to dump these properties onto the market in a big way, they could very well go bankrupt. They would be selling them at fair market, less 20 to 30% discount because of condition etc. These are the properties that we call “Shadow inventory” That word is often used to describe this looming potential influx of foreclosed homes hitting the market.
This, to me, prolongs the pain for all of us. The backlog is continuing to grow. The FHA backed loans currently in default status is reported to be 30% higher than a year ago. They are not foreclosed upon yet but are going to enter into the process unless those people start paying their mortgages again. So we have this already large inventory, hidden from the public that are already through the foreclosure process and a whole bunch more coming our way. The banks can’t hold on to them forever. The property conditions are certainly declining as they sit vacant. Your neighborhood may look a bit shabby because of these homes sitting around. They become great homeless shelters and perfect for schemers trying to rent them from across the seas to unsuspecting idiots who don’t understand, if it looks to good to be true, it probably is. Why hold them? Well the first part is clear, they are an asset on the balance sheet. But why else? Two reasons. One, if they dropped thousands and thousands of homes on the market, prices would fall and possibly worsen the so called recovery, in other words crap would hit the fan. Prices would plummet again in your neighborhood and mine. Think of supply and demand. If there is an abundance of Maryland foreclosures on the market, the demand drops and that scenario pulls prices down. Two, By holding the foreclosed properties on their books they are controlling the nationwide real estate market. You have heard about the recent discussions where many are saying we are on our way to seeing steady appreciation again. Inventory is down so prices go up. All about Supply and Demand. So if banks can cause an increase in market price, their losses are lower when they trickle the vast number of foreclosures they hold onto the market.
I think this process will cap potential appreciation in the short term and extend the down cycle in the long term. There was talk of renting these properties but as an REO agent I haven’t seen any evidence that shows they are. The biggest problem is the declining condition of properties sitting vacant for extended period of time. I often find water damage, discoloration, vandalism in the homes that are assigned to me. Some have been vacant a long time. When condition deteriorates, so does the price. In my mind, time is not on the side of the lenders as they believe it is.
It’s time for all of us to contact our Congressperson and tell them that this lingering inventory is going to prolong the housing bust and prevent you from seeing real appreciation for a long time.