Will lenders and investors find owner-occupant buyers when they liquidate?

The current housing market price rally is largely being fueled by investors competing for restricted inventory. Both the banks that are restricting the inventory and the investors who are buying it are counting on selling these properties to owner-occupants who are willing to pay higher prices for a place to shelter their families. Conventional wisdom is that a resurgent economy and low mortgage rates will bring owner occupants back to the housing market with a willingness and ability to pay higher prices. But will it really work out that way?

As proof that the current market rally is entirely fueled by investors, the chart below shows total home sales versus purchase applications. As you can see, purchase applications have been flat for three years, yet home sales are up. The only way to fill the gap is with all-cash investors.

Investors hold properties for a time, collect the rents, but then they want to sell later on. Most of these investors don’t expect to sell to another investor later on who will demand a high cap rate. Investors anticipate selling to owner occupants who aren’t motivated by cash returns and thus will pay more to provide a home for their family.

Housing’s Up, but Is Foundation Sound?

By NICK TIMIRAOS — Updated June 9, 2013, 7:26 p.m. ET

The housing-market recovery is here but there’s a growing debate among bulls and bears over how long it will last and how strong it will become, with both groups pointing to the same data to make their case: U.S. demographics.

The bull case says the housing market is in the early stages of a rebound that should last several years because the U.S. hasn’t built enough housing to support the country’s growth. The recession and the foreclosure crisis led to a sharp slump in new-home construction and in household formation. But the population didn’t stop growing. Instead, households simply doubled up or moved in with family.

I’ve been attending housing related economic forecasts for many years now. One theme pounded on again and again is the need for housing always outstrips supply. These same pundits made the same claims in 2005 and 2006 when we were radically overbuilding housing. Homebuilders want to hear this, so professionals come out with fancy tables and graphs to tell them what they want to hear. The truth is that housing bulls consistently over-estimate the demand for housing. Always have. Always will.

The bears argue that the recent gains in housing will be short lived, pointing to changes in access to credit, elevated consumer-debt levels, and an over-reliance on investors.

There are more problems than that facing the housing market. (see: The 10 biggest obstacles to reflating the housing bubble)

They don’t believe housing will crash again, and they concede that it should provide some contribution to economic growth. But they see little evidence that the price or sales momentum is durable or that housing will provide the big boost to the economy that the bulls are expecting.

That’s exactly right. I don’t think it very likely that house prices will crash. Instead, the next housing market deflation will be a long, slow grind. Further, I also don’t think we will return to the HELOC dependent faux economy of the housing bubble either because necessary deleveraging and a lack of HELOC abuse is keeping the economy down.

For anyone considering whether to buy a home to live in, the decision should focus primarily on whether they can afford the payments and other costs of ownership, regardless of where home prices go.

That is one of the finest pieces of real estate investment advice I have ever seen in the mainstream media.

The slump’s impact set up today’s dynamics. The country added around 1.3 million new households every year for the 10-year period ending in 2007, after which household formation fell to more than half that level. New-home construction ground to a halt in 2008 as home builders were sidelined by rising volumes of foreclosures and other distressed sales.

Housing bulls see the slow economic recovery releasing pent-up demand, first for rental housing and then for home purchases. More young adults—many of them among the 65 million “echo” boomers born to baby boomers between 1981 and 1995—are moving out of their parents’ homes and into apartments. Others that had delayed home purchases during the bubble are ready to buy.

Whenever you read the words “pent-up demand” alarm bells should go off. This is usually a realtor manipulation they conjure up whenever they have nothing else positive to say about the market. Never forget that desire is not demand. Also, the bulls are counting on pent-up demand from boomerang buyers that may not materialize.

Rising prices in many parts of the country today show what happens when demand outstrips supply. To be sure, some homes are being held off the market by owners who can’t sell because they owe more than their homes or worth.

Others are reluctant to sell at prices that leave them with little money to make a down payment on their next home. …

We know that negative equity is keeping homes off the market. But Mark Hanson has been reporting on the effective negative equity of not having enough equity to make a move-up.

The bear case, the outlines of which are laid out in a forthcoming paper by Joshua Rosner, managing director of Graham Fisher & Co., draws attention to several forces that had helped housing—and the economy—expand over the past few decades but whose end will now hinder growth.Mr. Rosner first highlights the end of the “democratization” of credit. On the way up, lenders extended loans on better terms to more borrowers during a period in which interest rates were also declining. That allowed more Americans to become homeowners and, later, to take cash out of those homes via home-equity loans when prices were climbing. Housing and consumption enjoyed a one-time boost as baby boomers moved from one-income to two-income households during the inflation spells of the 1970s and as those consumers entered their peak consumption years in the 1980s. Those forces fueled homeownership, renovations and second-home buying.

Mr. Rosner has come up with a fancy way of saying we gave out debt which consumers mistook for free money, and now they are struggling to pay it back. Home equity spending heightened the housing bubble and compounded the crash.

Now, those tailwinds are becoming headwinds, Mr. Rosner says. The democratization of credit ended during the bust, and a new period of much tighter credit standards has replaced it. Mortgage lending has seen little expansion amid a slew of new regulations and tougher capital rules.

It’s not new mortgage regulations and capital rules that is holding back lending. The fact that most of their customers are insolvent Ponzis is what’s really stopping the banks from lending. It’s not like regulation is hurting the economy, it’s the fact that millions of personal Ponzi schemes all collapsed at once that’s slowing the growth of lending and the broader economy.

Tight credit isn’t the only problem, argue the bears. Many Americans will face trouble qualifying for loans because they have too much debt relative to incomes that aren’t growing fast—particularly first-time buyers from the “echo” boom who have taken on heavy student-debt loads over the past decade. All of this is likely to unfold in a rising-interest-rate environment. …

I wrote last March that excessive student loan debt is another long-term drag on housing. Young people have too much student loan, auto loan and credit card debt. Their back-end qualifying ratios make them ineligible for home loans. And it’s not like regulators can change the DTI limits and make this problem go away. If we give those borrowers home loans, they won’t be able to afford the payments, and they will implode.

Earlier this year, I made that cast that HELOC abuse will not be as prevalent this time around. My reasoning is simple. When interest rates fall, people can take on more debt with little or no increase in debt service costs. When interest rates are rising, the opposite is true. Even if borrowers have equity, most will be reluctant to take that money when it isn’t free. Who wants to take on a HELOC at 8% when their first mortgage is 4%? In a rising interest rate environment, whether there is cash out or not, refinancing is almost non-existent because costs are rising.

Skeptics also haven’t taken comfort in the housing rebound because they see it as too dependent on investors. “We shouldn’t look at it as a fundamentally recovered housing market,” says Mr. Rosner. Sooner or later, he says, there needs to be “a handoff from the investor purchase to the primary-resident purchase.”How that handoff unfolds will go a long way toward deciding whether the bulls or the bears have the last laugh.

In all likelihood, it will play out in a way that both viewpoints declare victory. Purchase originations will certainly rise at some point in the future. We are originating mortgages at mid 1990s levels while our population and available housing stock has grown significantly.

If purchase originations resume the upward slope characteristic of the 1990 to 2005 period, the bulls can claim victory. If originations flatline for another decade, the bears will claim victory. The reality will likely be somewhere in between. I expect to see slow growth in originations, and we may not see the same volume as we had in 2005 before 2025. Who claims victory then?

The investors and lenders who are counting on a rebound in prices will likely get their wish. In our local market, we are already near peak pricing. The second part of the equation is for owner occupants to be ready, willing, and able to pay peak prices. That may be a bit more of a challenge.

I dont’ have the property records for today’s featured property. For whatever reason, it’s not in my database. Since they paid $508,000 in 2000 and the bank is selling it for a loss in 2013 for $802,522, you can surmise the former owners got at least $300,000 in HELOC booty out before the crash.

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[idx-listing mlsnumber=”PW13107490″ showpricehistory=”true”]

755 West ASTER Pl Santa Ana, CA 92706

$802,552    ……..    Asking Price
$508,000    ……….    Purchase Price
8/31/2000    ……….    Purchase Date

$294,552    ……….    Gross Gain (Loss)
($64,204)    …………    Commissions and Costs at 8%
$230,348    ……….    Net Gain (Loss)
58.0%    ……….    Gross Percent Change
45.3%    ……….    Net Percent Change
3.5%    …………    Annual Appreciation

Cost of Home Ownership
$802,552    ……..    Asking Price
$160,510    …………    20% Down Conventional
3.98%    ………….    Mortgage Interest Rate
30    ………………    Number of Years
$642,042    ……..    Mortgage
$158,112    ……….    Income Requirement

$3,058    …………    Monthly Mortgage Payment
$696    …………    Property Tax at 1.04%
$0    …………    Mello Roos & Special Taxes
$167    …………    Homeowners Insurance at 0.25%
$0    …………    Private Mortgage Insurance
$164    …………    Homeowners Association Fees
$4,085    ……….    Monthly Cash Outlays

($710)    ……….    Tax Savings
($928)    ……….    Principal Amortization
$221    …………..    Opportunity Cost of Down Payment
$120    …………..    Maintenance and Replacement Reserves
$2,788    ……….    Monthly Cost of Ownership

Cash Acquisition Demands
$9,526    …………    Furnishing and Move-In Costs at 1% + $1,500
$9,526    …………    Closing Costs at 1% + $1,500
$6,420    …………    Interest Points at 1%
$160,510    …………    Down Payment
$185,982    ……….    Total Cash Costs
$42,700    ……….    Emergency Cash Reserves
$228,682    ……….    Total Savings Needed
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