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Shadow Inventory Undermining All Major Metro Markets Now


In order to make an informed decision, you need to have a good sense of what's coming down the pike. To do that, it is essential to consider the so-called "shadow inventory."

Editor's note: The following is the first issue of Minyanville's Housing Report by Keith Jurow. This will be a twice-monthly subscription containing actionable data, analysis and much more to help subscribers make better real estate investment decisions. Each will also take an in-depth look at the housing landscape of a major metro area. In this first issue, you'll find Las Vegas. Learn more about the Housing Market Report.

Welcome to the free premier issue of our Housing Market Report. Whether you are an investor in 1-4 family properties or a homeowner trying to sell, this report will provide useful data, analysis and advice to help you make smarter, more informed decisions.

In addition to actionable information, each issue will also highlight a different major metro. This inaugural issue will feature Las Vegas -- in many respects the epicenter of the housing bubble and crash.

The Investment Landscape

Investors are pouring into housing markets across the country. According to the November Report of Market Conditions by Inside Mortgage Finance, 20% of all home purchases nationwide are now made by investors. In some major markets, this percentage is much higher.

What attracts investors these days is very different from what drew them during the bubble years. They are not really enticed by appreciation potential and leverage. Investors are lured mainly by low prices and positive cash flows.

Many of them are also searching for an alternative to the ridiculously low rates they now receive from money market funds, US Treasury securities or bank CDs. One knowledgeable Phoenix broker explained that his investor-clients are often 50 and older who have been pulled into residential investing because of the plunge in interest rates they've had to endure. Quite a few have liquid assets over $1 million and are looking for a better return.

Metros that experienced the greatest price bubbles and subsequent collapse have seen hordes of investors leap into their housing markets -- especially Las Vegas, Phoenix, several Florida cities, and cities in the California Inland Empire. These investors are fairly confident that prices are nearing a bottom and that the risks of major declines are minimal.

Let's take a look at some of these markets to see whether investors are acting on sound information. The following table from CoreLogic data shows the 10 weakest large counties in the US in terms of distressed properties which have not yet been foreclosed and repossessed by lenders as of the end of September 2010.

Note that this table shows the 10 large counties with the highest total percentage of first liens which were either seriously delinquent or had been placed into default. Keep in mind that these are properties which had not yet been foreclosed and repossessed. We know from historical cure rates (discussed in previous Minyanville articles of mine) that roughly 98% of these properties will eventually be forced onto the market as either foreclosures or short sales.

It is also important to know that CoreLogic's enormous database of nearly 42 million loans does not include the entire universe of first liens. I was informed by their key database person that they do not extrapolate from their database to estimate the total number of loans or distressed properties. Thus the total number of seriously delinquent and defaulted first liens in these 10 counties is somewhat higher.

Three of these counties contain the major bubble metros of Las Vegas, Miami, and Phoenix. This so-called "shadow inventory" will be thrown onto the market in the not-too-distant future and will clearly add to the glut of MLS listings.

It is very hard to determine how soon the banks will start to reduce this backlog of distressed properties. The servicing banks are clearly in no rush either to put seriously delinquent homeowners into default or to foreclose on those properties which are already in default. In December 2010, according to Lender Processing Services, 34% of seriously delinquent homeowners had not made a mortgage payment in at least 12 months. In early 2009, that number was only 10%.

The servicing banks can delay putting these homes into foreclosure to avoid having to write them down, but they will definitely be hitting the housing markets in these counties over the next few years.

How does this impact you? If you are an investor thinking of buying one or more properties in Miami-Dade County, for example, you need to know that 24.9% of all active first liens there were seriously distressed. This means that more than 91,000 properties are almost certainly going to be dumped onto the market. Will that exert downward pressure on prices? Absolutely.

If you are seriously considering investing in Miami-Dade, it is essential to factor in this huge and growing shadow inventory and be prepared for a further drop in prices of 10-20% or more. We'll look at Miami-Dade in depth in the next issue.

To a slightly lesser extent, the same thing is true for the Greater Las Vegas metro (see Featured Market: Las Vegas in this article).

Investors: Know Your Competition

As an investor, you need to find out the current rents and vacancy rates in the metro where you are considering purchasing. That includes learning what rents your competition is charging. For rental houses and condos on the lower price end, you will compete with multi-unit apartment buildings for tenants. The website provides an excellent quarterly table for the 40 major markets it tracks. This one is for the third quarter of 2010. It includes average rents, occupancy rates, and the change in average rents over the previous 12 months.

Keep in mind that as an active investor, it is essential to do your homework. You'll be wise to engage in real due diligence to see if a property makes financial sense for you.

To help you, I suggest going to the website of Leonard Baron, noted real estate author and San Diego State University Lecturer on real estate. He is often interviewed on major websites such as the Wall Street Journal. He has developed a terrific seven-page due diligence checklist that will help you thoroughly analyze a property that interests you. Just go to his website, and find the chapter listings for his new book on the right side of the homepage. Link to Chapter One, scroll down a little and you will see the checklist which you can print.
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No positions in stocks mentioned.

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