What About the Shadow Market?

We see a lot of articles right now about the shadow market. In general, the term shadow market refers to the raft of distressed housing that must be worked off over the next few years. What does this iceberg of supply mean to investors?

First, let's discuss the problem a bit. Depending on who you speak to, the shadow market consists of 1,000,000 (the wishful thinking crowd's number) to 8,000,000 (the dooms day folks figure) homes that are either in default or will default and have to be worked out of the market before the system can return to normal.

The first point to consider is that many of these homes will never go to market. There are areas with ranks of abandoned partially finished homes that will eventually be bulldozed and razed. There are large numbers of homes in such disrepair that they are no longer true assets or in locations where they won't ever be viable again. These will either meet the bulldozer or stand where they are until they fall down as occurred with many old homes vacated during the depression and has continued to occur in small rural towns that are slowly depopulating. These two factors substantially reduce the number of homes that must be considered as these assets are really irrelevant to the problem.

The next issue is why do we have such an oversupply of homes to begin with? One major factor is the baby boomers are now on the downside trend of producing housing demand. Add to this issue that the echo boomers will not be driving demand in a major way for several more years and you've stumbled on a historic slack period in demand for housing that typifies suburbia.

Finally, demographic interests, economic factors, political factors, and societal interest in lifestyle are weighing in against the suburban household. Greener living is more dense living. Cost efficient living is denser living. "

"Commuteless" living is denser living. Plus, the echo boomers are tired of suburbia. All of this is bad news for raft of defaulting housing. Essentially, what we have is a fire sale trying to create demand where demand is seeping away like air from a balloon.

Not everything is bad. The United States is still growing. People still need homes. Most of these shadow market houses have substantial economic growth near them and as growth goes suburban areas can become increasingly "urban". This implies that demand can be driven by price because in most areas people can conclude that the lack of demand is not forever.

So back to the numbers, with unemployment likely to remain weak even though total employment is growing, the current work off rate of 1,000,000 homes annually or so is likely to continue. So, if we assume the real news for shadow market inventory is that there are really between 3,000,000 and 4,000,000 homes in queue, we are looking at mid 2014 to reach the far side of the debacle. In the meantime values will be weak, falling, or only ticking up ever so slightly. Smart investors will stay away from housing unless they have a very smart strategy to create new value for some segment of the inventory.