What is 'Shadow Inventory'
Shadow inventory refers to uninhabited or soon-to-be-unininhabited real estate that that has yet to be put on the market. It's most often used to indicate properties that are in foreclosure but have not yet been sold, but it also encompasses homes that owners are waiting to put up for sale until prices improve. Shadow inventory can create uncertainty about the best time to sell and about when a local market can expect full recovery. In addition, shadow inventory often causes reported housing data to understate the actual number of properties on the market.
BREAKING DOWN 'Shadow Inventory'
Shadow inventory played an important role in the aftermath of the subprime mortgage meltdown of 2007-2008. With the unprecedented number of foreclosures stemming from the housing market collapse during that crisis, lenders were left with significant real estate holdings. Many lenders were slow to put their inventory up for sale for fear of flooding the market with so-called "distressed" properties. Since distressed properties sell for relatively little, more of them on the market drives down prices, which in turn lowers lenders' potential ROI. After the 2007-2008 crisis, however, shadow inventory has thinned out as the housing market has slowly recovered.
The Economic Impact of Shadow Inventory
Shadow inventories tend to grow when housing markets are struggling. When banks begin to release foreclosed properties at a higher rate, it is a sign that the housing market has bottomed out and is beginning to grow again. Since housing plays such a major role in the overall economy, a smaller shadow inventory generally coincides with strong economic growth.
At the same time, the release of foreclosed properties tempers housing prices overall. This is because distressed properties sell at a much lower price than other homes. When distressed properties make up a large proportion of houses on the market, they drive down prices across the board. According to the Federal Reserve Bank of Cleveland, foreclosed homes that have been on the market for less than a year sell for 35 percent below value, while those that have been on the market for more than a year sell for 60 percent less. These low prices negatively impact sellers, but they can also help buyers afford homes.
Real estate investors may also benefit from the existence of shadow inventories. Investors who form relationships with REO departments of small banks and credit unions can sometimes buy properties from the shadow inventory before the public knows they are on the market. Likewise, asset managers and real estate agents from larger banks sometimes provide lists of available properties to investors.