One resolution I had coming into 2010 was getting a better number for the shadow inventory in Southern California. It is rather clear that shadow inventory is a real factor in the current market but how big is this inventory? Can we really get an accurate figure for a large area like Los Angeles County? Well this is something I set out to do. The trouble with the current numbers is they are derived from a variety of sources. First, you need to pull MLS data for each of the 269 zip codes in Los Angeles County. This is the largest county in California with approximately 9,700,000 people living here. It provides an excellent cross section of all the ills California housing is currently experiencing. If we can get a handle on the actual shadow inventory for this area we can put together a better picture of the housing market for 2010.

The California housing market for 2010 is going to deal with the heavy flow of Alt-A and option ARM products hitting in conjunction with prime mortgages that are no longer able to remain current in this troubled economy. Let us first define shadow inventory at least how we perceive it. Some narrowly define shadow inventory as REO properties that are not on the MLS. This definition is wrong and too limited because it misses the bigger piece of the pie. That piece includes homes scheduled for auction and homes with a notice of default filed (NOD) that have yet to make it onto the MLS. Some argue that these homes are not shadow inventory because there is a chance they will become current and have no need of being on the MLS for sale. This is misguided because only 3 to 5 percent of these mortgages will be cured so the bulk will eventually end up as foreclosures and will get on the MLS at some point. This is what we can measure. Yet I would also argue that there is another layer of homes that are currently 90+ days late that have no NOD filed and these are also part of the shadow inventory.

I painstakingly over a few days pulled data on all 269 zip codes for Los Angeles County to get a better picture of what is really going on. Data was pulled from a variety of sources including the MLS, foreclosure filings, and DataQuick to name a few. Putting this together gives us a fascinating picture:

Here is the real story. The purple column is the MLS viewable data by the public. According to this data L.A. County as of the start of 2010 has approximately 19,400 homes. In November 6,257 homes sold in the county. This gives us some 3 months of inventory (a healthy amount). Yet that is probably where the normalcy ends. Let us go through each column. First, we have more homes in pre-foreclosure than the entire MLS data. These are homes that now have a notice of default filed. Next, we have homes that have an auction scheduled. These homes are deeper in the foreclosure process. This number is enormous and by itself is almost twice the size of the MLS data. Next, we have bank owned homes that is usually what some look at when they define shadow inventory. It becomes clear why some like to skew the data. Banks are lagging and when you only look at REOs, then it doesn’t look so bad. Yet this assumption falsely sits with the notion that the NOD and auction column are somehow going to miraculously cure with some programs like HAMP. Yet the data on HAMP is proving otherwise with roughly 4 percent of trial modifications becoming permanent. Add the shadow data columns up and you get a hidden inventory that is nearly 3 times the MLS data. The difference is 3 months of inventory versus nearly 14 months of inventory.

What does this mean? There is a tremendous amount of property in distress. Until this calms down the market is going to remain highly volatile. I also wanted to look at which zip codes had the largest number of shadow inventory in relation to the MLS data. As you would expect, more troubled areas have a larger number of shadow inventory but you’ll be surprised how many zip codes have more shadow inventory than MLS data:

Now this data is fascinating. Let us dig around the data to help explain what is going on. First, you’ll notice that the top 10 shadow inventory zip codes all fall around $300,000 except for one area. This would be expected since many of these areas are the most troubled. Let us use one of the examples above with Pacoima. Pacoima on the MLS has 118 properties listed. In the latest month of data 62 homes sold. So to the public, this looks like a city with less than 2 months of inventory, a very healthy market. Yet if we add up the shadow data a very different picture emerges:

NOD (318) + Auction (630) + REO (148) = 1,096 shadow inventory properties

Add in the shadow data with the MLS data and you go from below 2 months of inventory to a whopping 19.5 months of inventory. This is why this is so crucial. It is the difference in a relatively healthy market and a very unhealthy one.

As I mentioned before, I pulled data on all 269 zip codes in Los Angeles County. I wanted to get a better sense how dispersed shadow inventory really was. Some want to paint a picture that only poor areas are subject to large amounts of hidden inventory. That is not the case:

Out of 269 zip codes only 26 zip codes had less shadow inventory than what was appearing on the MLS. 206 zip codes actually have shadow inventory that is twice the size of the publicly viewable MLS data. Even more troubling 75 zip codes have shadow inventory that is five times the MLS data. This data is compelling enough to make you pause because what is being presented is not the entire picture.

Let us get a better picture of L.A. County by pulling up demographic information:

In L.A. County 1.178 million homes have a mortgage. Over 350,000 have no mortgage. Of those with a mortgage over 400,000 are underwater. This shows us a market that is in high distress. Simply looking at the MLS data and going by what the banks are telling us is really giving you a distorted picture of reality. The market is saturated with distress inventory to the point of overflowing the above charts. Over 90,000 homes with a mortgage are now 90+ days late. And here is where we jump even deeper into the rabbit hole. Of active distress properties (NOD + scheduled auction) we get roughly 60,000 homes. We’ll leave out the nearly 9,000 REOs since these are now fully categorized as “foreclosed” and are owned by the bank. So you have another 30,000 homes in L.A. County that are 90+ days late but have no notice of default filed. What is going on here? It could be that it is still early in the process. But what is more likely is that banks are simply stalling out the process. Unfortunately we do not have access to this data since this is where banks keep their Enron style accounting statements.

If you add the entire potential data:

90+ days late but not NOD + NOD filed + Auction Scheduled + REO = Approximately 100,000 homes

Los Angeles County has roughly 100,000 homes as part of the shadow inventory. This is an enormous number given that the MLS only lists 19,400 homes. In other words, the potential pool of properties in the county is five times as large as the public is currently seeing. And these are properties that are in distress. At the very minimum this is a borrower that has missed three mortgage payments. The likelihood of future foreclosure is extremely high. How many of these homes are Alt-A or option ARM connected? Hard to say but we can easily estimate that the vast majority of the shadow inventory that is also part of the Alt-A and option ARM circle is virtually assured to default.

Some areas seem to have very little shadow inventory but it is in the area where the fewest people live:

Now as you will notice the median price of all these areas is solidly above the $1 million mark. But even here, you’ll notice the large amount of inventory. A place like Beverly Hills with the iconic 90210 zip code has over 28 months of inventory if we also include the shadow data. But this isn’t uncommon in high priced areas.

Now it would be cumbersome to show all 269 zip codes here but given that I have covered Culver City, Pasadena, and Santa Monica in the past I’m sure many of you would like to see that data:

The same patterns play out in these areas. Factoring in the shadow inventory the data takes a different shape. There are many factors that are going to determine where housing will head in 2010 but the above is rather clear. Shadow inventory is large in L.A. County and I would imagine an analysis of many other counties would yield similar results.

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