Typical sources of housing demand largely absent
For a true recovery in housing, the market needs resurgent demand from first-time homebuyers and move-up buyers. These two groups are typically the largest source of housing demand. The first-time homebuyer is the bedrock of the housing market. Without first-time homebuyers, no move-up market exists.
The first-time homebuyer market is driven by job growth and household formation. When the economy is strong and creating good-paying jobs, young people form new households and use their new income to bid for real estate. This displaces existing homeowners who then execute a move-up trade and often buy a nicer home.
That’s how the market is supposed to work, but the collapse of the housing bubble destroyed the fundamentals underpinning a strong housing market. Household formation dropped from 1.5 million households per year to 500,000 per year. The first-time homebuyer market dried up, and as a result, rather than comprising 40% of sales, today they only make up 29%. Further, with 25% of existing homeowners underwater and another 20% effectively underwater and unable to sell and execute a move-up trade, demand from the move-up market is also down by a third or more. Only investors are keeping the market afloat. Without the manipulation of inventory by desperate bankers, the housing market would almost certainly see a dramatic downturn.
… a growing share of repeat purchasers driving the U.S. housing recovery, as appreciating property values and low mortgage rates give many the wherewithal to relocate. The same forces are also benefitting longer-term homeowners who had wanted to move and didn’t want to sell until prices improved.
This is an erroneous way to look at a move-up purchase. Rising property values doesn’t give a buyer the means to relocate unless they were underwater. The properties a move-up buyer wants to buy is also appreciating, probably at the same rate as their existing house. Unless the potential buyer has increasing income and can borrow more money, the quality of housing will not be higher. It may be different, but it won’t be better.
Homeowners returning to the market accounted for 54 percent of sales of existing properties in June, up from 49 percent a year earlier, according to data from the National Association of Realtors. First-time buyers were 29 percent, a decline of 3 percentage points in the past year and compared with a typical share of 40 percent amid strict lending conditions and a lack of lower-priced properties.
First-time homebuyers are not absent from the market due to stricter lending conditions and a lack of properties. That is realtor spin and nonsense. First-time homebuyers are absent due to lack of jobs and excessive debt burdens. These are deep structural problems that are not solved quickly. First, these potential buyers must find a job, then they must save money for a down payment, and finally, they must retire enough student loan, credit card, and car debt to qualify to buy a house. That doesn’t happen overnight.
Repeat buyers will remain a crucial element of the real-estate rebound until a better-heeled economy also opens the way for more first-timers to rejoin the market.
“What we’re seeing are these buyers who’ve waited around and who have finally realized – this is a good time to move,” said David Crowe, chief economist for the National Association of Home Builders in Washington. “They will feed the demand until our economy gets a little more solid.”
“If they have built up equity in their homes, in the last year of so, home values have risen much more than the value of lots of other investments,” said Jed Kolko, chief economist at real estate website Trulia Inc. in San Francisco. “That helps them put down a larger down-payment or not need a mortgage in the first place.”
The prudent homeowners who didn’t Ponzi borrow during the housing bubble are being rewarded for their prudence right now. They are the only ones capable of a move-up trade.
“The economy looks to be on a sounder footing, home prices are rising, and expectations are that they’ll continue to increase,” said Michelle Meyer, a senior economist at Bank of America Corp. in New York. “Not only would they be able to sell their current property, but also in terms of purchasing their larger home, they’ll feel that their homes will appreciate with time.”
In Rancho Santa Fe, California, increasing buyer confidence has helped K. Ann Brizolis’s luxury home real estate business to “crawl back” from the bust.Now that homeowners can sell their current residences at less of a loss or at a gain, more are able to move up to the $2 million to $3 million average price point of homes Brizolis sells. “It’s sort of a trickle-up environment.”
The key word being “trickle.” With so many homeowners raiding the home ATM machine during the bubble, the equity that ordinarily fuels the move-up market has been greatly depleted.
“We are seeing a decent amount of first-time home buyers, and unfortunately for those people, the competition in the market for cheap houses is crazy,” said Jennifer Ames, who has worked as a real estate agent in Chicago for 19 years. She said one client wrote five contracts before winning a bid.
Five contracts? That’s not very many by California standards. She actually had to work for that commission.
To be sure, the housing rebound cannot be sustained without first-time buyers, said Stuart Hoffman, chief economist at PNC Financial Services Group in Pittsburgh.
“You can’t sell your house and move to a bigger one if you can’t find someone to sell your house to in the first place, and often that person is a first-time homebuyer,” said Hoffman. “First-time homebuyers are still a very important part of the market.”
With home prices being higher, first-time homebuyers will find it more difficult to enter the housing market. Many of these were marginal buyers using FHA financing, and with rising borrowing costs and rising prices, many of these buyers are being priced out of the market.
Russell Price, a senior economist at Ameriprise Financial Inc. in Detroit, said the fact that first-time buyers are a smaller share of sales isn’t a major concern for now, since inventories are too low to accommodate demand as is.
Unfortunately, he’s right. The manipulation of MLS inventory engineered by the banks is working, and it will probably continue to do so.
As the job market improves, young people who now lack the financial security to buy a home will re-enter the market, he said.
“We simply need to see the employment conditions mature,” he said, predicting that more first-time buyers will enter the market next year, and the share will increase even more the following year, helping to keep up the speed of the housing recovery. “We’re at a pace right now that can be maintained for the intermediate term, I think it’s a healthy pace.”
Who is he kidding? It’s a dismal pace. And although the number of first-time homebuyers will likely increase, it won’t improve at a rate typical of a durable housing recovery. What do we make of an economy where the second largest employer is a temp agency? They aren’t buying homes.
Both first-time homebuyers and move-up buyers are largely absent from the housing market. Their share of home sales is much less than historic norms. Investors are carrying the market right now, and their numbers are projected to dwindle. With higher home prices, more move up buyers may enter the market, but higher prices will also be a headwind to first-time homebuyers who can’t afford higher prices. Lenders can force prices to go up by restricting inventory, but sales volumes will likely weaken because this recovery is not built on strong fundamentals.
A little help from his friends
The owner of today’s featured property is selling it in the face of a foreclosure proceeding. He bought it ages ago, and over the years, he put $2,500,000 in debt on the property from a variety of private parties. Apparently, he isn’t paying them back. On three occasions since 2007, he has been served with notices of default. The latest one was pushed to a notice of trustee sale. Given his $10M+ asking price and only $2.5M in debt, if he doesn’t sell it in time, he stands to lose a lot of equity.
[idx-listing mlsnumber=”S724190″ showpricehistory=”true”]
518 HARBOR ISLAND Dr Newport Beach, CA 92660
$10,428,000 …….. Asking Price
$975,000 ………. Purchase Price
2/2/1988 ………. Purchase Date
$9,453,000 ………. Gross Gain (Loss)
($834,240) ………… Commissions and Costs at 8%
$8,618,760 ………. Net Gain (Loss)
969.5% ………. Gross Percent Change
884.0% ………. Net Percent Change
9.5% ………… Annual Appreciation
Cost of Home Ownership
$10,428,000 …….. Asking Price
$2,085,600 ………… 20% Down Conventional
5.02% …………. Mortgage Interest Rate
30 ……………… Number of Years
$8,342,400 …….. Mortgage
$2,173,391 ………. Income Requirement
$44,886 ………… Monthly Mortgage Payment
$9,038 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$2,173 ………… Homeowners Insurance at 0.25%
$0 ………… Private Mortgage Insurance
$50 ………… Homeowners Association Fees
$56,146 ………. Monthly Cash Outlays
($5,442) ………. Tax Savings
($9,987) ………. Principal Amortization
$4,079 ………….. Opportunity Cost of Down Payment
$1,324 ………….. Maintenance and Replacement Reserves
$46,120 ………. Monthly Cost of Ownership
Cash Acquisition Demands
$105,780 ………… Furnishing and Move-In Costs at 1% + $1,500
$105,780 ………… Closing Costs at 1% + $1,500
$83,424 ………… Interest Points at 1%
$2,085,600 ………… Down Payment
$2,380,584 ………. Total Cash Costs
$706,900 ………. Emergency Cash Reserves
$3,087,484 ………. Total Savings Needed