The concept of supply and demand is relatively easy to understand. It applies to real estate as it applies to any other industry. We must look forward to determine the upcoming supply of housing inventory just like every other industry does. As an example, let’s assume I own a hardware store in town. I have done $1 million in retail sales each and every year for the last ten years. What should I budget to do in sales over the next twelve months? Approximately $1 million seems like the correct answer. However, if I found out a Loews or Home Depot was building a store in the vacant lot across from my store, should I change my planned budget? Of course I should.

What does this have to do with the current real estate market? There is a ‘Home Depot’ being built as we speak. It is called ‘shadow inventory’.

‘Shadow inventory’ consists of homes that are not yet on the market but fall into one of these categories:

• Houses that have not come to market because the homeowners didn’t put their homes up for sale in the last few years hoping that by waiting they will get a higher price.
• Homes that have already been reposed by the banks (REOs) but not yet on the market.
• Homes that are in already in the foreclosure process but have not yet been reposed by the banks.
• Homes that are 90+ days behind on their mortgage payments (less than one percent will ever catch up. 99% will become a distressed sale).

What number are we talking about?

Pent-up Selling Demand

Zillow just recently released a survey on the category of ‘pent-up selling demand’. They asked:

“If you saw signs of a real estate market turnaround in the next 12 months, how likely would you be to put your home up for sale?”

The responses extrapolated to show actual numbers:

• 5.3 million home owners would be ‘very likely’ to put their home up for sale
• 6.1 million would be ‘likely’
• 10.6 would be ‘somewhat likely’

By comparison, 5.2 million existing homes were sold during 2009.

Assorted Distressed Properties

There have been several organizations that have attempted to quantify the other category (delinquencies, homes in the foreclosure process and REOs). Here are their findings:

• The Mortgage Bankers’ Association believes that there are 4.3 million homes in this category.
• Barclay’s Capital puts the number at 4.7 million.
• Capital Economics says 5.5 million.
• Morgan Stanley, in a very recent study, claims 8 million.

Total Shadow Inventory

If we take the lowest number in each category, there could be an additional 9.4 (5.3 + 4.1) million homes entering the market.

Again, by comparison, 5.2 million existing homes were sold during 2009.

What does this mean to you?

If the concept of supply and demand applies to real estate, there will be a tremendous downward pressure on prices.