Real Estate Shadow Demand Outweighs its Shadow Inventory

March 20, 2013

by Mike Simonsen


Quit your yapping about how strong the real estate market is, Simonsen. It’s a fake rally. There is no actual demand.

That’s the bearish argument I’ve been hearing lately. I’m not buying it.

For years we’ve been watching the phenomenon of “Shadow Inventory” of potential homes that need to be sold, and looking for impact on the market. This set of underwater or distressed properties is now shrinking rapidly.  The number of homes with underwater mortgages fell by nearly two million last year. According to the Fed, home price gains of 10% will be enough to move 40% of underwater borrowers back above water. These home sellers are highly likely to buy another home in the same or comparable market, off setting new supply with new demand.

Meanwhile another phenomenon that emerged from the bubble burst has been developing, and it’s hit the market with full force. Shadow Demand. Demand for homes that went unsatisfied, primarily due to financial and economic uncertainty, that can now emerge as jobs recover and mortgages remain cheap.

Housing’s Shadow Demand

Let’s look at the source of new demand. Increased demand for housing comes from new “households.”

household formation Cumulative Household formation surpluss/defecit relative to 5 year average (millions). Source: Federal Reserve Bank, Altos Research

From 1997 through 2007, each year an average of 1.3 million new households were formed per year. Our population grows via immigration and kids maturing. These people need to  rent or buy homes, or they double up with friends and family. During the Great Recession, household formation was closer to 600,000 per year. Population growth continued at about the same pace but people didn’t move into homes of their own.  That means for the three years of 2008, 2009, 2010 we had “Shadow Demand” forming around 2 million potential homes that can’t wait to launch on their own.

In the chart above, you can see that households get formed during times of economic strength. People hide when the economy is bad.

Household formation in the five years of the housing bust was lower than any five year period since the 1960s.  This is the Shadow Demand and it’s now hitting the real estate market. These millions of potential buyers were waiting until they were financially stable and until the bargains arrived. In 2012, these conditions converged. In 2013 employment and recovery is stronger. Real estate demand is higher. 

Despite all the risks in the US and global economies, the 2012 real estate market’s demand is a function of years of pent up purchases. After years of historic lows, this demand trends seems poised for a multi-year recovery.



marcos March 20, 2013 at 5:06 pm

there's a typo in your headline. it's should be its. since it's is the contraction of it is.

the shadow editor.

mike simonsen March 22, 2013 at 9:42 am

Oh and I'm usually so careful with my punctuation!

Jessie B March 21, 2013 at 10:13 am

Mike, excellent points. Traditional forces coming into play. Also another thought with your shadow demand.

Majority of people who did lose homes (4-5 years ago) are now starting to be eligible again for financing and are re-entering the home buying market. They probably view current prices as being a bargin, are at the peak homebuying age and tired of renting, since in many markets, rents are more expensive than owning.

Tim Flynn March 22, 2013 at 6:12 am

Mike, I think you want readers to interpret your message as that, in light of positive news from the media and Altos research, shadow demand is much greater than shadow supply and the market is positively balanced. Therefore , it’s a good time for homebuyers and RMBS investors to engage in the probable upside in the Market.
I’d like to introduce a couple of facts I didn’t see mentioned in your article.
First, I agree that “Shadow Inventory” (including distressed and underwater properties) is currently, gradually diminishing which is good news for the market if it continues. . Aggregately these two categories currently amount to 14 to 16 million homes (about 22% of the total 76 million owner-occupied housing stock) and any amount it is reduced is positive for total inventory/supply. What I believe is missing from your analysis is the 8+ million homes that are either fully paid for or have very low mortgages that have been held off the market as their owners wait for home values to recover—most of which are homes in the mid-to-upper price range of the market.
Even if we assume that these new families enter the market as you suggest, most of their purchases would have to be the first transaction (entry level) in a typical step-up market, Unfortunately, in this segment we know there is a shortage of inventory due to all of the private and institutional investor activity. As we look for prospective step-up buyers in the in the balance of the mid-market, we have to consider the minimum overhang from the shadow inventory suggests that at least 14 to 16 million existing homeowners won’t be in a position to be step-up buyers for at least 5+years because of credit and insufficient “step-up” equity related issues. So, unless these new families are going to start purchasing the mid-to-upper-priced housing stock which is unlikely, I don’t see how they will be able to make an impact.
Finally, I wouldn’t consider disputing the FED’s or your numbers (chart) on family formation. My concern is with your inference from these current numbers (last 5 yrs) that an historical extrapolation is appropriate to conclude there exist 2 million households of latent “shadow” demand. Two factors support this concern: first there are significant changes that are occurring in the trends of the sociological behavior of traditional family formation and second is the impact that a Trillion dollars (and growing) in college debt will have on the mortgage qualifications of this latent demand!
While we are all looking for that “Silver Lining,” (and sincerely hope that it does exists) I’m not convinced it will be found in “Shadow Demand.”

Jim Ruby March 23, 2013 at 9:46 am

Excellent analysis, Tim, far more balanced than the post you were responding to. It's remarkable how few people realize the huge risks posed by the Fed's endless "quantitative easing" and its subsequent distortion of all market signals.

mike simonsen March 23, 2013 at 1:47 pm

Hi Jim – don't confuse my posts illustrating the actual facts of the current housing market with cheerleading for US housing policy!

Tim – Don't confuse me reporting the fact that the market is hot that I give a damn about whether you should buy or sell. I'm not at all interested in motivating home buying. I'm personally thinking of selling. And of course I concur that future demographic shifts will impact the market in the future.

This post is merely an explanation of what's happening right now.

Jim and Tim – I'm interested in measuring the actual conditions. The actual conditions happen to be on fire. None of this is reported anywhere as good or bad. It just is. If the market were tanking then my articles would be about that. I have 7 years of blog posts and speeches titled things like "It's worse than you think" to prove it!

Tim Flynn March 25, 2013 at 11:41 am

Michael, your blog posts and speeches add an important perspective and I sincerely thank you for the reminder. Just one gentle heads-up, in March of 2006 things were pretty hot as well and almost everyone in the analytical community was just measuring and reporting the data as it was flowing in.

I just hope from that period, we all acquired a few "Lessons Learned" to help us find the clarity of thinking that escaped so many during that previous period.

mike simonsen March 25, 2013 at 12:16 pm

One of the things we like about our data is that it leads the headlines by 3-6 months. My very first blog post for Altos in October 2005, before we even launched the company was about San Jose prices turning flat for the first time in years!

At the time, we had much shorter history, and I had much less confidence in what we were seeing, so I didn't crow as loudly. We've now had seven years of leading the headlines by 3-6 months. We get to call the inflection points before anyone else does. Right now, the market happens to be up. It's been up for over a year, so the headlines happen to be saying similar things as the real-time data.

Rob Kinnon March 25, 2013 at 8:14 am

Excellent content! I really enjoyed reading specially the comments! :)

Tim Flynn March 26, 2013 at 7:59 am

Exactly why I enjoy following your thinking. I'm tracking a little ahead of you and understand that that may shade my accuracy a bit, but I do believe, from many perspectives, we are much closer to a major inflection point than I see anyone suggesting. Be well and keep writing.

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