Excerpted from Nick at the wsj.com:

Listings of foreclosed properties have fallen in 17 of the last 19 months through July, according to research firm Zelman & Associates. Listings are down 47% from their October 2009 peak and by 23% from one year ago. Banks are selling more homes to investors at courthouse trustee sales, rather than taking them back themselves. They’re also approving more short sales, where the property is sold for less than the amount owed.

“If you don’t understand the shadow inventory, it’s very ominous and concerning,” says Ivy Zelman, chief executive of Zelman & Associates. “But if you understand the flows and how it is brought to market” it looks less intimidating, she says.

Nationally, Barclays estimates that the number of bank-owned properties will decline a bit more this year, before accelerating next year to a peak of around 575,000 in early 2014.

Meanwhile, as the shadow inventory has dropped over the past year and as banks and states have slowed down the process, demand has picked up. That’s especially the case for foreclosed properties at low price points that can be held as rental properties by investors, or rehabbed and flipped for a profit. Investors are raising billions of dollars to buy homes in hard-hit markets such as Phoenix, Atlanta, Las Vegas, and across Florida and California.

“What most of the bears aren’t focused on is understanding demand,” says Ms. Zelman. This is one reason she’s turned bullish. Her most recent forecast calls for a 5% increase in home prices this year, a change from her initial forecast of a 1% decline when the year began. Getting a handle on demand “allows us to have a complete picture of the housing market.”

Finally, shadow inventory isn’t a national phenomenon. Instead, it is heavily concentrated in particular markets—and within those, in particular submarkets. To the extent banks to ramp up the foreclosure process, the shadow is more likely to resemble a “tornado” than a “flood,” as it will strike particular communities while bypassing others, says Jeffrey Otteau, president of Otteau Valuation Group, an East Brunswick, N.J., appraisal firm.

So when people use the “shadow inventory” trump card to argue that housing is poised for another decline, it’s important to be precise about which market they’re talking about. “It’s not like you have all these properties distributed all across the country,” says Michael Sklarz, president of Collateral Analytics, a Honolulu-based research firm.

Buyers in Santa Monica, Calif., shouldn’t “expect a flood of foreclosures to come onto the market,” says Mr. Sklarz, even if neighborhoods just a few miles away in South Los Angeles do face a larger backlog of foreclosures. “You really have to look at it market by market,” he says.

This excerpt is from part 2 of Nick’s three-part series:


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