Here's a Statistic I Dare You to Challenge

Sellable listings in the San Diego MLS represent only 25% of the distressed loans out there.

This short sentence gets right to the point, but admittedly contains some open-ended terms that vary widely by interpretation. By narrowing down the definitions of these terms, and by getting our arms around their underlying sentiment, we will shed light on some significant implications, unlock some “aha” observations, and stimulate a whole lot of thought… not so much about where things stand in today’s real estate market, but about the types of questions we should be asking.

To squeeze the underlying juice out of this powerful statistic, here’s what we will do:

• We will break down each term to arrive at a lowest common denominator.
• We will explore where this statistic did NOT come from.
• We will discover where this statistic WAS found.
• We will re-triangulate the findings.
• We will resist the urge to make fun of folks who think we are at a “real estate bottom”… by focusing instead on a golden opportunity being missed by government over-regulation and by the (in)action of individuals whose incentives are not aligned with a plan for a broader economic recovery.
• Then we will invite you come back again soon… to poke fun at folks who think we are at a “real estate bottom”.

Breakin’ It Down

Let’s deconstruct this statistic by defining it’s parts:

• By “sellable listings” I mean mostly lower-end, mostly non-short sale. I hereby estimate 83% of active homes on MLS as “sellable”. If you care to know why, click here. If you clicked, and you still don’t like it, write your own blog. (The main reason higher-end homes are mostly un-sellable, is because there is virtually no marketplace for their financing. The main reason short-sales are mostly un-sellable, is because bank managers have incentives to make their banks money… not lose money… and so they are reluctant to approve losses).
• By “MLS” I mean the “Multiple Listing Service”, which agents use as the industry standard, and by which the vast majority of all US homes are sold.
• By “distressed loans” I mean any mortgage whereby the consumer missed two monthly payments in a row and who has not yet paid it back.
• By “out there”, I mean not on the MLS …yet.

Here’s where I did NOT get this statistic:

It did not come from the media, public records, the California Association of Realtors, or even omnipresent Google. Its not that I didn’t try… but rather that they all pretty much conclude that this statistic is virtually unknowable.

Not being a conspiracy theorist, I felt a bit paranoid at first suspecting the government and banks to be “in on it”… obfuscating the truth and all that. Then I settled on a far more satisfactory conclusion, which is namely, to not give these institutions that much credit… they’re not that smart.

Seriously though, there are some legitimate reasons why these entities can’t quantify the amount of what some insiders and bloggers are starting to refer to as “shadow inventory”.

In a brief interview with the President and CEO of the California Bankers Association, who actually does come across as one of the smarter people I know, Mr. Rodney Brown, explained that the term “shadow inventory” would imply that there is an actual inventory out there, i.e. a pipeline of bank owned properties that the banks are unable or unwilling to sell.

He was quick to point out how banks are in the business of earning money on loans, not holding onto nonperforming assets or renting via property management. When banks take back inventory (from consumers who are in default), they place it on the MLS in short order.

OK, point well taken. However, maybe we should tweak the definition of “shadow inventory”. Or better yet, as I have done with this statistic’s phraseology, just lump this mystery “inventory” into “distressed loans out there that have not found their way onto the MLS… yet”.

The thing is, people have short memories. 12 to 18 months ago, we had a record surplus of (bank owned, foreclosure, REO, short-sale, traditionally owned) properties flooding the market, especially on the lower-end.

So, what the heck?

Why are we agents, the ones still standing after staving off economic ruin, by powering through a 12 to 18 month period of unprecedented industry challenges, stalled transactions, massive lower-end price declines, inane legislation, and mass peer exodus, etc. Why are we agents, who have now seemingly willed from the ether, a fresh batch of first-time home buyers to work with, some of which who actually have 20% to put down. Why are we having to show each client literally 100+ properties, and make dozens of offers, while bidding 20% over list price, before we can get one to go to escrow??

Are all the problems solved? Did we hit a bottom while nobody was looking? Is it truly a seller’s market?

Being an industry insider, having executed both loans and real estate transactions for many years; having witnessed the stock market’s total dislocation from reality leading up to the subprime collapse; seeing how the stock market is still, perhaps, even more dislocated from reality; understanding that we’ve had no let up on defaults of loans since last year when we’ve had record surplus of distressed sales; I really started to wonder: where the hell is all this inventory? Did it go to the place where lost socks and faxes end up?

Where this statistic WAS found:

Shortly after I became a full-fledged broker, after serving for a while as a (half-fledged?) agent, I was somewhat surprised to quickly realize there was only one major difference behind the role that came along with the new title: there is no higher up authority to go to when you have questions, so you learn to trust yourself.

Now I’m just one guy, and when your own smarter than average father-in-law who routinely teaches you a thing or two, about a thing or two, looks at you sideways when you make such a bold assertion, its easy to second guess your thinking.

So I asked another insider colleague, who’s gut feeling not only confirmed my most aggressive projection, but was even more aggressive in his own projection. And so I asked another insider… and then another… each of whom backed up my gut feeling within a small variance. It was then that I realized there was some juice to this.

In all, I asked 20 seasoned, professional, industry insiders, including loan officers, mortgage bankers, REALTORS, escrow officers, title representatives, real estate investors, and a former banker turned options trader.

The most conservative projection was that the MLS represents only 50% of the distressed loans out there.

Scientific? Controlled? Foolproof? Maybe not… but who to trust? Fickle media? Self-interested institutions? Politically motivated bureaucrats? California Association of Realtors, who just yesterday discovered a “computer error” responsible for drastically overstating home sales

• “This March, the 90-day delinquency rate shot up 2.6 percent from March last year… but the rate of home loans going into foreclosure was… up just 0.3 percent over the year. That means there were more loans falling delinquent than received official notice of default -- indicating a bottleneck and a potential flood of foreclosures to come.”
• “This March, 25 percent of the county's Alt-A loans were at least 60 days delinquent… (and) 38.5 percent of the active subprime loans… were at least 60 days delinquent.”
• In April, 5.74 percent of outstanding mortgages were at least 90 days late on payments… but only 1.5% of homeowners (received “Notices of Default”).”
• In a recent study, RealtyTrac compared its database of bank-repossessed homes to MLS listings of for-sale homes in four states, including California. It found a significant disparity - only 30 percent of the foreclosures were listed for sale in the Multiple Listing Service. The remainder is known in the industry as "shadow inventory."

“Google’s not too shabby after all”

The act of writing this post itself helped to adjust my Google thinking cap… and guess what happened after I dialed in my keywords using phrases like “how will the foreclosure moratorium affect shadow inventory”?

• In default again?

How could this be?

“Government gets its peanut butter all over the banks’ chocolate”

• In one way or another, there has been some form of a foreclosure moratorium in effect for the last 18 or so months. This means, banks with some exceptions, have been disallowed from foreclosing on non-performing loans.
• Fannie and Freddie issued moratoriums.
• Banks issued some voluntary moratoriums… perhaps attempting to cut losses while getting some, rather than no payback… perhaps reluctant to drive the real estate market down further… perhaps to create demand, by limiting supply… or perhaps because they’re in no hurry to report more defaults to shareholders.

“Creation of even more irresponsible lending standards”

• Ever heard of “stated income”? This was when borrowers (over)stated income and assets to obtain loan approval. Want to know how loan modifications work? Borrowers (under)state their income and assets to determine a “fair” payment.

“Lowering standards” works especially well in conjunction with the “peanut-butter-chocolate theory”

• Don’t allow banks to foreclose on consumers unless they offer loan modifications to folks who have demonstrated that they need help… by missing their mortgage payments.
• We’ll just assume that the people who have been working three jobs to make their payments come hell or high water are less deserving than the folks who have missed their payments.
• Never mind that the folks who have missed their payments will default again the first chance they get. Don’t take my word for it? Did you know over half of the modifications already granted… are

“Fuzzy math shenanigans”

• Whew, good thing banking stocks rebounded recently… why bother adding up those tedious mortgage lates… is there really any rush to alert the shareholders and drive down stock prices?
• Right, and while we’re keeping share prices from dropping like an empty can of soda, how about we 86 that pesky mark-to-market accounting practice to “free up” our reserve requirements!
• Yeah… and “zero down loans” are so 2007… let’s call them FHA loans… we’ll make people cough up 3.5% so it won’t have that “zero down” stigma… good deal, but if the government is going to be in on it, they have to get theirs too… right, right… we’ll just tack on 1.75% to the loan balance to keep Uncle Sam happy.

“In marble lobbies we trust”

• Banks have no obligation to report statistics on loan defaults.
• Banks have no obligation to report statistics on loan modification requests.

“Working the system”

• Some folks seem to stave off the foreclosure man by making partial payments or pressing the right levers or I don’t know how but they are still in “their” homes.

And not factored into my homegrown statistic… “the mother lode of shadow inventory”

• Consumers who are 30 days late.
• Consumers who are current but can’t hold on for long.
• Per Bloomberg, nearly 25 percent of ALL mortgage holders are upside down.

The Golden Opportunity Being Missed

The purpose of taking this poll, posting its results, and researching its guts out, was not to sarcastically attack the banks and government for perpetuating an already bad situation. The purpose is to call attention to a golden opportunity being missed.

While all this havoc was being wreaked upon our economy, a new freshman crop of first-time home buyers came online while nobody was looking. With good credit, a stable job, and 20% down from savings or from a little help from the ‘rents… the under $325k market is actually the one segment that does make sense to buy right now.

The rates are still low. People can qualify. More importantly, people can afford it. The post write-off payment is on par with rental prices. The sales prices have already taken a serious beating, and even planning for the worst… if the downward trend continues, future monthly payment savings will likely be offset by higher rates. There’s also that tax credit thing nobody really knows how to explain or whether it will be around long enough as advertised, but hey, it can only help too. In short… it makes sense.

And in this one and only market segment where it does makes sense to buy… the government is doing its darnedest to artificially limit supply.

This stance creates a head fake to higher-end markets that the tide has turned, which will irresponsibly cause more consumers to be caught off guard. It also sends a message to the hardest working class of consumers we have, who have not made room for any excuses, that it pays to quit.

We have a chance here to stop subsidizing more of what we don’t want. We likely have enough pent up demand to replace non-performing borrowers with performing ones. And if the demand on deck does not prove to be sufficient… then now is the time to find out. It is so important that we firm up a bottom to this madness in advance of the high-end displacement yet to come. A low end line in the sand is desperately needed to create a last chance foothold from which to draw a bridge when the high-end drops off the precipice. I say take the hit now while we still can:

• Remove the moratoriums.
• Set up an REO conservatory to rent to foreclosure displaced consumers.
• Enforce banks to report defaults and non-performing loans to shareholders.
• Let the market take care of itself.
• Adjust incentives for bank managers to execute short sales (rather than pretend).
• Recognize that new home purchases will stimulate the economy.
• Understand that nobody “deserves a home”.
• Stand up for the contracts that underpin our social fabric.

Invitation

All all you real estate junkies are cordially invited to revisit my page in the next few day to find out why we are so not even close to a high-end “real estate bottom”.

Comments

[K.C.Jones]

Great article. I have a friend here in Chicago and he is telling me the same thing. Banks are sand bagging foreclosures, and the market is nowhere near a bottom.

2009 Jul 08 07:12 AM

[I need more cowbell]

One of the best SA articles in some time. You obviously put in a lot of work-kudos.
What are your feelings about commercial real estate, if you have any?

2009 Jul 08 07:56 AM

[conceptwizard]

Nice aricle. I was reading the Realty Trac information on this a month ago. They have been aware of the "Shadow Inventory" for some time. The estimates at that time were 600,000 homes that were not listed on MLS.

I still do not think it is well advised to venture your capital into the mid-range housing right now. Knowing this information and accepting it as true, this means the markets could still fall up to 30%. They have 10-15% to go just to get to median lines. Having said that at 25% down payment which is what most of the banks want now, would evaportate your investment pretty quick. Those that are not urgent to buy a house would not be out anything to bide a bit more time.

2009 Jul 08 09:07 AM

[RealtorPam]

Good thoughts and true, I saw this as the plan last Fall, as we started bemoaning foreclosures, the one way to artifically manipulate RE prices is exactly what they are doing, holding it off the books, letting people live for free and hope all the current inventory is eaten up and prices stabilize.However, gov. officials did not count on so many people walking off the homes, they don't want loan work outs, a majority of people bought them to flip, that party is gone, they can't or do not want to pay the utilities on these mega mansions, much less the mortgage, so we are looking at vacant properties, sitting, not foreclosed on, which would get it on the market and sold to a fresh buyer, instead we are paying groups of people to knock on vacant doors trying to save uninterested folks. The result of politicans trying to fix a free market venture...once again. a failed expensive waste of taxpayer dollars..

2009 Jul 08 09:08 AM

[enigmaman]

Limit foreclosure supply, mitigate price declines, create demand, shadow inventory gives way to more shady market conditions. Problem is real estate market is still being manipulated, by all concerned parties, this predominately false real estate market will correct itself again and take down those that believed it was for real, One time same on you two times same on me, those who get caught in the meat grinder yet again will no longer want to play anymore and that is the real problem facing the economy down the road, good times, bad times, good times , bad times, why not stay on the side lines

2009 Jul 08 09:11 AM

[Tony Petroski]

It strikes me that a simple way to research "shadow inventory" is simply to observe on the ground through sampling how many buildings are vacant or being rented in neighborhoods where they would normally be occupied by homeowners and create a percentage. After all, the housing inventory can't be stockpiled in a bank vault like gold or diamonds, so this shadow inventory can't be all that mysterious.

I am familiar with a recent housing development that boomed about 7 years back and now is stable but not growing. The development has primarily "median-priced homes" (realizing that the median price has dropped and seems to be stabilizing). There are about 250 homes. In the development there are three homes that are vacant but without "For Sale" signs, i.e., part of the "shadow inventory," and I assume buildings in foreclosure that will be placed on the market after the foreclosures are complete. With foreclosure moritoriums, there is a small percentage of homes that are still occupied by their "owners" but will at some point become vacant and ultimately listed for sale. There are a very small number of rentals that at some point will be for sale--rental licensing information should be able to confirm these. There are partially-completed units that remain empty plus empty lots growing weeds.

Out of 250, the "shadow inventory" in this development is probably less than 25 or less than 10%. The "visible inventory" is less than 10%. The banks can't hide the buildings in their vaults waiting to drop the inventory on the market once prices and sales activity firm up.

There is a huge pent-up demand--people who want to move for personal reasons but who are staying put because they can't find buyers (or haven't tried yet) for their present homes who will be buyers once they have a market for their present homes--that is the shadow inventory. That number is large, and once unemployment bottoms out, we should see many homes changing hands for this reason with the likelihood of prices bottoming or rising.

2009 Jul 08 09:11 AM

[Moto]

Even if the government is limiting supply there is still a lot of it. If there were so much pent up demand, wouldn't the supply be much less. Maybe I misses something. I do know that the liars than can figure are good at hiding things on balance sheets and income statements. Barney Fife...er Frank will save the day.

2009 Jul 08 09:21 AM

[Glen L.]

In a free real estate market, location is everything. In a goverment-rigged market, timing is at least as important. If you can time a real estate buy to take advantage of the real bottom (my guess: winter 2010) and before the FED hikes interest rates in response to raging inflation, you can do very well indeed. Good luck with that. Just make sure you get a fixed rate loan, and pay it off early with inflated Fed Reserve Notes.

2009 Jul 08 10:08 AM

[Larry House]

It never hurts to have the facts and a dose of reality.

2009 Jul 08 10:38 AM

[MarkitWacha]

I like your analysis and suggestions. It makes complete sense. That's why it won't happen. You need to find some way to make the politicians in the House happy, as well as the bank bondholders that pull their strings.

Marxism is occurring all around us, and this apathetic democracy is powerless to stop it. It won't be until 2010 that we the people have a snowball's chance. Till then, and possibly after, we're screwed.

2009 Jul 08 10:43 AM

[Ca Real Estate reality]

I did a study tonight looking at all Homes REO homes listed in San Diego County for the past 7 days. Only 15% were pending after 7 days. During the same period more homes were taken REO at trustee sale than were sold REO. Only 18% of homes going to Trustee sale statewide are taken back by the bank at any one time most of the rest are postponed. 3% of all NODs are becoming modified loans. For every 1 Trustee sale there are 1.5 NODs. IF the Bank owned property listed in REALTY TRAC is correct we have approximately 2-3 years of inventory at current prices. However without the Bankowned property in REALTYTRAC we will still see a steady price decline just based on Trustee sale data and NODs compare to Multiple listing service data of all sales in San Diego for past 30 days. The numbers are staggering prices will need to drop 30-50% to get all the inventory back into the hands of people willing to responsible for making month payments.

2009 Jul 08 10:47 AM

[KIT]

This will not be cleared before interest rates climb putting more down pressure on home prices.

2009 Jul 08 12:31 PM

[Ca Real Estate reality]

As a CA real estate broker I will tell you that it is hard to tell. Banks are letting people stay in the home until they offer cash for keys. Vacant homes are bad, occupied homes good. So what if they are not paying anything. They act as if they own the home to all of their neighbors. I have to constantly check Realty Trac against public records. Most of the homes going to trustee sale 97% are occupied and it takes 6 months to get them out unless they opt for cash for keys. Good idea hard to do.


On Jul 08 09:11 AM Tony Petroski wrote:

> It strikes me that a simple way to research "shadow inventory" is
> simply to observe on the ground through sampling how many buildings
> are vacant or being rented in neighborhoods where they would normally
> be occupied by homeowners and create a percentage. After all, the
> housing inventory can't be stockpiled in a bank vault like gold or
> diamonds, so this shadow inventory can't be all that mysterious.
>
>
> I am familiar with a recent housing development that boomed about
> 7 years back and now is stable but not growing. The development
> has primarily "median-priced homes" (realizing that the median price
> has dropped and seems to be stabilizing). There are about 250 homes.
> In the development there are three homes that are vacant but without
> "For Sale" signs, i.e., part of the "shadow inventory," and I assume
> buildings in foreclosure that will be placed on the market after
> the foreclosures are complete. With foreclosure moritoriums, there
> is a small percentage of homes that are still occupied by their "owners"
> but will at some point become vacant and ultimately listed for sale.
> There are a very small number of rentals that at some point will
> be for sale--rental licensing information should be able to confirm
> these. There are partially-completed units that remain empty plus
> empty lots growing weeds.
>
> Out of 250, the "shadow inventory" in this development is probably
> less than 25 or less than 10%. The "visible inventory" is less than
> 10%. The banks can't hide the buildings in their vaults waiting
> to drop the inventory on the market once prices and sales activity
> firm up.
>
> There is a huge pent-up demand--people who want to move for personal
> reasons but who are staying put because they can't find buyers (or
> haven't tried yet) for their present homes who will be buyers once
> they have a market for their present homes--that is the shadow inventory.
> That number is large, and once unemployment bottoms out, we should
> see many homes changing hands for this reason with the likelihood
> of prices bottoming or rising.

2009 Jul 08 02:41 PM

[datadave]

sounds to me that your 'cure' is worse than the disease. Just throwing people out of the houses would probably worsen the situation and develop a glut of houses for sale to a smaller population of buyers who' d love to chisel your prices down for a distressed, unoccupied house. The banks, brokers, rating agents got us in this mess, despite your belief the big bad govt. did. Remember those easy loan terms brokers were approving just to make the sale and commissions?

2009 Jul 08 03:04 PM

[Seth Chalnick]

Thank you very much for reading my article and for providing such thoughtful feedback.

I believe the only direct question asked of me was by ‘More Cowbell’ regarding the commercial sector outlook. I really can’t offer up the same inside scoop about this, but on a gut level, I feel like office buildings and shopping malls are about to get their heads handed to them. I was a buyer of SRS (ultra short commercial) until I realized that the underlying basket of companies have some exposure to the downside along with the broader market, but are somewhat better positioned to get through this, i.e. medical buildings, etc. I also can’t stand how the group can lose value over time… and SRS still goes down? Leveraged ETF’s are so weird that I’d rather just buy puts since at least I understand the risk. I have not yet identified which companies look spotty, so I’m all ears.

The only point of clarification I’d like to make is that “the real estate market” is highly segmented... by region… and by price point. Most of the inventory being held back is in the low end of the market. There are rumors of properties in Rancho Santa Fe being withheld to keep the market from crashing… but it’s nothing more than rumor as far as I can tell. The high end stuff has plenty of inventory… but it’s not shadow. It’s flat out sitting on the MLS with no buyers. This trend will likely continue and worsen as more and more “prime” people start to default.

2009 Jul 08 09:29 PM

[Moon Kil Woong]

Last I heard banks are even refusing to take back homes because they don't want to pay for maintenance, etc. And fannie Mae and Freddie Mac are still out there loaning away at rates they know won't cover the defaults. Banks are licking it up. Last I heard over 90% of all new home loans are sold to Fannie and Freddie or more properly said, over 90% of all the risk is trasferred directly back to the taxpayer.

So is the the stated home loan market real? No. Would a bank write even 50% of the loans they do now at the interest rates they do now if they had to keep them on their books? No. Are all the forclosed homes on the market? No. I agree with Seth Chalnick that this market is still not reflecting or dealing with economic fact.

Banks and financial institutions are still hoping for a 20% equity rise that will mysteriously revalue all their underwater assets closer to the amount they discounted them. LOL. They should go talk to Nick Lessen, AIG, and Enron about refusing to acknowledge losses and then piling on more.

2009 Jul 08 11:06 PM