Ask The Expert: Shadow Inventory, Bad Credit, Illegal Additions

Q. I keep hearing about forclosures and “Shadow Inventory”.  What is this term, and why should I care?

A.  One big topic lately in real estate circles has been the issue of bank-owned distressed properties, many of which they’ve kept off the market in order to keep housing prices from dropping even lower as well as to provide a more orderly clean-up process.  These properties, owned by the banks but not yet on the market, due to deliberate lender hold-backs, are known as “shadow inventory”.

Lenders nationwide are sitting on hundreds of thousands of foreclosed homes that they have not resold or listed for sale, according to numerous data sources. And foreclosures, which banks unload at drastically reduced prices, are a major factor driving home values down.

“We believe there are in the neighborhood of 600,000 properties nationwide that banks have repossessed but not put on the market,” said Rick Sharga, vice president of RealtyTrac, which compiles nationwide statistics on foreclosures. “California probably represents 80,000 of those homes. It could be disastrous if the banks suddenly flooded the market with those distressed properties. You’d have further depreciation and carnage.”

Without a doubt, the “Shadow Inventory” exists. In my opinion, banks are stabilizing prices by controlling supply, whether this is on purpose or a temporary inability to process so many foreclosures. Rather than a single large wave of REOs, I believe we will see a number of greater-than-normal size groups of REO’s at the end of the fourth quarter of 2009 and throughout 2010.

If you are a seller, or plan to be in the next 18-24 months, you should care, because each wave of bank owned properties that hit the marketplace are direct competion for you.  If you are a homeowner who is well ensconced, the effect of the shadow inventory won’t affect you directly, but will impact your marketplace, and the overall current “value” of your property.  In addition, the market recovery time is being affected by the “shadow inventory”.

As a buyer, the “shadow inventory” limits the total amount of homes to choose from at any given time, but virtually guarantees that affordable properties will continue to come into the marketplace throughout 2010.  So my advice is as always, “Plan for the future and pounce on the present.” In other words, be prepared in the buying process, hire a Buyer Agent who can provide ongoing market data interpretation and analysis,  set your criteria, make sure you have a loan pre-approval (not simply a pre-qualification), and be ready to act the moment the property becomes available. Perhaps the best advice anyone can provide regarding the timing of purchasing a home in this environment is the saying that, “The best time to buy a house is when you are ready to purchase a home.” In this case, it would be best if you have at least a 5-7 year plan of ownership, plus an exit strategy.  A good Buyer agent can help structure that for you.

If you would like a more individual interpretation of how “shadow inventory” will affect you in the next 18 months, please contact us.

Q.  I’m trying to buy my first home, and I wanted to get some advice before taking any drastic steps. I want to buy a home with my signficant other;  however, the main question I have is whether I will be able to qualifiy by myself. I make $40,000 per year and have a FICO score of 702.  I have minimal debt because all my credit cards have been payed off and all my school loans are in deferment. My sigificant other makes around $42,000; however his credit is pretty bad. What is the best possible route to take?

A.  I had two partners in my office just last week, and we encountered the exact same situation. Yours is a very common problem for first time homebuyers: One of the two has income + good credit, and another has income + bad credit. Does it help to have two incomes, even though one parties’ credit hurts the equation, or is it better to qualify with one income +good credit?
Steve Eckhoff of First Capital Mortgage, the financial agent for The Bremner Group, will order a residential mortgage credit report (RMCR), which is the most thorough report available. Based on your financial information, he will then advise you on your FICO score and your credit standing. If necessary, this will give you the time, before you apply for a loan, to improve your score, which will allow you to qualify for the best interest rate. Steve will address the different loan programs available, the best down payment options and compare rates for you that are offered by the lenders and investors currently available in the national market. In addition, he will qualify you individually and jointly, and tell you which option is best for the two of you. The key part of the pre-qualification process will be to determine the amount that you’re comfortable spending on a monthly basis which will establish a price range of appropriate properties.

In addition, Steve will provide us with the loan pre-approval letter, which we will include with any offer to purchase, showing potential sellers that you are ready and able to purchase. Once Steve has advised us on all of the basic “qualification aspects” of your financial situation (NO confidential information will be disclosed!), we will determine your maximum loan amount, but choose only a mortgage type that you understand and a payment level with which you feel comfortable, which may very well be less than the maximum for which are approved.

In your situation, it is possible that Steve would recommend that only you apply for the loan and take title to the property, unless you are able to clean up your partner’s credit. Sometimes this can be a simple issue, and Steve can direct you in that regard, or sometimes it can take several weeks or months, depending on the problems. However, the amount of home that you can qualify for individually may drop to some degree. I would reccommend taking the meeting with him to find out.

Q.  I’m looking to buy a house on the Westside.  Many houses I’ve seen include “unpermitted” structures.  Some of these “bonus” rooms are accessible from the house, many are garage conversions or located under the house and/or with entrance outside the house. The quality and usefulness of these structures varies. My agent says not to worry about this as long as you don’t pay for the extra square footage in the price of the house. What should I be concerned about in buying houses with structures like this?

I disagree with your agent, and the rather cavalier comment of “just don’t worry about it”. In my 33 years as a Realtor, I have seen this situation turn out badly far to often to give that advice to any of my clients.

The risk in accepting a property with areas done without a permit? There are plenty of risks, some of which have been mentioned in previous Q&A’s. First, the lender may refuse to grant a loan, if the appraiser notes the non-permitted structure, and the work appears to be sub-standard or a health and safety issue. Second, if you, or anyone you sell the property to down the road, decide to add on or remodel, and the inspector discovers the un-permitted work, you may be asked to bring it to code as part of the scope of the work, before they will issue a certificate of occupancy on any future remodel. Third, it is always possible that one of your neighbors might complain to the city about the unpermitted structure, which usually ends up with a city inspector coming out to have a look. At that point, they might require that you get a permit for the area in question (if it is in fact permittable), or remove it all together, and that’s AT YOUR COST.  And fourth, just as you are expressing concern about buying a property with non-permitted work, so will any buyer you try to sell to in the future. Considering your purchase from an investment standpoint, this inevitably brings up questions of health and safety from the purchaser, and results in a longer selling time at a lower selling price.

Here’s some further food for thought on unpermitted additions/construction.

Additions that have not been properly permitted have also, most likely, not been properly inspected to ensure the addition was built to local codes and requirements. Additionally the homes size (square footage) has been changed and not properly reported to local property tax authorities. If the mortgage company does not discover this through the appraisal process then the insurance company might. If neither catches the “illegal additions” and the mortgage does complete these are the possibilities at a later date:

1. If you ever experience a claim on the home with your insurance carrier, especially if it deals with the illegal addition, then your insurance carrier may refuse to cover the claim as the home has had improperly permitted additions, changes, modifications to it.

2. If the local taxing authority discovers the changes and determines when they were made they might assess you retroactively for the amount of taxes, penalties and interest they could have collected.

3. If the local building department discovers the illegal additions (the taxing authority will advise them if they find it) then you may be subject to penalties, potentially have to remove it or at least parts of it for inspections, etc., etc.

4. If in the future your mortgage company discovers that you have illegal additions, and that you were aware of them, they might also have methods of redress to prevent any issues with the loan such as prematurely calling in your loan with an immediate payoff demand. The mortgage company is not going to want to expose themselves to potential future liabilities and have many avenues of redress to prevent them of which this is one.

5. If the illegal additions violate local zoning ordinances, setback requirements and/or extends onto your neighbor’s property then your title insurance company is most likely not going to cover this situation either. It can result in you bearing the full cost of rectifying the problem.

6. If your illegal addition causes your neighbors any problems, or your relationships with your neighbors sour, then they can call the local building department and get the ball rolling for any/all of the above to occur.

7. If you are lucky to not experience any of the above and try to sell the home later it may then be discovered and cause you significant grief in the sales process. First off you know it is an illegal addition and will have to disclose that.

If you know or suspect a home has illegal additions to it then you should perform additional due diligence before your contingency period expires. It is a simple thing to visit the local building department and check the history of the home for its original build size and any permits that may have been requested for additions, major upgrades, modifications, etc.

Sellers are required to disclose these things but Seller Agents are not required to research a home to make sure the seller tells them the truth.

The onus of performing due diligence and its consequences is solely on the buyer. Your agent will assist you where he/she legally can but ultimately it will be your call.

Have a question you want answered?  Contact us at TheBremnerGroup.com, and let us know.  Or just leave a comment below.  We are always happy to help.