Shadow Inventory
Refers to the real estate-owned (REO) properties that are vacant but not yet on the market.
What Is Shadow Inventory?
Real estate-owned (REO) properties that are vacant but not yet on the market are referred to as shadow inventory. This can apply to properties still going through the foreclosure process and those owned by locals or banks and awaiting a better selling environment.
A home listed as an REO property is owned by a mortgage lender, bank, or real estate investor after the foreclosure process failed to sell the property.
To sell REO homes as fast as possible, they may be sold at a reduced price before they are even placed on the market. It's intriguing to learn that others besides real estate speculators are paying careful attention to the shadow inventory.
For a number of reasons, economists are also keeping a watch on it. First, this is because banks are indicating their expectation that the housing market has already plunged and is about to rise when they start to release properties in significant numbers.
Additionally, a declining shadow inventory indicates a rising economy because housing is a significant component of the overall economy.
Key Takeaways
- Shadow inventory refers to real estate-owned (REO) properties that are vacant but not yet on the market.
- These properties include homes going through foreclosure and those owned by lenders or individuals, waiting for a better selling environment.
- Economists track shadow inventory because its decrease signals a rising economy, indicating a housing market upturn.
- Banks often wait to sell shadow inventory until the market improves to maximize profits.
Understanding shadow inventory
The phrase "shadow inventory" in real estate refers to homes held by mortgage lenders, banks, or homeowners for eventual release to the public but are not yet on the market.
Additionally, it can comprise distressed properties, houses that will go into foreclosure, or houses that a bank currently owns.
Distressed properties are those which are on the verge of foreclosure by banks or financial institutions.
Since distressed properties often sell for lower prices, having more of them in the market tends to lower prices in the housing sector overall, reducing the possible return on investment for lenders.
Since banks sometimes buy the properties and store them for years out of sight of the general public, the term "shadow real estate" is employed. Eventually, they are put up for sale in an attempt to increase sales and attract fresh interest.
1. Effects on real estate
We often hear the term "the real estate market is booming." This means that the economy likely has a high growth rate. This term is often used when property investors can sell quickly and for enormous gains.
In such conditions, the economy has fewer distressed properties, which, in turn, increases the prices of all other houses in the economy.
The same holds when inversed. If there is a higher number of such houses, real estate prices would be low, and investors would generally choose to hold on to such properties.
2. How is REO recognized?
Housing plays a vital role in the financial sector. Most of the mortgages issued today are backed by valuable assets, like houses, at least partially owned by the lender.
It is also a well-recognized profitable method of investing money, as there is less risk attached as compared to trading stocks. Most investors spend money on such fixed assets when prices are discounted and have high probabilities of appreciation.
"Brokering" is also a popular word when it comes to housing. Brokering here is a technical word, holding the same meaning as bargaining. Real estate brokers have huge lists of contacts for lower-cost properties.
Generally, brokers, mortgage lenders, banks, credit institutions, and financial institutions have some ROEs pending sale. Sometimes, these institutions also conduct auctions or post them online for better pricing and more interest.
Foreclosure Process
A lender can repay a defaulted debt through the legal process of foreclosure; this involves seizing possession of and selling the mortgaged property.
The foreclosure process is governed by state-specific legislation, although lenders generally assist borrowers in catching up on payments to avoid foreclosure.
On the websites of banks, foreclosed homes are often readily available. These properties might appeal to real estate investors because, in certain situations, banks would sell them below market value, which is bad for the lender.
Inventory in real estate: A property is counted as inventory once it is listed for sale. It becomes a pending sale when it enters into a contract. Inventory is computed monthly by counting the number of active listings and pending transactions on the last day of the month.
Here is one of the examples of listing foreclosed properties by an established bank like Chase.
Low numbers of homes were sold in the last couple of years and, as a result, a real estate industry slump. Because of this, home builders throughout the nation have struggled to increase sales as planned.
This has created a sizable inventory of unsold homes. This housing is considered inventory in the world of real estate.
Challenges in Purchasing Distressed Properties
It can seem like a great deal to buy these houses. But, first, you must consider your preparedness for the delays, disappointments, and high repair costs frequently accompanying foreclosed houses.
When distressed homes are offered at auction, inspecting them before the sale can be challenging; even if you are given a chance to look around the property, the vendor is cash-poor. In light of this, there is no possibility of repair negotiations.
In case of auctions or online bidding, before the deal is sealed, there is no assurance you will be able to buy the house.
Comparing the sale of an ROE to purchasing a property from a homeowner, many challenges must be cleared before buying such ROE properties.
While the typical closing time for a regular home is 6 to 8 weeks, the closing time for a distressed property might be 6 to 12 months.
This is because the lender is generally the one you are working with, and they are frequently unconcerned with the length of the closing procedure. You may also have to clear a lot of hurdles before the sale is complete.
Handling the Shadow Inventory Issue
When a bank or lender owns a property, the purpose is to sell it at the highest feasible price. If the market is sluggish, a lender may decide to keep the property until the market picks up.
A thriving market might result in greater property values and profit for the lender. For instance, when the market skyrockets, there is likely to be less accessible shadow inventory because house prices and property values are greater.
Why don’t banks sell shadow inventory sooner?
There are two big reasons why banks and credit institutions do not sell these sooner than later:
- As discussed earlier, one of the most significant reasons why it takes longer is the delay in the process. This delay is due to some state laws forcing deals to take longer than usual, as the two parties must complete all the requirements and documentation.
- Another reason this happens is that lenders may wait until real estate prices go up. So now, though the property will be sold at a discount, they will earn more money.
The Attraction for Investors
ROE has the potential to benefit real estate investors significantly. They can, for example, engage with lenders and banks to purchase foreclosed properties from the shadow inventory at a discount before they hit the market.
This means there are plenty of opportunities for real estate investors to profit from deals.
Are REOs attractive to investors?
If the investor is sensible, knows the ups and downs of real estate, and is financially capable of acquiring a property at a reasonable price, they can stand to benefit.
The ideal option for an investor to begin purchasing shadow inventory is to work directly with a real estate agent, who will almost always know of at least a few properties that will be available in the near future.
As long as the investor has the funds to reinvest in the property, he may sell it for a profit. But, again, the idea is to obtain information from someone on the inside, preferably a foreclosure specialist.
What is a Short Sale?
A short sale occurs when a mortgage lender accepts a mortgage payback amount that is less than what is owed to enable the sale of the property by a financially troubled owner. The lender then forgives the outstanding loan sum.
Under a short sale, a lender must consent to accept less than the balance owed on the property. In contrast to a foreclosure, investors usually pay even less for the house because they are not responsible for repaying the current loan or making up for any arrears.
Instead of dealing with a foreclosure, investors are making a deal with the current lender to accept less than what the lender is owned.
Are short sales and ROE different? ROE is slightly different from a short sale in just one aspect. In a short sale, the property is owned by the borrower, whereas, in the case of an ROE, the house is owned by banks or mortgage lenders.
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