Lack of first-time homebuyers starting to weaken the move-up market

The lack of first-time homebuyers purchasing homes and gaining equity over the last six years is weakening the move-up market.

want_a_houseOver the last two years, the move-up market has shown more strength relative to the lower market tiers because move-up buyers who didn’t HELOC themselves to oblivion are the only ones with the good credit and down payment necessary to close the deal. The reflation of the housing bubble from 2012 to mid 2013 restored some equity to homeowners and allowed a few to execute move-up trades; however, this effect appears to be petering out, and the move-up market is weakening.

Back in early 2013, I wrote that the move-up market would suffer for a decade due to the lack of first-time homebuyer participation and the legions of underwater borrowers who don’t gain equity from rising prices.

How the move-up market works

Most first-time homebuyers don’t have 20% down for a house, particularly at today’s high prices, so most opt for a 3.5% down FHA mortgage or a 5% or 10% down conventional mortgage with private mortgage insurance. Over time, assuming they don’t refinance or add more debt with a HELOC, a homeowner will build equity by paying down an amortizing mortgage. With wage growth in the area, house prices will rise 3% or 4% per year, and presumably, the borrower will have a higher income as well. So after 5 to 7 years, a prudent homeowner will have sufficient equity to cover the closing costs of a sale and have 20% to put down for a move-up purchase.

The collective action of all homeowners who purchased at the same time provides the demand for a move-up market. The equity ported from a previous sale is used to bid up prices in the most desirable neighborhoods which is why markets like Newport Beach always trade at a healthy premium to rental parity. However, the current move-up market is broken because potential move-up buyers don’t have the equity to make the move. Also, some speculate that current owners with low-rates won’t want to sell and give up their current mortgage; some will become long-term landlords even if they move.

Most move-up market sales get their equity from the profitable sale of a previous home. With the crash of house prices, those who bought over the last 10 years have no more equity than they originally put down, and most are underwater. This potential buyer pool is dead. As we know from the chart on originations, the number of buyers who purchased at the bottom is relatively small.


Plus, many more buyers than usual are either small investors or hedge funds. In a normal market about 35% of purchases are for investment (the inverse of a 65% home ownership rate). Over the last few years, about 50% of home purchases have been investors. Investors don’t sell their properties to complete a move-up trade, so 15% of the market that ordinarily would have been move-ups will not be over the next decade.bubble-money

As I pointed out in One man’s mortgage debt is an entire neighborhood’s equity, the equity that would otherwise be accruing to homeowners is instead recollateralizing the bad loans on underwater properties. With 25% of properties underwater, a huge portion of the move-up market won’t have equity because that money will instead be going to a bank.

With 15% of the move-up market removed by investors and 25% removed by recovering underwater loanowners, 40% of the demand for future move-ups is gone.

In reality, the move-up market has not been that robust over the last few years. Sales volumes are low, but since sales volumes at the low end are even worse, it looks good by comparison. Now it appears the lack of move-up buyers is starting to weigh on the housing market.

Data Fizz

Stale Demand at Lower End of Home Pricing Fizzing Up to Upper-Middle Price Segments

Sam Khater, June 26, 2014

Listen up. Do you hear it? That faint-but-consistent fizzing sound all around you is not due to tiny bursting bubbles in nearby soda cans or champagne flutes. It is the popping of tiny price bubbles across the U.S. This “data fizz” is a reflection of weakening home sales that originally began at lower-priced segments, but are now moving up the price continuum to the higher-priced segments. It is well-known that higher-end home sales activity has been strong over the last two years, however, recently there’s been a shift, from both directions. Not only have higher-end home sales themselves started to weaken over the last few months, but the weakness in the lower-end segment is expanding into the upper-middle segments of the price distribution.

Figure 1 below is a data visualization of the percent change in home sales by price segment. Sales of higher-end priced homes[1] picked up steam in early 2012, reached an apex later that year and grew at a healthy clip until very late in 2013, when weakness began to emerge. The very low-end price segment[2] was weak throughout 2013, and that weakness started to expand upward in the second half of 2013.


For example, home sales in the $350,000 to $550,000 price range were up 44 percent on a year over year basis as of July 2013, but just four months later, they were only up by 9 percent in November. Weak sales at the very lower-end was not a surprise, given the stagnant economy combined with declines in the number of distressed sales and very high home price appreciation for low priced properties[3]. However, the migration of the slowdown in sales beyond the lower-middle of the price distribution is a concerning development given that higher-priced home sales had been one of the few bright spots in the real estate sales market over the last few years. If the slowdown continues heading into the fall, it indicates that the higher-priced market is entering a new phase where the generally low rate environment and rapid increases in the stock market are still not enough to power home sales increases.

The housing market is stalling out because prices have reached the limit that incomes can push them higher, and the weak economy is not creating enough new high-paying jobs to provide demand. Weak owner-occupant demand is one of the Four traits of the new normal in the US housing market; it’s a condition that’s likely to be with us for a while.

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