The National Association of Realtors'® (NAR) have taken a stab at estimating just how wide and deep the much discussed "shadow inventory" of housing may actually be.

 Shadow inventory is generally described as the number of homes in bank inventory waiting to be sold plus the homes in that have been foreclosed but for a variety of reasons (redemption periods, marketing or legal reasons) are being held off the market and homes where the mortgages are delinquent and are likely to eventually be foreclosed. The shadow inventory is considered to be a marker for how long it will take for a depressed housing market to return to normal.  

The study, conducted by NAR Research Economist Selma Hepp, estimates shadow inventory on a state-by-state basis using the following data sources:

• Numbers of 1st lien loans in the foreclosure inventory and a share of delinquent loans anticipated to enter foreclosure based on Lender Processing Services (LPS) roll rates.
• The share of delinquent loans already on the market based on NAR's Realtors Confidence Index (NCI) in which Realtors report what share of their sales were short sales or foreclosures.
• Loan modifications as estimated from the Office of Comptroller of the Currency/Office of Thrift supervision Mortgage Metric Q3 2010 report; the assumption is that 30 percent of the state level number will default.
• REO not currently on the market based on state level share of existing sales that are foreclosures from the NAR's RCI.

Hepp points out that the foreclosure epidemic, while a national problem, has not been evenly distributed across the country.  Four states, Arizona, California, Florida, and Nevada have suffered highest foreclosure rate and account for 42 percent of the foreclosure inventory today; adding in Illinois, New York, and New Jersey brings that number up to 60 percent.  Delinquencies seem to be easing; in the last quarter of 2010 serious delinquencies fell in all but four states and the national rate is down 38 percent.  As a general rule those seriously delinquent loans did not begin to perform, rather they entered into loan modifications, were sold pre-foreclosure or progressed from delinquent to foreclosed. As a result of the last disposition foreclosure inventories in all states rose between the third and fourth quarters of 2010.   

The two states with the largest shadow inventory are Florida (441,461) and California (227,964), followed by Illinois (121,226), New York (107,485), and Texas (93,761).  The issue in Florida, Hepp says, stems largely from the sheer size of the foreclosure inventory which takes a long time to clear while in both Florida and New York the pending foreclosures are inflated because of an extended time for delinquencies to reach foreclosure.  On the other hand, Nevada and Arizona, despite ranking in the top three states for foreclosures for several years, are 16^th and 11^th in shadow inventory because their inventory is moving faster through the pipelines and makes up a larger share (55 percent in Arizona and almost 70 percent in Nevada) of all home sales.

However, the actual number of homes in the shadow inventory is not the problem.  The difficulty lies in how long it will take before those homes are cleared.  Until that happens, they will continue to exert downward pressure on prices and increase the marketing time of non-distressed properties.

Hepp derives the number of months for each state to rid itself of its inventory by dividing the inventory by the monthly number of distressed sales.  The numbers range broadly from seven months in Nevada to 51 months in New Jersey. Much depends, Hepp says, on the saturation of distressed sales. As New Jersey has reported that about 20 percent of existing home sales over the last year were distressed sales it will take a longer period for the shadow inventory to clear than at Nevada's 70 percent rate mentioned above.  At that rate the current shadow inventory would clear in 7 months.  While no other state comes close to New Jersey, other states facing protracted number of months to clear inventories are New Mexico (38), New York (34) Colorado and Rhode Island (32), and Delaware (30).

The study concludes that it is very likely that saturation of distressed properties will continue to vary widely among states but also vary within states from month to month. Also, the months' supply estimate is dependent on levels of monthly home sales by state. The estimate presented here is based on 2010 existing home sales, thus any change in existing home sales would impact clearance of shadow inventory. And finally, there continue to loom various issues which may also affect shadow inventory and how long it takes to clear it. One current issue is the controversy over banks' foreclosure processes and documentation which has a significant impact on what happens with shadow inventory.