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of Columbia that fall into the non-judicial foreclosure category, REO inventory in February stood at 357,000. Cutbacks in California California is seen by many as a harbinger for the rest of the United States, and its real estate market bottomed out early in 2007, according to Leslie Appleton-Young, VP and chief economist for the California Association of Realtors. She says the REO inventory in California—a non-judicial state—is disappearing rapidly with minimal new inventory coming down the pipeline. In December 2012, 11 percent of California's single-family home sales were REO sales and 25 percent were short sales. Those percentages were about the same as in November 2012. Dial back to October 2012, however, and short sales held true to their 25 percent market share, but REOs were 27 percent of the state's total sales. Based on California's monthly rate of property sales and its REO and pre-REO numbers, the state's current inventory would last about 34 months, Appleton-Young says. "The big question mark is what you assume about all of the people who are underwater; how many of those are going to end up in foreclosure versus other options?" Appleton-Young stated. "It really is the $10 million question." She added, "[A]ll 2 million of [California's underwater homeowners] are not going to end up in foreclosure. It's probably going to be less than half of that." Another burning question revolves around underwater homeowners and their response when they gain enough equity to rise above water, assuming price appreciation continues to accelerate, Appleton-Young says. She asks: Are they going to stay in their homes or are they going to list them? While investors who converted REOs and pre-REOs to rentals bolstered local housing markets, Appleton-Young is concerned about what may happen if those investors decide to sell at the same time. "The very-low-rate environment that the Fed [has fostered] has created a situation where investors can go to equities or they can go to housing, and that's kind of it," Appleton-Young said. "One of the concerns is how will investors behave when rates go up. I don't have an answer, but it's something I worry about." She continued, "I think when you get away from this low-rate environment, you're going to see some significant changes, and I would guess that you'll see more inventory from investors coming back on the market." Shadow of a Doubt While REO inventory is shrinking, the socalled "shadow inventory" is still significant— between 2.5 million and 4 million, depending on whose numbers are used, says Rick Sharga, EVP of Carrington Mortgage Holdings in Santa Ana, California. Sharga estimates there are 3 million properties in shadow inventory. With about 1.5 million distressed properties selling per year, the number of homes in the shadows represents about two years' worth of supply by Sharga's assessment. His definition of shadow inventory includes properties that are seriously delinquent, in foreclosure, and those that have become REO assets but are not yet on the market. He does not include upside-down loans that are not delinquent in his definition. About 1 million properties are in the foreclosure process and more than half of the REO inventory—300,000 to 400,000 of the 500,000 REOs—has not been put up for sale, he says. REOs that aren't for sale are not in sellable condition or have title or other issues, Sharga says, but he rejects theories that banks have held back some of their REOs to avoid flooding the market. "I've been hearing those theories for years now, and they make less sense to me today than when I heard them a few years back," he said. "Right now, given market price appreciation and the incredibly limited numbers of all types of property, if you're a lender and you're sitting on a sellable property in one of those markets waiting for things to get better, you've got to be crazy." A little more than two years ago, when distressed sales as a percentage of overall home sales hit their peak, only 15 percent of REO inventory was available for sale, Sharga says, but supply loosened considerably as overall inventory has dropped. Homes are increasingly sold out of shadow inventory before they even become REO properties, primarily as short sales, Sharga says. Last year, according to RealtyTrac, short sales in the United States exceeded 1 million for the first time. Sharga says he expects to see strong short sale numbers continue in 2013, Distressed Sales Activity, January 2013 Source: Lender Processing Services *Estimated monthly volumes Core-Based Stastical Area (CBSA) Short Sales* REO Sales* Total Home Sales* Short Sales (as % of total sales) Short Sale Price (as % of full market value) REO Sales (as % of total sales) REO Price (as % of full market value) Miami-Fort Lauderdale-Pompano Beach, Florida 3527 2201 1326 9853 22% 72% 13% 78% Los Angeles-Long Beach-Santa Ana, California 3145 2127 1018 8856 24% 77% 12% 84% Riverside-San Bernardino-Ontario, California 2787 1800 986 5955 30% 76% 17% 82% Phoenix-Mesa-Scottsdale, Arizona 2257 1509 748 8222 18% 79% 9% 86% Tampa-St. Petersburg-Clearwater, Florida 1847 1017 830 5116 20% 71% 16% 73% Las Vegas-Paradise, Nevada 1748 1402 345 3945 36% 81% 9% 89% Orlando-Kissimmee, Florida 1458 845 613 3371 25% 74% 18% 79% Sacramento-Arden-Arcade-Roseville, California 1305 871 434 2914 30% 77% 15% 84% San Francisco-Oakland-Fremont, California 1295 883 412 3882 23% 77% 11% 84% San Diego-Carlsbad-San Marcos, California 50 Total Distressed Sales* 1200 869 331 3164 27% 78% 10% 86%

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