A recent paper by Yongquiang Chu (an assistant professor at the University of South Carolina’s Moore School of Business) discussed portfolio choice and asset pricing of owner occupied housing over time.  Chu used empirical evidence to prove that extra demand for owner-occupied housing creates extra demand for the asset class.  Further, we already know that housing is the dominant asset in most household portfolios, but also that owner-occupied housing is the most important consumption good.

The paper proves that essentially housing has a special feature of both being an investment and the largest consumption good for owner-occupants.  This presents a special advantage of housing that lies within owner-occupied areas.  I think that’s important to point out this does not apply to non-owner occupied multi-family housing.  I would extend this further to areas that are primarily investor owned.  The asset values in non-owner occupied neighborhoods rarely rise (with exceptions) over long horizons.

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The housing industry is looking for signs of recovery and today’s report by CoreLogic wasn’t one of them.  CoreLogic reported that the shadow inventory has increased to 2.1 million units, up from 1.9 million a year ago.  The shadow inventory, also often called, “pending” inventory considers REOs, foreclosures, and delinquent loans (90 days+ past due) not yet on the market.  Some analysts factor in the shadow shadow inventory which includes pent-up sales demand of people who want to sell but are in negative equity situations, and people waiting on market conditions to improve.  While I think it’s important to consider the shadow inventory as it relates to the timeline of recovery, prices are affected by homes visibly on the market.

The overall supply last year was roughly 6.1 million according to CoreLogic last year and is presently 6.3 million.  I would expect this time next year we’re under 6 million as home-building is going to add roughly half of the homes necessary to keep up with new home demand in 2011.  We’re likely to see inventories work down and while the visible inventory unchanged at 4.2 million in the last year may still stand at a similar level, we’re likely to see the decline come from the shadow as more REO and foreclosures work through the system.

Read the entire shadow inventory report by CoreLogic.

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Using CoreLogic’s data, Bloomberg put together a list of the 21 most improved housing markets.

While the usual suspects remain at the bottom (places like Phoenix and Miami), some of the ones at the top might surprise you.

Here’s the list.

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In February the average sales price of a home was $112,035 up slightly from January’s $111,598 according to the Memphis Area Association of Realtors.  This reflects some demand from 1st-time home buyers executing on the soon to expire tax credit.

While this number is good, it’s still down 5.5% over February 2009 as home prices struggle to recover.  Also inventories increased slightly as foreclosure pace picks up.

I’m seeing inventories increase more in the lower end where I think investors will continue to see prices drop.  The strong sales activity seems to be near the average sales price.   That $100,000-125,000 range is hot right now for first time buyers,  people moving up from smaller homes and those downsizing to lower their cost of living.

Of course I’m slightly biased as that also is the average value of the investment homes Investor Nation offers for sale here in Memphis.  I’m a huge proponent of investing in what is the highest in demand and average sales price is that product.

With the lack of new homes being built it, foreclosure inventory will be absorbed quickly in 2010.  Unfortunately that doesn’t mean someone who wanted to build a new home in the $125,000 range isn’t going to purchase a $30,000 home in place of it.  My strong belief is that the inventory swell will be in highest on the low end and lowest near the middle.  The people in the middle will buy near the average sales price when they can’t build a home.

You’ll see appreciation this year in Memphis near this average sales price and slightly higher.  So target investments with multiple exit strategies that have appraised values $90,000 and higher.  This should catch the bottom of the owner occupant contingent.  If long term value is not on your list, then take a closer look at the lower end.  Keep in mind the equity on the lower end can be false as the exit strategy is usually to another investor versus an owner occupant.   You also need to pay attention to socio-economic factors such as crime, unemployment, schools, and education levels.  These can impact your cash flow significantly.  Analyzing the numbers along isn’t enough.

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The existence of a large shadow inventory has become hotly debated in real estate circles.  I wrote an article on the Bigger Pockets real estate investment blog discussing what exactly the shadow inventory is and its potential impact on the real estate economy.

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