Entry-level houses scarce because underwater owners can’t sell

Entry-level housing is not available for sale because many owners of these properties are still underwater and unable to list and sell their homes.


From 2000 to 2005, house prices more than doubled in many areas of the country. Although rates of home price appreciation that high can’t be sustained, most people don’t know or believe that. In fact, most people who bought late in the rally extrapolated the short-term rally to infinity. They really believed they were going to make a fortune, and all their dreams were coming true.

It didn’t work out that way.

Only the strongest markets across the country are back above the housing bubble peak. Late buyers and refinancers who used amortizing loans and consistently made payments are above water, but many others are not.

Borrowers with loan modifications endure larger mortgage balances because the fees and missed payments added on. Further, many (if not most) private loan modifications don’t amortize, so those borrowers are likely still underwater. Those borrowers don’t list and sell their homes today because the consequences are too severe, particularly with the tax on forgiven mortgage debt back in full force.

By far the majority of these people are still trapped in their entry-level homes. Many obtained loan modifications, but many others struggled to make sky-high mortgage payments, and they struggle to this day.


How the property ladder works

In the real world, most first-time homebuyers use an FHA loan and buy a low-cost property because it takes too long to save 20% for a down payment on a conventional loan. First-time homebuyers use FHA loans because the 3.5% down payment is within reach. Further, once these buyers are in a property, they merely wait five or ten years for loan amortization and wage-based appreciation to magically give them 20% to 30% equity in a property to use on their move-up purchase.

Once the owner has enough equity to get a closing check large enough to fund a 20% down payment on a move-up property, they can complete a move-up trade. Since this is usually quite some time after buying their FHA financed property, it’s likely the household’s wage earners are making more money. They take their larger family income and their 20% down payment and buy a more expensive move-up property.propert_ladder_pressure

The broken property ladder

For the property ladder to work, home prices and wages must rise steadily and borrowing costs must remain stable, or better yet, mortgage rates should fall gently. If any one of these features is missing, the property ladder becomes unstable.

During the housing bubble, prices rose very rapidly, but rather than enrich an entire generation of homeowners, lenders allowed them to borrow and spend their equity, so while house prices doubled during the bubble, aggregate home equity actually declined. This left an entire generation of homeowners over-indebted and trapped in their starter homes. This lack of move-up equity and lingering problems with underwater borrowers explains the unusually low levels of for-sale housing inventory.

Today’s entry-level homebuyers in Coastal California must pay upwards of $600,000 in nicer areas. With as large as that number is, the number is financeable by many entry-level buyers with high family incomes. If the previous generation would have only paid $450,000, those owners would have $150,000 in equity they could use to move up to a $750,000 home, and the property ladder would function.

However, that’s not how much the previous generation paid. Many entry-level buyers from 10 years ago paid $650,000 to $750,000 with their option ARM loans with teaser rates. Any while many of those buyers lost their homes to foreclosure, many more obtained loan modifications, so rather than $450,000 or less in debt on their starter home, they still have $650,000 or more in debt, and they can’t sell.greedy_sellers

Since the owners stuck in entry level homes carry too much debt, they aren’t listing and selling their homes, and they can’t make a move-up trade. Housing analysts concoct many plausible reasons for the lack of for-sale inventory, but the real reason is the excessive debt still carried by the previous generation of homebuyers.

The problem with a lack of inventory is most acute at the entry level because an entire generation of entry-level buyers is stuck. And since they can’t sell until they get enough to cover their debt, and since most won’t sell until they have enough left over to make a move-up trade, entry-level housing is scarce.

In recovering housing market, the starter home remains elusive

By David Randall and Nichola Groom, Aug 10, 2016

Low interest rates and an improving job market have created a wave of prospective first-time home buyers, but they’re being stymied by a dearth of available starter homes.Nationwide, the inventory of homes costing $250,000 or less fell more than 12 percent between June 2015 and June 2016, according to the National Association of Realtors.

Bear in mind that the inventory at the bottom of the housing market becomes more scarce as house prices move up. However, the lack of inventory at the bottom of the market isn’t due to the general increase in all house prices.

The shortage stems from higher labor, land and building permit costs that have caused construction companies to focus on higher-end homes that bring more profit. In addition, institutional investors are snapping up affordable homes by the thousands in select markets nationwide and converting them to rentals.

The two reasons given above have little to do with the

Builders would provide more entry level homes if they believed they could sell more volume. Builders shun this market today because despite the shortages, they can’t sell these any faster than they’re selling more expensive homes. Since they make more on more expensive homes, that’s what they build.

The shrinking supply of affordable homes is one economic trend among many that is conspiring against younger workers and families in building wealth as their parents once did.

Real average hourly wages of often debt-laden college graduates fell between 2000 and 2014, according to the Economic Policy Institute, while the Case-Shiller U.S. National Home Price Index jumped more than 25 percent, adjusted for inflation, over the same period.

hid_the_housesThe rally of 2012-2013 was obviously not based on improving fundamentals. The higher house prices were engineered by lender policy with an assist from the federal reserve’s low interest rates.

Younger workers who can afford to save for a down payment, meanwhile, are forced into bidding wars for the dwindling number of houses they can afford.

This is exactly what the powers-that-be were hoping for. The only way to raise prices rapidly and bail out the banks was to force the few buyers to compete for even scarcer real estate.

Some decide instead to strain their budgets for a home that would have been traditionally considered a trade-up.

Not here in Coastal California. Very few entry level buyers possess the income or down payment to obtain the first level of move-up homes.

Over the past four years, the number of entry-level homes for sale – defined as those priced in the lower third of a local market – has fallen by 34 percent, according to a Reuters analysis of data compiled by listings firm Trulia.

“We don’t see a lot of value today in running out into the exurbs and buying a lot of lots,” PulteGroup Chief Financial Officer Bob O’Shaughnessy said at an investor conference in May.

If there’s another housing downturn, he said, “that is the stuff that will shut down first.”

The Millennials currently cope with excessive student loan debt, which is also preventing them from buying houses. Millenials delay marriage, and they don’t form new households at the same rate as previous generations. Most housing market analysts blithely assume Millennials will follow the same path as preceding generations once they have opportunity, but what if Millennials decide not to buy homes? Baby Boomers don’t want to think about that possibility.

What happens to the housing market if first-time homebuyer rates fall to record lows and remain there for many years? Over the next decade, we’re going to find out.


Perhaps an improving economy, strong job growth, and strong wage growth will cause house prices to rise as much over the next 25 years as they did for the baby-boom generation. If mortgage rates remain permanently below 4%, that could happen. Perhaps we really have reached a permanently low floor in mortgage rates.

Due to the stability in housing brought about by Dodd-Frank, I don’t believe today’s homebuyers have much to fear, but that same stability means prices won’t shoot up wildly like past bubbles either, so today’s homebuyers don’t have much to gain. Buying a house as a family home is still a good idea. It’s reverted to the old stable and boring retirement piggy bank it used to be. And in my opinion, that is a good thing.

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