Understanding the Impact of Shadow Inventory

What is shadow inventory?
It is an inventory of houses that will come to market as a distressed properties at a discounted price. Each of the data companies define shadow inventory in slightly different ways. Standard & Poors defines it this way:

“We include in the shadow inventory all outstanding properties for which borrowers are 90 days or more delinquent on their mortgage payments, properties in foreclosure, and properties that are real estate owned (REO).

We also include 70% of the loans that “cured” from being 90 days delinquent (loans that once again became current) within the past 12 months because cured loans are more likely to re-default. Our calculation of the months to clear the shadow inventory is the ratio of the total volume of distressed loans to the six-month moving average of liquidations."

Is this inventory increasing?
The report shows that shadow inventory is decreasing in many parts of the country as banks are starting to release distressed properties to the market. From the report:

“We estimate that it will take 45 months to clear the national shadow inventory. This is seven months below our peak estimate but three months longer than our estimate a year ago. Twelve of the top 20 MSAs recorded declines in months-to-clear during the quarter, while eight reported increases."

What impact will shadow inventory have on real estate?
One of two things will happen:

1. The inventory will continue to mount and be a hindrance to a housing recovery
2. The inventory will be placed on the market and impact prices

As the report states:

“Despite the recent stability of our months-to-clear estimates and liquidation rates, these distressed loans continue to loom over the housing market and threaten to further depress home prices. Though fewer additional loans are currently defaulting, the overall volume of distressed loans remains huge. Low liquidation rates over the past two years allowed the shadow inventory to grow as distressed homes have remained tied up in foreclosure proceedings.

The shadow inventory will continue to jeopardize the housing market’s recovery until servicers are able to improve liquidation times. However, if and when that happens, an influx of homes will likely enter the market, increasing supply and driving prices down further.”

Bottom Line
We believe the inventory will come to market impacting prices now but bringing about a housing recovery in a much shorter period of time.

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Higher FHA Loan Limits Reinstated for High Cost Housing Markets

Uncle Sam has thrown California and other high-priced housing markets a lifeline.

President Obama on Friday signed into law a bill that will reinstate higher limits for Federal Housing Administration-backed mortgages in high-cost areas. In expensive housing areas such as Los Angeles and Orange counties, the limit for these FHA-backed loans had dropped to $625,500 from $729,750 on Oct. 1. The change became effective Friday.

Similar ceilings applying to loans that can be backed by Fannie Mae and Freddie Mac will not increase. The California Assn. of Realtors and its larger national partner association had lobbied for all of the loan limits to be reinstated.

The group is “pleased the Senate and House were able to come to a reasonable compromise,” LeFrancis Arnold, president of the group, said in a statement Friday. “However, we are disappointed that the Senate and House could not agree on increasing the loan limits for Fannie Mae- and Freddie Mac-insured loans.”

A bipartisan group of California lawmakers had sought the increase of all of the old limits, but the House Appropriations Committee had raised concern that Fannie and Freddie, which have received more than $150 billion in financial rescue money from taxpayers, have received public scrutiny for “questionable business practices,” The Times previously reported.

The FHA has also come under increased scrutiny as that agency said in a report to Congress this week that it could be headed for its own taxpayer bailout.

Rep. Brad Sherman (D-Sherman Oaks), in a statement said the passage of the higher FHA loan limits would help “prevent a collapse of housing prices in high-cost areas like Los Angeles.”

Indeed, sales of properties in Orange and Los Angeles counties with loans between $625,500 from $729,750 fell sharply, to 102 last month, according to San Diego real estate firm DataQuick. That was a 71% decline from 350 in September and down 71.5% from 358 sales in October 2010.

But the Obama Administration warned this week that it is important for the federal government to get out of the mortgage business.

“We believe that lowering the limits is a step to ensuring that private capital will return to the market,” Carol Galante, the acting FHA commissioner, said during a congressional confirmation hearing Thursday. “We understand at the present time FHA is playing a somewhat outsized role in the market.”

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Is It Really Time to Buy a Home?

On Monday, we gave you the links to four different articles that came to the same conclusion: it’s time to buy a home. Today, we want to take a closer look at one of the sources, the JP Morgan’s Market Insights report. Right from the beginning, the paper identifies the greatest challenge in today’s housing market: consumer emotion. They attempt to overcome that emotion with logical reasons why now is the time to buy a home. They break it down to the following.

Price-to-Income Ratio
One measure of housing values is the ratio of personal income to home prices. The report explains where we are today:

“Since 1966, the median price of an existing single family home in the U.S. has varied between 150% and 251% of personal income per household. However, roughly three-quarters of the time it has been in a relatively narrow band between 185% and 230%. In September 2011, the ratio was just 153%, implying that to get back to an average price to income ratio, home prices would have to rise by about 27%.”

Current Mortgage Interest Rates
With current 30 year mortgage rates, housing payments are at historic lows as compared to personal income.

“During the week of October 7, Freddie Mac reported that mortgage rates had fallen to an average annual level of 3.94%. Assuming the use of a fixed rate mortgage with 20% down, this would make the median mortgage payment on a single family existing home just 6.9% of per household personal income, compared with an average of 14.4% since 1966.”

Monthly Rent vs. Monthly Mortgage Payment
Is it less expensive to own a home or rent a home? The answer to this question helps families make the decision whether or not to buy a home. The report explains:

“By the third quarter of this year, we estimate that the implied median mortgage payment had fallen to just 78% of the median asking rent…”

Bottom Line
The paper comes to the conclusion that now is the time to buy.

“The numbers on housing have an important message for American families today, and particularly younger families setting out on life’s great adventure: Five years ago, at the peak of the home-buying euphoria, it was emphatically a time to rent. Today, when home ownership is depreciated more than ever before, the numbers tell us it is a time to buy.”
We agree.

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