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Shadow Inventory Undermining All Major Metro Markets Now

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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."

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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 realfacts.com 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.

Featured Housing Market: Las Vegas

The Greater Las Vegas housing market is perhaps ground zero for the housing bubble and collapse. In 2003-2004, speculators swarmed there like locusts looking to make easy money in what was becoming the hottest market in the nation.

According to a little-known 2005 study by CoreLogic, flippers were playing a major role in the Las Vegas market as early as 1999. Take a good look at this revealing chart from that study.




Notice that in 2004, more than 40% of all sales in Clark County (where Las Vegas is situated) were by flippers who had bought the property within the previous two years. Two other charts from the study showed that nearly 20% of all sales were properties which had been purchased by flippers within the previous six months.

The speculative madness was nicely captured in a May 2005 online article posted by CNNMoney.com. The author described the adventure of a 30-something California couple who had moved to Las Vegas in 2003 after making some money on foreclosed properties purchased in Florida a year earlier. By early 2005, they had purchased 20 properties, most in Las Vegas, having borrowed some $400,000 in down payment money from friends and family when they ran out of cash. She admitted to the author that "it's a risk." But she pointed out that even if the market crashed, "it's not like it's worth nothing."

Although the median sale price of homes rose an incredible 40% in 2004, warning signs started to appear in early 2005 when the percentage of six-month flips began to decline. The market was beginning to run out of buyers at those elevated prices and speculators started to dump condos and single-family homes onto the market. One young flipper interviewed for the CNNMoney article had sold five of his seven properties by the spring of 2005. The reason was that he was seeing the same investors at each new development site. This convinced him that the bottom was about to fall out of the market.

Although median prices continued to rise nearly 20% in 2005, that statistic hid the fact that inventory on the market was soaring and that thousands of speculators were trying to cash out before it was too late. By the spring of 2006, sales volume started to plunge and the market has never recovered. The chart below from mortgagedataweb.com shows what happened to prices and sales volume.



This chart needs to be explained. To read it correctly, you must understand that it captures only sales which were financed with a mortgage. I learned this when I checked with a reliable source at mortgagedataweb. While the chart gives us a good picture of what has occurred in Las Vegas, it does not portray the entire story.

The median sales price and sales volume numbers in the chart exclude all the low-end distressed properties bought as all-cash deals because no mortgage was involved in these transactions. So keep this in mind as you review the chart.

What Is Really Going on in Las Vegas?

To truly understand the Las Vegas market, it is necessary to dig beneath sales volume and median price figures. What I found is that the housing market has been kept from collapsing by investors purchasing most of the low-end distressed properties with cash. The Greater Las Vegas Association of Realtors (GLVAR) reported that in January of this year an incredible 51% of all resales were bought with all cash. They pointed out that this percentage had been rising steadily for a year.

Cash buyers have been focusing on the thousands of bank REO properties and short sales hitting the market each month. The website dqnews.com is a widely read and highly regarded source of data for major housing markets. They reported that 56% of all December sales were bank-owned or bank-serviced foreclosures. It was the third straight month that this percentage had risen.

These foreclosed properties were overwhelmingly sold at prices substantially below the median price level and roughly 36% were under $100,000. Also, the GLVAR reported that more than 26% of purchases in January were short sales. Taking these two reports together, only one out of four purchases is what we might call a normal sale.

This enormous appetite of cash buyers for foreclosure properties could not prevent the median sale price for single-family detached houses from dropping to $72 per square foot in December. That figure was at the lowest level since November 1996.

Although the median price of $130,000 for single-family homes in December was only 4% lower than a year earlier, it was $5,000 lower than the previous month. Back in June 2006, the median sale price had peaked at $312,000. That is an incredible collapse.

The median price for condos in December was down a whopping 14% from the previous year to $62,700. Why? It was partly due to the supply, but largely because it is much harder for investors to find tenants for a condo than for a detached house. Most homeowners who have lost their property to foreclosure or a short sale prefer to rent a house, not a condo.

Is It Time to Leap Into the Las Vegas Market?

With median prices having plunged so far since mid-2006, many investors are probably thinking that now may be a good time to invest in one or more properties in Las Vegas. Surely we must be near the bottom.

It isn't really that simple. In order to make an informed decision, you need to have a good sense of what is coming down the pike. To do that, it is essential to consider the so-called "shadow inventory." As I've written in a previous Minyanville article (see In Reality, Housing Is Not Even Close to Stabilizing), this shadow inventory is very real and extremely important.

Go back to the table on the opening page of this report (Top 10 Counties). It shows that in Clark County (where Las Vegas is situated), nearly 33,000 first liens were seriously delinquent by 90 days or more at the end of the third quarter of 2010. An additional 32,000+ properties had been placed into default by the banks but had not yet been foreclosed. That is a total of more than 65,000 properties which are almost certainly going to be thrown onto the market as either foreclosures or short sales -- 18.1% of all properties with first liens.

Let's not forget to add in all the bank-owned properties. Most of them are not currently on the MLS active listings. It is not easy to determine the full count of bank-owned properties since the banks don't like to publicize that number. The website foreclosure.com, listed a total of 15,486 foreclosed properties for Clark County on February 20 of this year. Adding this number to all those not yet foreclosed gives us a total of more than 80,000 distressed properties that will be hitting the market in the next few years.

Do you think the Las Vegas housing market can absorb that many properties without a further decline in prices? No way. Keep in mind that only 3,214 existing single-family homes, condos and townhouses were sold in January according to GLVAR. To clear so many distressed houses not yet on the market will require prices to drop.

What's more, as I mentioned earlier, all-cash investors have kept prices from completely collapsing. Who are these investors? In mid-November, I talked with Glenn Plantone, a broker, investor and major player in the Las Vegas market. He stated that he had a database of roughly 2,000 investors thinking of buying. More than 90% of his investor deals were with all-cash buyers. Roughly half of them were from other countries. Many were from Canada and a considerable number from India. He told me that the American investors were looking for a better return on their money.

His focus was on distressed properties. Because investors had run up the prices of low-end foreclosures, he had shifted into more short sales. His strategy was to buy distressed properties, do light rehabilitation, and then resell them to eager all-cash investors. Before he sells the property, he brings in a tenant under a lease/option-to-buy arrangement. Many had lost their own home through foreclosure or short sale. He explained that they willingly paid several thousand dollars for the option because it was credited toward the purchase price if they decided to buy. The tenant was also willing to pay an above-market rent because a few hundred dollars would also be credited each month to the purchase price if they bought the house.

Now you may be wondering that if it is possible to buy a house and find tenants willing to pay above-market rents, why not do this? That is a good question.

It is not too difficult to locate a decent house to buy in Greater Las Vegas for $100,000 to $150,000 if you do some careful searching. Foreclosed properties under $100,000 are also plentiful. But you certainly want to avoid the trustee sales on the courthouse steps where you would end up bidding against other investors. That's not smart.

The important question is whether you can find a quality tenant in a reasonably short time. And what kind of rent will your property command? Be very careful talking to brokers or property managers with the hope of getting accurate market data. They are not an unbiased source of information. So where can you turn to get reliable numbers?

Before deciding whether a single-family house or condo makes sense as an investment for you, it is imperative to examine comparable properties which actually leased within the last three months.

I've done some digging and discovered that you can make use of Las Vegas realtor Renee Burrows' terrific search tool on her website. Just go to her site and press #8 to search for house rentals that have recently-signed leases. You can then input whatever parameters you want to look at including geographical area and the date on which a signed lease was closed on a property. You will learn both the listed rental amount asked by the owner and the actual amount agreed to by the tenant. I tried the search tool and it works great. She also has some good statistics and charts.

After obtaining this up-to-date rental market information, you can then put pencil to paper and use conservative rent, vacancy and expense estimates. Make sure that the cash flow on the property will be positive.

Advice for Investors

If you are comfortable with the scenario I've been painting for the Las Vegas housing market and the likelihood that prices could decline 10% or more in the next year, then do your due diligence work. Run a cash flow analysis with the tools I've provided. If you want to make an offer on a property, I suggest that you go in with a low-ball bid. Here's why.

I had been closely following a decent foreclosure property in New Haven, Connecticut offered by HUD. The price had been lowered to $98,000 in August 2010. I lost interest in the property but then recently learned that it had been sold in October for $55,000. Some smart buyer went in with a low-ball bid and guess what -- HUD said okay. Fannie Mae, Freddie Mac and mortgage servicing banks might do the same.

However, if you're likely to toss and turn worrying about how low prices might go, here is my advice. Sit tight for now. Wait about 12 months and see whether the huge shadow inventory has been whittled down. You can then revisit the situation and decide whether it is finally time to invest in Las Vegas. I will be updating the Las Vegas market.

Advice for Homeowners Hoping to Sell


Countless homeowners are understandably frustrated with how long their property has languished on the market. They may have listed it months ago but have gotten little traffic. Some may have dropped their asking price once or even twice without success. Others have pulled their house off the market with the idea of waiting until the market strengthens in the late spring.

Is it a smart move either to refuse to drop your asking price or to keep your home off the market with the hope that buyers will be willing to offer more as the peak selling season approaches?

After researching numerous major housing markets, I have found that many sellers are listing their properties as if this were 2006. It just doesn't work. The following data from ZipRealty shows the decline in median asking prices that has occurred in six major metros.



Notice that the median listing price for properties actively for sale dropped steadily in all six of these major metros. The largest decline actually occurred in San Diego, another metro tracked by ZipRealty, where the average listing price plunged from $649,000 in July 2009 to only $379,000 in January 2011. Even the relatively strong market in Washington D.C. saw average listing prices drop 10% between November 2009 and January 2011.

Home sellers need to seriously consider these figures. Listing prices are falling under the pressure of buyers saying "No thanks" to the asking price. While there may be other factors, the main reason your house is not selling is because it is priced too high for your particular market.

If you are a homeowner hoping to sell your property, it's essential to take a good look at your situation and the state of your local housing market. Just about any house will sell if it is properly priced. This means what an active buyer in the market is prepared to pay for your property. Unfortunately, that buyer does not care if you have financial problems or that you don't want to consider a short sale.

You need to do your homework and ask these questions: What are truly comparable homes actually selling for in your neighborhood right now? How likely is it that your market will strengthen when the peak selling season arrives? If prices were to decline another 5-10% or more in the next year, would you feel awful if you delayed selling?

To answer these questions, you'll have to find the most accurate information that can inform you about the state of your market and where it is probably heading. Local brokers may not be the best source of market data for your property. They are not disinterested parties and may be looking to get your business. At the very least, compare what they tell you with what you read in this report.

In each issue of this report, I will try to provide relevant data that home sellers or potential sellers find useful in deciding what to do. The section of the report geared to investors has obvious implications for you as a seller. I will be doing a feature on all of the nation's 25 largest metropolitan areas over the next year. Stick with us and we'll help you to make a smarter decision about selling your property.

Next Issue: Miami-Dade County
Coming Soon:
Chicago
Phoenix
Washington DC
San Diego
New York City Metro area

Subscribe today to get every issue of the Housing Market Report by Keith Jurow for the very low price of $129 for 6 months (12 issues) or $199 for 12 months (24 issues). You can also purchase single issues for just $29. Pre-purchase some of the "coming soon" and we'll send it to you as soon as it's published. Learn much more about the Housing Market Report.

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