Understanding Shadow Inventory: What Banks Hold & What It Means for the Market

Shadow inventory is a term used to describe properties that are typically real estate owned (REO), which means they are in foreclosureForeclosureWhen a homeowner stops paying on a loan used to purchase a home, the home is deemed to be in foreclosure. What it ultimately means is that the ownership of, have been foreclosed on, and are being held by banks to be released back into the market at a later date. The “shadow” part of the term is used because banks often acquire the homes and park them for a number of years, far away from the eyes of the public. This is done in order to generate new interest and higher sale prices when they are finally put up for sale.

Shadow inventory is released here and there. However, as of 2019, there is a minimum of a four-year backlog of bank-owned homes still waiting to be put on the market, according to the National Association of Realtors.

Summary: 

• Shadow inventory is the store of homes that are generally owned by banks and being stockpiled in order to keep housing prices at optimal levels.
• Sometimes, clearing out shadow inventory can become a burden for banks, particularly with properties that aren’t as valuable as some others.
• Working with an agent who specializes in foreclosures is a great way for investors to get the insight they need to get the best of shadow inventory, allowing them to sell it for a good profit.

Handling the Shadow Inventory Issue

Banks often hope to sell off shadow inventory homes for a profit later on. However, they tend to hold onto the homes not simply for that purpose. In many cases, there are simply too many homes stockpiled to release. Putting them all on the market at once could ultimately tank the market, which is great for buyers but not for banks or other home sellers.

Sometimes, banks attempt to sell pools of REOs, even leasing or selling the homes back to delinquent owners in an attempt to clear out some of the inventoryInventoryInventory is a current asset account found on the balance sheet, consisting of all raw materials, work-in-progress, and finished goods that a. The practice, of course, isn’t always beneficial for investors in such pools. They may find themselves saddled with properties that they can’t move. The bank passes the responsibility on, and the investor is left with the fallout.

The Attraction for Investors

Shadow inventory is, however, not something for investors to shy away from. Provided the investor is rational enough, understands the ups and downs of real estate, and is financially capable of purchasing a house at a decent price, they can stand to make a decent profit.

The best way for an investor to tackle investing in shadow inventory is to start working directly with a real estate agent,Commercial Real Estate BrokerA commercial real estate broker is a middleman between sellers and buyers of commercial real estate, helping clients sell, lease, or purchase them. who will almost always know of at least a few properties that will be available in the near future.

As long as the investor holds enough funding to put money back into the property, he can then turn around and sell it for a profit. The goal is to get information from someone on the inside, preferably from an agent who specializes in foreclosures. Banks are likely to be secretive about their shadow inventory. An agent who knows about and understands foreclosures can provide key insights about potential properties and guide an investor to the smartest buys.

Related Readings

CFI is the official provider of the global Financial Modeling & Valuation Analyst (FMVA)™Become a Certified Financial Modeling & Valuation Analyst (FMVA)®CFI's Financial Modeling and Valuation Analyst (FMVA)® certification will help you gain the confidence you need in your finance career. Enroll today! certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional CFI resources below will be useful:

• AmortizationAmortizationAmortization refers to the process of paying off a debt through scheduled, pre-determined installments that include principal and interest
• Fannie MaeFannie MaeThe Federal National Mortgage Association, typically known as Fannie Mae, is a United States government-sponsored entity that was established to expand the secondary mortgage market by making mortgages available to low and middle-income borrowers. It does not provide mortgages to borrowers, but purchases and guarantees mortgages
• Mortgage-Backed Security (MBS)Mortgage-Backed Security (MBS)A Mortgage-backed Security (MBS) is a debt security that is collateralized by a mortgage or a collection of mortgages. An MBS is an asset-backed security that is traded on the secondary market, and that enables investors to profit from the mortgage business
• Non-Performing AssetNon-Performing AssetA non-performing asset (NPA) is a classification used by financial institutions for loans and advances on which the principal is past due and on which no