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Six Reasons to Fear the Overhang of Unsold Houses

Peter Coy

The huge “shadow inventory” of unsold homes doesn’t seem to scare people the way it used to. Home prices are rising and builders are ramping up production. The number of properties for sale is the smallest in a decade. In an excellent article on Nov. 29, Bloomberg’s John Gittelsohn and Prashant Gopal reported that some housing doomsayers are recanting their words.

Real estate professor Susan Wachter is one of those erstwhile doomsayers. She thought that once the big banks resolved legal issues that had stalled foreclosures, a wave of homes owned by banks would hit the market, pushing down prices. “I was wrong,” Wachter, who teaches at the University of Pennsylvania’s Wharton School, told Gittelsohn and Gopal.

Paul Ashworth, chief U.S. economist for Capital Economics, has also changed his stripes. He notes that an Obama administration plan has made it easier for people to refinance, so fewer are walking away from their homes. “We were originally skeptical,” Ashworth wrote to clients. “But we have to admit that it has made a significant difference.”

It may be a little too soon, though, to cast off doubt and join the real estate recovery celebration. Shadow inventory remains a very real threat to housing’s future. Here are some reasons for worry:

1) The foreclosed houses that are selling are the best-maintained ones, which fetch the best prices. Banks are still sitting on a ton of homes that have been neglected and are falling into disrepair, says Joshua Rosner, a bank analyst at Graham Fisher in New York. Selling those will depress the market and force banks to recognize big losses, Rosner says.

2) An unknown number of homes is being rented out because the owners can’t sell them. They aren’t counted in shadow inventory. Add them in and the overhang of properties ready to hit the market looms larger.

3) Builders, eager to get back to business, could take the signs of recovery too seriously and once again overbuild, warns Nela Richardson, a senior economic analyst with Bloomberg Government. She notes that the price increases are occurring “on very little volume” and says that with mortgages hard to get, those without high credit scores and a big down payment are still frozen out of the market. “I would hate for the builders to become speculative at any point in this cycle,” Richardson says.

4) “Lending is tight because the regulators are beating the banks to death,” says Christopher Whalen, senior managing director at Tangent Capital Partners in New York. Convoluted foreclosure processes that require judges’ approval in states like Connecticut are also weighing on the market and will continue to do so, says Whalen.

5) A softening of the economy could easily kill the nascent housing recovery. “I’m still worried about home price declines,” Yale University economist Robert Shiller told Bloomberg. “It’s funny how people have so much confidence in the recovery. History shows that these markets are hard to predict.”

6) The rebound in home prices will remain uncertain as long as potential supply is bigger than potential demand, as seems to be the case today. “The best cure for any market meltdown is to let prices fall to whatever level is needed to clear it,” economist Anthony Sanders of George Mason University told Bloomberg. Because that hasn’t happened, the real estate recovery might just be a house of straw.