Recently I found myself in a discussion about real estate with a very knowledgeable real estate investor client. The subject: Shadow Inventory.
A little bit on shadow inventory. Shadow inventory does not consist of foreclosures or short sales that are currently on the market, but rather potential foreclosures & short sales that will be coming on the market.
Many people (including myself) believe the big banks strategically foreclose on properties and list them as bank owned homes for sale in a controlled fashion. This strategy allows for the bank to prevent another substantial plunge in real estate prices.
The problem with this methodology is that there is no ‘real’ way to know exactly how much shadow inventory there is, AND this will only prolong the current market.
Here is what I mean. So let’s use an analogy of a river dam. Before a river dam is built, the river can flow freely and run its natural course. One day, someone makes the decision that the water is flowing too fast and something must be done to control the flow. Man decides to insert dam (slow down foreclosures), and start controlling the amount of water allowed through. The new dam starts to work and the river starts to stabilize back to normal levels, but there is 1 problem. Just upstream from the dam the water is coming into the river at even greater levels before. There is no adjustment in the amount of water allowed to come through the dam, so the river upstream just keeps growing and growing, turning into a significant lake of water that threatens to destroy the dam altogether.
Now, you can add to this mix the foreclosure mess of banks halting foreclosures altogether until they can be sure the foreclosure mills they are using are not falsifying documents. And the lake grows…