Distressed Home sales are tracked by CoreLogic in their monthly Market Pulse
Distressed Sales and shadow inventory are closely related. Distressed sales include Real Estate Owned (REO) and short sales. REO sales are generally foreclosures, while short sales are below the current outstanding debt on the property. Distressed supply will put a damper on pricing as the discount for a property in foreclosure is around 18%, and the discount for a short sale is in the low to mid teens. Distressed sales put in low comparables (comps) which reduces the value of the properties around them.
Shadow Inventory is an estimate of the supply of distressed homes that are in foreclosure or 90 days delinquent, but are not yet bank-owned. It is an estimate of the number of homes that are coming up for sale in the next year. Real estate owned (REO) is not counted because those homes are usually already for sale. Analysts will focus on shadow inventory in order to gauge supply going forward.
Distressed sales are driving activity in the hardest-hit areas.
Distressed home sales have been playing an outsized role in the housing recovery. In some of the hardest-hit localities like Phoenix and Las Vegas, distressed inventory has been snapped up by professional investors and has created large price spikes. Distressed home sales are closely related to shadow inventory and both have the effect of depressing existing non-distressed properties.
Ironically, the number of distressed sales has left many mortgage lenders watching from the sidelines. Distressed sales are almost always cash transaction because the seller wants to move the property quickly. In some hot markets, mortgage loan officers are watching activity all around them, but are not participating.
Real estate market watchers have been confounded by the current market, where supply is constrained in the face of high shadow inventory. Part of the reason for this has been a divergence between the judicial states, where a judge has to approve a foreclosure, and the non-judicial states, where no judge means faster timelines. For non-judicial states, the foreclosure pipeline has been largely dealt with and prices are rising at a fast pace. For judicial states (NY and NJ especially), the pipeline is still full and prices have been more or less stagnant.
Many investors had raised capital for the huge deluge of supply that never materialized. Many hedge fund managers who started their careers in the late ’80’s with the Resolution Trust Corp were waiting for the government to force banks to sell their underwater mortgages, which never happened. Instead, the government forced banks to hold off foreclosures, which may have temporarily held up prices, but elongated the process. Many of those investors have ended up in the rental business, where they pay cash for distressed properties and rent them out.
Impact on home builders
Increased distressed activity affects home builders, like KB Homes (KBH), Toll Brothers (TOL), Ryland (RYL) and Lennar (LEN), by depressing real estate prices and competing with new homes. Lower home prices means lower average selling prices for builders, appraisal difficulties, and a glut of foreclosures means lower sales. So the slow drop in shadow inventory is good news for home builders. For home builders in non-judicial states, shadow inventory is something that isn’t really going to affect them. For home builders in judicial states, another year of sluggish pricing may be on the horizon until shadow inventory is worked off.
Slowly, but surely, new home sales are beginning to grow as a percent of home sales. New home sales have been largely absent from the recovery, but finally that is changing. More homebuilding activity will create a virtuous circle of higher employment, which will help drive home prices higher, and repair household balance sheets.