In the world of real estate, homes on the market are referred to as inventory much like products found in the warehouses of the almighty Amazon.com. “Things that can be sold for consideration.” You find a product you want, enter into some sort of agreement to purchase, exchange your monies, and receive shipment. Granted, in the world of real estate, there are many more details involved, but that’s the basic framework to facilitate a standard supply and demand scenario.
Over the past few years through the disaster we all know as the mortgage meltdown, a common term that, to this day, continues to be thrown around is “Shadow Inventory.” I call it the Unicorn of the Real Estate Industry. Some believe wholeheartedly that it exists while others think it’s just a myth.
I’m going to explain exactly what shadow inventory is, and why it’s nearly impossible for the average real estate agent to measure it. In fact, it’s really not something anyone can accurately measure. Shadow inventory, as they say, is presumed to be a collection or list of homes that have not yet been put up for sale, but will be at some point, which for some reason has influenced the thinking processes of various individuals in the industry, both agents and investors, in terms of market predictions and future conditions.
This Shadow Inventory, if it truly existed, could be divided into three types, so to speak. I’ll break them down for you.
Type 1: Homeowner Defaults
There are thousands of homeowners who are living in homes that they have defaulted on, meaning they haven’t paid their monthly mortgage payment in the time allotted by their lender as agreed upon in their original note. This creates a group of homes that are in the infancy stage of Shadow Inventorianism to coin a completely obnoxious term. These are homes that, at the lenders discretion, may or may not be on the soon to be auctioned list. It’s a completely unmeasurable number of homes. Without having access to each lender’s books, or the omnipotent knowledge of everyone, one would not be able to determine who these people are, nor where the houses are that contain delinquent borrowers. Shadow inventory? Unmeasurable, therefore it doesn’t really exist in terms of calculating market conditions and statistics.
Type 2: Trustee Sales
Lenders have the right in Arizona to issue a Notice of Trustee Sale without first issuing a Notice of Default (A.R.S. § 33-809.) By law, when a Notice of Trustee sale is issued, the owner of the property is given 91 days to remedy the problem before the house can be sold to a new owner at auction. This information is public record, offering anyone and their brother a list of these properties free of charge. News flash…there’s no secret to obtaining this information. It’s public record. If shadow inventory existed, this would be one of the three types that could possibly be measured. The problem with using this information is that there’s no guarantee by the lender who hired the trustee to auction the home that the auction will actually occur 91 days after notice is given. Often, especially in recent years, home owners have been very fortunate to continue to live in homes that are scheduled to be auctioned, but have had their auctions postponed month after month after month. In addition to that, many of those homes will have an opening bid at auction far greater than would make sense to any investor, and as a result, will simply go back to the lender as an REO or bank owned property (the third type of Shadow Inventory.) There’s a real possibility to measure the quantity of potential inventory that may come to the market, but no way to nail down when or if those homes will actually be listed to affect the market. Granted, there are effects on local neighborhoods as a result of vacant homes, or homes that no longer receive the care they require (deferred maintenance).
Type 3: REO (real estate owned) or bank owned homes
Once a home is sold at auction, mechanically, it is no different than selling the home to a new happy home owner. The lender will set an opening bid based on their own methods of valuation much like the home owner would set an asking price. If that opening bid is higher than the value of the home, (which has been the case many times over, but is less common now) then nobody in their right mind, including other lien-holders on the property will bid on it. At that point, the bank simply takes ownership of the asset which satisfies the terms of the home owner’s original note regarding default. Essentially, the bank becomes the new happy home owner. So what does that mean? Well, banks are in the business of lending money. They are NOT in the real estate business. Walmart, McDonalds, and Starbucks may be in the real estate business, contrary to the evidence based upon their offerings to the general public, but banks are not. As a result, they do not want to hold property in any “investment portfolios.” It can be expensive, and the last thing they want is to drive their costs up. Banks are all about profits. What it ultimately means, however, is that the likelihood of the house being listed for sale, increasing the available inventory, is unknown. We know it will probably happen at some point, but again, we don’t know when, so counting that inventory, which could be classified as “Shadow Inventory” would be as productive as counting all of the homes you drive by every day as shadow inventory.
All in all, the conclusion that I’ve come to is that “shadow inventory,” the Unicorn of the Real Estate Industry, doesn’t really mean much at all until it’s on the market. Think about how many properties are sold outside of the MLS. There are bulk purchases, pocket listings, and buyer to seller transactions that happen all the time in the world of real property without the help of real estate professionals. Not all of those houses would be classified as “inventory” for the purposes of tracking the market, and classifying them as “Shadow Inventory” just doesn’t make sense.
Unicorns are cute and magical, but they just haven’t been found yet. The only difference is that I really want to see an actual Unicorn. I don’t much care about what’s in the shadows.