Expect years of low sales volumes in residential real estate

At this point we can be certain that banks are going to avoid or delay foreclosure or short sale until prices rise so they don’t have to lose money on the sale. They have no choice. With banks still exposed to $1 trillion in unsecured mortgage debt, they simply can’t take the losses that are coming. No matter what else happens in the market, unless the banks are forced to change their policies by the government regulators or the federal reserve (a very unlikely event), lenders will continue to kick the can with loan modifications and suspend homes in cloud inventory for as long as it takes. Since problems in the market cannot be resolved by lowering price, the inevitable problems that arise will cause sales volumes to remain weak. As a result, you can expect years of low sales volumes in residential real estate.

The current fantasy among banks and policy makers is that a resurgent economy will bring back first-time homebuyers in large numbers who will in turn reignite the move-up market and allow lenders to clear out their cloud inventory while sustaining modest rates of appreciation. Some economists actually think this might happen. While some version of events may resemble that fantasy, the reality will fall short in many significant ways. When reality is different from the fantasy, clueless economists will act surprised and lament the “unexpected” results.

One of the major hurdles facing a sustained rally in real estate prices is the relative absence of first-time homebuyers, the bedrock of the market. First-time homebuyer participation is near historic lows. As I’ve pointed out, the only increase in housing demand is coming from investors. Banks have done a remarkable job of restricting inventory to push up prices, but what happens to the market if prices are so high that first-time homebuyers can’t afford them? Some first-time homebuyers will hold their nose and substitute down to lower quality properties, but many will simply not buy and chose to rent instead. The result will be fewer transactions and low sales volumes.

Potential first-time homebuyers are underemployed, over-indebted, and unenthusiastic

There are three reasons we don’t see many first-time homebuyers. For one, many are unemployed. People without a job don’t buy homes (anymore). Further, many potential first-time homebuyers have too much debt. They have large student loan payments, excessive credit card debt, and the lease their cars. They don’t have any money left over to save for a down payment, and even if they had the savings, they don’t have the qualifying back-end debt service ratio required to get a loan.

On the Rise?


… unemployment, which remains high for young adults between the ages of 20 and 24. Last month’s 13.3% unemployment rate for this population …

Nineteen percent of U.S. men ages 25 to 34 live with their parents, says Mark Mather, a demographer with the nonprofit Population Reference Bureau. But that is up only five percentage points from 2007. The percentage of 25-to-34-year-old women still living at home is 9.7, up from 9% in 2007.

There is almost $1 trillion of student debt outstanding in the U.S. today, which could limit the purchasing power of Millennials. “These people have a mortgage and no house,” Francese says. …

In the recent new mortgage regulations, back-end debt-to-income ratios were capped at 43% for all qualified mortgages. If the borrower wants to max-out their loan with a 31% front-end ratio, they can’t spend more than 12% of their gross income on student loans, credit cards and car leases combined. Many young people spend that much on each of those. Any potential homebuyer with a student loan and a car payment — which is most of them — is unable to qualify for a loan. And that’s a good thing because if they got a loan, they couldn’t afford the payments anyway.

And finally, after witnessing the catastrophic collapse of home prices that trapped the preceding generation in their starter homes, many potential young buyers simply don’t want to take the risk. Perhaps rising prices and endless NAr bullshit will force kool aid down the gullet of this generation, but many will learn the hard lessons of the housing bubble and refuse to overpay for a house.

Decoding the First-Time Homebuyer

By Meg Handley — April 26, 2013

First-time homebuyers are crucial to any housing market, not least because they allow existing homeowners to move out of starter homes and into their next place, keeping the real estate cycle moving.

First-time homebuyers are a catalyst for the rest of the market,” says Cara Ameer, a Florida-based broker associate and realtor with Coldwell Banker. “They’re really the domino that triggers other buyers–they have a contagion effect.”

Without sales volume at the low end from first-time homebuyers, there won’t be sales volume in the move-up market.

[READ: Why the Housing Market Can’t Move On Without First-Time Homebuyers]

But a variety of factors are keeping homeownership out of reach for many would-be homebuyers, including student loan debt – the average 20-something has almost $30,000 of it – and the ability to rustle up enough cash for a down payment.

These are not short-term problems, and there is no magic fix. Lenders are not going to come up with an “innovative” loan program which will solve this problem. These potential buyers simply can’t afford to buy a home, and until they pay down their debts and save some money, they won’t be adding to demand in the housing market.

First-time homebuyers also face stiff competition from investors and all-cash buyers in some markets, especially because the inventory of homes for sale has been so low, as the stream of foreclosures have dried up and many homeowners remain upside down on their mortgages.

“It creates a lot of pressure for first-time homebuyers who are already constrained by a limited price range,” Ameer says. “There are only so many choices, many of which may not be viable or need too much work for their budget or skill.”

Still, first-time homebuyers make up almost 40 percent of the entire buyer pool, according to a recent survey by Doorsteps, an online resource that connects buyers, agents, lenders and service providers. Here are a few more stats the describe today’s typical first-time homebuyer:

Note that 76% of first-time homebuyers save for their down payment. Since saving for 20% down requires a decade or more, most of these buyers will use FHA financing.

Remember 2007

Everyone is lamenting the lack of MLS inventory, but even if we had an explosion of cloud inventory, it wouldn’t change much. Inventory that’s priced above what people can afford is the same as inventory that isn’t there. Back in 2007, we had an explosion of inventory.

Many observers mistakenly believe the influx of inventory in 2007 pushed prices down. That isn’t the case. In 2007 the normal listings that came to market found no buyers. Prices fell steeply in 2008 despite declining inventory for most of the year. Transaction volumes dried up in 2007 because the toxic financing was taken off the market and people couldn’t finance the large sums necessary to pay peak prices (see red line below).

Since that 2007, mortgage interest rates have fallen from 6.5% to 3.5% thus allowing buyers to finance mortgage balances similar to those during the housing bubble.

Price or volume but not both

Lenders hope to have it both ways. They want the high prices of the bubble, and they want high transaction volumes so they can clear their inventory of bad loans. Unfortunately, they can’t have both.

The banks are acting as a cartel similar to OPEC. Each cartel member benefits from higher prices, but the only way to sustain high prices is to keep supply off the market. Banks could liquidate their entire inventory of REO and bad loans in a few years if they were willing or able to accept market-clearing prices. As we all know, they aren’t selling property at the prices needed to clear the market. Instead they are suspending prices in the clouds. As a result, they will accept lower sales volumes and a much longer time to clear the market. By the time they are done, some borrowers will have squatted in their homes without making payments for 10 years or more. Not a bad deal for them.