The shadow inventory is probably one of the most pressing issues determining the future of real estate prices. In recent weeks, mostly those with close ties to the real estate industry, have started having faith in the banking industry that somehow incompetent banks that wouldn’t know a loan modification if it bit them in […]
The shadow inventory is probably one of the most pressing issues determining the future of real estate prices. In recent weeks, mostly those with close ties to the real estate industry, have started having faith in the banking industry that somehow incompetent banks that wouldn’t know a loan modification if it bit them in the rear are going to somehow systematically pump out real estate in an orderly fashion. Really? This of course is based on their tiny subset of localized information. I’ll get into the macro reasons later why the crutch holding real estate up right now is merely temporary. The argument is basically a gut reaction of, “well I know banks are going to slowly put homes into the market because they can.” The Popeye argument unfortunately doesn’t work here. This is similar to the old NAR argument that real estate prices always go up because they always go up. In reality the U.S. Treasury and Federal Reserve have purchased a window for banks and toxic inventory. That is it.
Banks Becoming Greedy Dad or Loser Dad?
Think about the issue for a second. 1 out of 10 homes in the U.S. is either in foreclosure or in some stage of distress. Who is losing out? Many banks are merely puppet fronts for mortgage backed security holders and do you think they are happy that their cash flow is suddenly being suffocated? It is a calculated short-term plan if you can even call it that. Instead of taking a $200,000 write-down on some Real Home of Genius they would rather take a monthly $2,000 hit when no mortgage payment comes in. But how much time does that buy? This notion that suddenly banks are going to be landlords is absurd. What do you think this is going to do to an already weak rental market? Take a look at vacancy rates:
This is the highest rental vacancy rate going back to 1956! Yes, great time for banks to be landlords. This is assuming they even rent the places. Knowing how they operate they’ll be doing NINJA rental applications and end up with Bandos in their properties. Probably won’t even qualify because of their loan sharking fees! It is the circle of crony banking life. We can rest assured that they are running Pollyanna scenarios where rental rates will go up in a few quarters. That argument is absolute nonsense. We can even break down the vacancy rate by region:
With places like California, Arizona, and Nevada holding a giant chunk of Alt-A and option ARMs these loans are already exploding internally like a volcano spewing their crap lava on the bank balance sheet. If the strategy is to convert some $1 trillion in Alt-A and option ARMs into rentals they will saturate the rental market like putting hot sauce on a Bhut Jolokia. Those in the real estate industry give too much credit to their banking masters who by the way, created this damn mess in the first place. Now we are to believe they will somehow go from HGTV addict flipping maniacs to a more subdued prudent investor by becoming a buy and hold cash flow investor? They will not.
As someone that owns rental property I can assure you that the turbo capitalist on Wall Street would have no patience in fixing toilets or repairing sinks or even getting their hands dirty since they wouldn’t even know what to do with construction tools. There model was a hyper ADHD sucker mania that would lure a herd of sheep until the sheep caught wind that they were being led off a cliff. So hopefully that puts a perspective on this rental argument but I know just like people denied shadow inventory in the early days, some people will continue to believe this argument even though it has no merit.
I Can Hold Inventory Forever and Ever and Ever!
The next argument is based on banks holding out inventory forever. Again, who owns the security? In some cases, the bank is simply servicing the loan. Do you think investors will be happy with no monthly nut (dividend) from their security? And the non-performing loans that banks have at a certain point have to come into the shining light of day. Again, let us use an example. A bank gave a loan on a craptastic home for $700,000 at the peak. The home is now worth $400,000. The owner knowing about strategic defaults suddenly decides to stop paying his mortgage. If the bank sold the home in today’s market, they would only get $400,000 and need to writedown $300,000 of the note. So instead, they hold the note at face value (which is what many are doing) but at the same time, they are losing out on a $4,000 or $5,000 monthly payment. After one year, the bank will eat $60,000 in lost payments but they can still claim the home is worth $700,000. See how this by default can’t go on forever? They are betting on a resurgence of the bubble but this is another delusional real estate industry argument.
First and foremost, our economy is in shambles if you haven’t noticed. Who in the hell are you going to sell these homes to? Anytime you hear a real estate puppet tell you that banks know what they are doing simply ask them what industry is going to turn our economy around? In most cases they will have no clue. And by the way, the jobs report last week was horrific. We have now lost some 7.2 million jobs officially in this recession but Mish Shedlock and Zero Hedge and Mybudget360 caught a major revision to the jobs report. It actually turns out that they had to revise by get this, a gigantic 824,000! In other words, we have officially lost over 8 million jobs since the recession started. Turns out we have shadow inventory in real estate and also in jobs. California currently has 2.2 million officially unemployed but in reality, the true unemployment and underemployment rate for the state is upwards of 23 percent:
Let us now focus on California real estate. The reason homes appear to be selling at a brisker pace are the following:
(1) $8,000 tax credit (most inefficient waste of taxpayer money – you can thank the real estate lobbying arm and our sold out Congress)
(2) Federal Reserve pushing mortgage rates to historical lows (killing the U.S. dollar by the way)
(3) Shadow inventory temporarily giving the illusion of lower supply
(4) Cheerleading from the real estate industry again
(5) Pent up demand for people just itching to buy (big jump with first time buyers)
(6) Seasonal boost (spring and summer always help housing)
Combine this funny money elixir and you get some stability in prices. But make no mistake this is coming at a gigantic price. Today we are going to examine 3 homes in the Westside of Southern California. So-called prime country USA. These areas have been resistant to the pain of the Inland Empire but have seen prices come down. These areas also have some of the biggest shadow inventory in the world. As they say, the bigger they are the harder they foreclose. Today we salute you Santa Monica, Culver City, and Rancho Park with our Real Homes of Genius Award.
Santa Monica
One of the prime locations of the Westside is Santa Monica. In fact, there are many aspiring 30000k millionaires that rent a tiny studio apartment, take a phone with this prime area code, and lease a car beyond their means to live the all hat and no cattle life. You have to be a really prime city for that kind of action to happen. But Santa Monica is not immune to shadow inventory. On the MLS, I pull up 311 listings. But what lurks in the shadows?
Notice of Defaults: 97
Auctions: 61
Bank Owned: 24
Turns out like in life, a lot of action is happening behind the scenes. Let us look at a home with a Notice of Default that isn’t on the MLS:
This is in a good location of Santa Monica. But even that isn’t enough. This is a 2 bedrooms 2 baths home that has 1,093 square feet. If you look at the loan history we see a lot of action:
The home last sold for:
Sold 12/21/2005: $1,870,000
So let us retrace some steps here. The home looks like it was initially purchased with a 70% LTV structure:
Sales Price: $1.87 million
1st note: $1.309 million (70% of home value)
This was done in December of 2005. But in August of 2006, not even a year later we see the home equity monster machine come out:
Chevy Chase Savings: $1.5 million (1st)
National City: $220,000 (2nd)
Good times! The home is still “worth” $1.87 million supposedly so now we simply went in and yanked out $220,000 on that second and instead of only having that $1.309 million mortgage it is now up to $1.72 million. So we now have:
$1.87 million – $1.72 million = $150,000 of equity left
This of course is assuming the real estate never goes down go-go days. So are we finished? Nope. In May of 2007 they go back and yank out the little that is left in equity for a 3rd mortgage of $110,000. Which brings us full circle. The home now has a notice of default filed on it for:
July 2009 NOD: $65,562
If these people want to bring the home current, they have to pay that NOD (plus whatever additional payments they have missed). If this goes on a few more months, we are going to go up to $100,000+ just to get the place current. It looks like additional work has been done on the place since it is registering 7 rooms (although Zillow has 2 for the moment but this also includes bathrooms etc). Either way, this home is not on the MLS and is already in pre-foreclosure. Shadow inventory is real in every segment of the market, you just need to know where to look.
Culver City
Culver City is always a fun place to look at because this is where you have the bulk of “professional couples” looking to buy segment. This is the couple making $125,000 to $175,000 that just “needs” to buy so they can say, “I’m from the Westside” like some SoCal rapper. Oh, and they also “need” to lease the Mercedes and BMW. By the way, that isn’t enough for a $600,000 home but some think it is. Many are just itching to buy that home like a gambler needing to double down on that eleven and put their financial future at risk. If we look up Culver City on the MLS we will find 88 properties being listed. But this part of the Westside doesn’t come close to the prime style of Santa Monica. Let us dig into the shadows here:
Notice of Defaults: 77
Auctions: 72
Bank Owned: 16
The shadow inventory for Culver City is twice as big as the actual MLS listings. This time let us look at a bank owned home that isn’t on the MLS. We only find 5 foreclosures on the MLS.
The home we will examine is bank owned and has the following details:
05/06/1998: $180,000
05/01/2006: $620,000
This place is right next to the freeway. Any closer and you will be driving in the carpool lane. The home has 2 beds and 1 bath and has 1,157 square feet. For 2 bedrooms near a freeway in Culver City and a price tag of $620,000? No wonder why it was foreclosed. Let us look at the details:
Did you do the math? This was a freaking 100% financed deal on a $620,000 home! And you wonder why California finds itself in this current mess. The winning bid hit in August of 2009 and was taken over for $475,000. Where this property is at is anyone’s guess because it isn’t listed on the MLS. Shadow inventory we love you!
Rancho Park
Rancho Park (90064) is one of those trendy L.A. neighborhoods. Not prime like Santa Monica or Brentwood but still technically part of the Westside. On the MLS we find 90 listings. Let us look at the shadow inventory before showing an example home:
Notice of Defaults: 37
Auctions: 30
Bank Owned: 4
Seems to be in better shape than Culver City. Let us mix it up with a condo this time in pre-foreclosure.
This condo in some sources is listed as an “apartment” so it may be a condo conversion (it’s off Purdue so some of you in the area may know). Either way, it is now full of condos one way or another. The condo in question is a tiny 1 bedroom 1 bath place that has 548 square feet! Let us look at some sales history:
Sold 01/09/1995: $106,500
Yet this number isn’t the final sale. Also, if the conversion occurred it must have been a very long time ago. If we look at the note details it looks like this condo was moved around in other forms:
Whatever the circumstances Citibank put a loan on the place in 2005 for $243,000. By sheer luck another go-lucky lender put a $356,250 loan in August of 2006 on a 1 bedroom condo in Rancho Park that is no bigger than a college dorm room. Then what happens? Brilliant Wells Fargo doing their best impression of Jim Cramer gives the borrower a $71,250 second mortgage (kiss that goodbye) on this condo right before the crap hits the fan! So by the start of 2007 this place had a wicked $427,500 in mortgages.
Like thousands of other stories this condo is now in pre-foreclosure. The notice of default was only filed a few days ago in late September for $29,249. So the clock is now ticking to get this thing current. Do you think this place is going to sell to bring those notes current? Wells Fargo is out for probably 100 percent on that stupid second mortgage.
Now who would buy this place when in the same area another condo that has 647 square feet is selling for $315,000?
Frankly the $315,000 is still too high for a 647 square foot condo.
Either way, these are concrete examples of shadow inventory in prime Westside Los Angeles. People can deny it all they want but much of this is coming to a market near you and many analysts believe the same thing (typically those who don’t stand to make dough on a 5 or 6 percent commission).
Today we salute you Santa Monica, Culver City, and Rancho Park with our Real Homes of Genius Award.
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Real Homes of Genius: 3 Westside Shadow Inventory Homes. Santa Monica, Culver City, and Rancho Park. Banks will not Hold Inventory Forever.
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