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‘Shadow market’ may undercut real estate rebound

Only 30 percent of foreclosed homes are currently on the market nationwide. Could the backlog of hundreds of thousands of empty or rented homes swamp recovery?

By Staff writer / May 22, 2009

A sale sign is seen in front of a foreclosed home in South Los Angeles.

Aurelia Ventura/La Opinion/Newscom


Surprise, Ariz.

Brian Mehigan, the self-described “Mayor of Tara Lane,” knows all too well the rise and fall in real estate prices that he calls, simply, “the madness.”

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One of a handful of original owners left in this decade-old Phoenix-area subdivision, the freelance plumber can tell you the fate of homes up and down his street. He points them out one by one: That one’s for sale, that’s now a rental, rental, foreclosure, short sale, foreclosure, original owner.

“Who knows what’s going to happen,” says Mr. Mehigan, as he keeps a watch on the street. “All I know is I’m not going anywhere.”

In the cookie-cutter burbs ringed by saguaro groves here in the shadows of the White Tank Mountains, there’s new hope for neighborhoods in disarray after the housing quake. Plumbers like Mehigan are busier, and Phoenix real estate is suddenly red-hot as buyers snap up bargains.

But, despite the short sales, foreclosure sales, and the burgeoning rental inventory, there’s also a massive “shadow market” of empty or rented homes yet to come on the block, as banks try to optimize returns on failed investments and homeowners hold off, waiting for a rebound.

In this foreclosure capital – over 75 percent of homes on the market in Phoenix are owned by banks – such a big backup of inventory could affect streets like Tara Lane for years to come. And it could dramatically impact the trajectory of the much-awaited recovery.

“Taking a house in foreclosure but not putting it out on the market, that’s common right now,” says Rajeev Dhawan, a real-estate economist at Georgia State University in Atlanta. “Short term, it’s good, but long term you’ve got a problem. When the market starts to recover, they’re going to dump the inventory,” pushing prices down again.

As many experts glimpse a possible bottom to the housing market, theories diverge about the potential impact of the shadow market.

Sudden boom

For now, investors are wading into the Phoenix real estate market in droves. Foreclosures are leveling off, sales are being bid on by five to 10 buyers, and more homes are being bought than any time since 2006. Home prices in the Phoenix area have slid nearly 34 percent since the mid-2006 peak and are still falling at about 3 percent a month. More than half of all home sales in the first quarter of this year were made by first-time homebuyers, reflecting affordability that’s at a 20-year high in many parts of the country.

The positive sales numbers and the slowing price slide – mirroring trends in California and Florida, two other housing-crash epicenters – is a sign that the real estate market may finally be shoring up, said Arizona State University real estate professor Karl Guntermann in a recent report.

"It appears that we're turning," said Professor Guntermann.

Housing investor David Isom has seen the buying craze firsthand. Despite being able to offer cash, he bid unsuccessfully on 15 homes in the past few months before scoring one with a pool in nearby Glendale, Ariz.

“I don’t follow the herd, man, you're talking to a different guy,” says Mr. Isom, explaining his foray into the market. “Most people are reactive. I go against what most people do. It's the only way to be successful.”

A ‘phantom inventory’

Despite such exuberance, many real estate experts are predicting more of an L-shaped recovery than a V-shaped one, as properties glut the marketplace in response to home-buying activity.

Only 30 percent of foreclosed homes are currently on the market, meaning that some 500,000 sit vacant across the country, part of a vast “phantom inventory” that the market has yet to grapple with.