Shadow Inventory Will Impede Housing Recovery

"The single largest impediment to a recovery in the housing market is the large number of loans that are either in delinquent status or in foreclosure that are destined to liquidate. This creates a huge shadow inventory. We estimate this housing overhang at 7 million units, 135% of a full year of existing home sales. We are concerned that, in light of this housing overhang, the stabilization we have seen in home prices the last few months is temporary." — Amherst Securities Group

In a September 23 report, Amherst Securities estimates that 7 million housing units are destined to default, and then be seized by lenders. This is a "shadow inventory" that hasn't yet hit the market, but soon will.

That number represents well over a year's worth of home sales. Amherst believes that this housing overhang is the single biggest obstacle to a housing recovery.

To put that into perspective, existing home sales total around 5.2 million units — so the overhang is approximately 1.35X one year of existing home sales.

This shadow inventory has grown measurably in recent years; there were just 1.27 million such units in 2005.

Based on the current pace of existing home sales, Amherst analysts say it would take 1.35 years sell these properties — assuming no other homes are on the market. Naturally, that is a highly unlikely scenario.

Amherst noted that efforts to rework mortgages and avoid foreclosure will not make much of a difference, with perhaps a reduction of 1 million from this shadow inventory. Amherst also noted that "many of these borrowers would default later, if they remain in a negative equity position."

For that estimate to be accurate, Amherst concluded that those 1 million modifications would have to be more successful than historical modifications. That makes such an outcome seem optimistic, if not unlikely.

Amherst is a securities firm specializing in trading and advising investors on home-loan debt.

Earlier this year, Barclays' analysts wrote that once it starts, the housing recovery will be dulled by a “pent-up supply” of homes from owners who have put off sales during the slump. That inventory will further dilute an already weak market.

Banks are loathe to acknowledge this large shadow inventory for fear of what it wold do to their already troubled balance sheets. However, they can't keep this supply hidden indefinitely. At some point it will have to be acknowledged, and the supply will once again begin depressing home prices even further.

According to the Mortgage Bankers Association (MBA) Quarterly Delinquency Survey, about 55.9 million homes in the United States have a mortgage. At the end of Q2 2009, a staggering 13.54% of mortgages in the MBA survey were in some stage of delinquency.

This suggests that some 7 million are already in the delinquency pipeline and will eventually liquidate.