Thirty-eight states posted year-over-year increases in real estate owned (REO) properties in May, according to a report released on June 18 by RealtyTrac, an industry researcher and consultant. The list includes heavily populated states such as New Jersey (up 197%), New York (up 116%), Ohio (up 114%), Georgia (up 108%), Pennsylvania (up 106%) and Florida (up 63%). RealtyTrac also says that overall REOs in May increased on a year-over-year basis for the third straight month. This shadow inventory "is not massive," as some had expected, said Daren Blomquist, vice president at RealtyTrac. But it "is a backlog coming to market. It's taken longer than expected for this inventory to come out. Shadow inventory is typically defined as homes with mortgages that are 90 days or more delinquent but not yet repossessed or listed for sale. Market watchers have long feared that banks were holding a large amount of shadow inventory, and worried that if these houses finally came onto the market all at once, they would wreak havoc on prices. But now the strength of the housing market can withstand the foreclosure boost, analysts say, and investors may see more REO buying prospects as some of the shadow inventory comes on the market in the next 60 to 90 days. Tight Supply RealtyTrac reports that foreclosure filings — including default notices, scheduled auctions and bank repossessions — totaled 126,868 U.S. properties in May. That was a 19-month high. Thirteen of the 20 largest metro areas saw annual increases in foreclosure activity. Most REOs in this latest wave were repossessed by the Department of Housing and Urban Development, Blomquist said, followed by some of the big banks like Wells Fargo (WFC) and Bank of America (BAC). Yet Blomquist and others aren't worried that the foreclosure increase will harm the housing market's recovery. For one thing, the volume of repossessions is still "less than half of what it was at the peak back in 2010," Blomquist said. For another, "demand has come back to the housing market, so these foreclosures won't have as much of an impact," said Gus Faucher, senior macroeconomist with PNC Financial Services Group. Meanwhile, housing inventory remains tight. The National Association of Realtors (NAR) said last week that unsold existing home inventory "is at a 5.1-month supply at the current sales pace. That's not only down from 5.2 months in April — it's down from nine months in 2008-2009, when foreclosures peaked , Faucher said. So why are banks finally repossessing properties and cleaning up their shadow inventory? A number of factors are at work. In judicial-foreclosure states such as New Jersey, New York and Florida, the process of foreclosure is much slower than in non-judicial states. In a judicial foreclosure, a court must confirm that the debt is in default before the foreclosure can move ahead. Thus, the banks and the courts have had a backlog of foreclosures to process in these states. Non-judicial foreclosures are processed without court involvement. In fact, the process has been so slow that banks might now face statute-of-limitation rules on foreclosures, Blomquist says. He points out that in Florida, the statute of limitations for a foreclosure is five years. In New Jersey, it's six years. Banks may be motivated to now finish foreclosures in these states or face giving up the right to repossess some properties. Even states without judicial foreclosure or a statute of limitations have enacted rules to protect homeowner rights and encourage loan modifications. These rules also have slowed default processing. Resetting second mortgages may be another factor boosting delinquencies and foreclosures, says Maria Giordano, a real estate investor and flipper in the Phoenix area. She says that a number of sellers who bought at the height of the boom purchased homes using second mortgages with adjustable rates. Many of those loans had a 10-year grace period before their rates reset. If a buyer bought a property in 2005, the rates are due to reset this year. Of course, banks also recognize a robust market, and now is a good time to sell. The rise in foreclosures "actually helps the market because we're adding inventory when supply is somewhat limited," Faucher said. "This is not going to be a big drag on housing prices. Another plus: First-time buyers are coming back to the market. First-time buying will "see the biggest growth" for the rest of 2015 and 2016, Faucher said. An improving job market, wage growth, high rents and easing credit are all fueling the increase in first-time homebuying. Madeline Schnapp, director of economic research at PropertyRadar in Truckee, Calif., says that demand is pushing up housing prices a little bit even in the California exurb counties of San Joaquin and Stanislaus. Some real estate wonks figured that these outlying markets would never come back, as buyers opted for shorter commutes and urban living. But counties like these offer a bargain compared to the astronomical prices of housing in metro areas like San Francisco. Flipping Without Foreclosures Are investors and flippers excited about more foreclosures coming to the market? Not so much. Flipper Lance Young, who works in the Washington, D.C. area, says that he won't wait for banks to bring more REOs to the market. Instead, he's been working with realtors to find homes that older people are ready to sell or that are pre-foreclosure. Young looks for houses that are neglected and need a complete gut job. He wants them "in as bad a condition as possible," which gives him the best opportunity to buy them below market value, rehab them and make money. Giordano has bought REOs and short sales, but she says that banks are pricing them too high now. So she's finding pre-foreclosure houses to flip via realtor contacts and her own direct marketing. Like Young, Giordano is focusing on acquiring "the ugliest of the ugliest" properties, which she buys, fixes and flips.
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