The following is an abridged editorial version of the original article. For the full article, please click here.

The presence of real estate owned (REO) properties held by lenders and not yet on the market, known as the shadow inventory, is a constant reminder to those in the real estate business that the real estate market still has a way to go before it normalizes. To build a market and get out of this real estate limbo, REOs must first be resold to owner-occupants or income property investors, not speculators, even though the possible REO deluge will likely have an observable but temporary adverse effect on home prices.

However, with so many banks, speculators, trusts and government-controlled entities holding REOs using different methods to report their foreclosed home holdings, it’s difficult to ferret out the exact number of REOs that remain to be placed on the market. This wildcard creates a quandary for brokers and agents looking forward to the day real estate prices finally stabilize and then begin their annual upward rise — probably limited to the rate of inflation for the next few years into 2015.

What reports do exist indicate that REO inventory is rising as banks are beginning to initiate more foreclosures on those homebuyers who are not eligible for loan modifications or who re-default after modification. So where are the REOs taken in by lenders on foreclosure, and how long will it take them to show up to the party?

The “missing REO” phenomenon is a symptom of a bigger problem, and it’s not the destabilization of prices by putting the REOs on the market immediately after foreclosure. Here’s what the banks aren’t talking about when explaining the slow trickle of REOs onto the market: when they sell an REO, they must then for the first time report the loss (as all REOs currently are supporting an unreported loss) on the lender’s books. It doesn’t take a mathematician to figure out that these massive losses could topple the solvency of any bank that may be on shaky ground — and many of them, even the largest ones, are.

Thus, we probably won’t see a flood of REOs any time soon. Banks are biding their time, holding onto the REO losses and waiting for the economic recovery to see them out of their difficulty.

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Tagged as: delinquencies, REOs, solvency