Housing market momentum lost as investors purchase fewer homes
House prices carry price momentum. Once prices start moving up — or down — they tend to continue in the same direction for long periods; however, sustainable house price momentum propels on job and income fuel. The only viable source of sustainable housing demand springs from owner-occupants who gain new jobs and increase their incomes. Job creation drives housing demand because new employees relocate to areas near work and bid up prices of available housing stock, both rental and resale. Irrespective of what may happen with financing costs or supply availability, the relentless push of increased housing demand caused by job creation spurs housing momentum.
For the last few years economists believed a resurgent housing market was key to economic recovery. They posited that more housing demand would put housing industry people back to work. This in turn would create the jobs and housing demand leading to housing market momentum and ultimately to economic momentum. It hasn’t worked out that way. Since the economic problems we face are centered in housing, the economy needs an outside force or industry to jump-start demand. Housing is reactive; housing demand will not increase until some other industry creates jobs to launch housing demand.
Like other economic observations, economists understand little about how house price momentum works. This lack of understanding prompted legislators, lenders, bureaucrats, and the federal reserve to embark on innumerable market manipulations to reverse declining home prices from 2007 to 2012. Each time their policy manipulations caused prices to move up against the downtrend, the manipulators cheered the results and prayed for “escape velocity” to resist the pull of foreclosure gravity and sustain upward price momentum. The first attempts quite predictably failed. The most recent effort is working for now, but some economists suggest this latest house of policy cards may collapse as well.
Published: Tuesday, 26 Nov 2013 | 10:50 AM ET[dfads params=’groups=165&limit=1′]
By: Diana Olick | CNBC Real Estate Reporter
A striking surge in home prices this fall was not enough to convince one of the nation’s top housing economists that the recovery is on solid ground.
“We can’t trust momentum in the housing market anymore,” Nobel Prize-winning economist Robert Shiller said on CNBC’s “Squawk Box.”
Why not? Investors, specifically institutional investors, have vast sums of cash. They have bought about 100,000 homes, most of them previously foreclosed properties. They bought the homes in a limited number of markets, mostly in the West, pushing prices dramatically higher as competition for the properties increased. They are now renting them, and even selling bonds backed by the rental streams.
The trouble, according to Shiller, is that investors are a fickle bunch, and if they see lower-than-expected returns they won’t hesitate to dump the properties and move on to another trade.
The large hedge funds accumulating single-family homes have the power to crash the market. If they decide to liquidate with alacrity, house prices will fall, but how likely is that?
Will investors dump their properties and precipitate a crash?
I don’t foresee investors dumping their homes on the open market in a manner that crashes the retail price. First, despite opinions to the contrary, this trade is working out largely as planned. Investors obtained properties providing cash returns superior to other investments, particularly multi-family where prices were bid up far too high to provide decent returns. These investors anticipated higher cash returns, but they also anticipated flat resale prices for several years. None anticipated 20% to 40% appreciation in less than two years. Realistically, the only factor that may prompt some funds to exit is that returns far exceeded their projections.
Those investors who may exit to take advantage of their sudden windfall probably will not sell individual properties on the open market. Investors recognize their holdings are illiquid if they dispose of them one-at-a-time, so any sales will likely be in bulk to another investor, or they may become a REIT and cash-out by selling to small investors through the securities markets. Either way, any sales will likely be outside the MLS, other than perhaps pruning some of their weed properties.
The doomsayers who decry the REO-to-rental business model are wrong. They fail to see that cash returns still outperform competing opportunities, and they fail to anticipate liquidation opportunities that won’t impact the housing market. The doomsayers may want this model to fail, but wishes aren’t horses, and this business model won’t drown in a sea of investor liquidations.
If anything, investors in the REO-to-rental business model are disappointed they could not acquire more properties. Most investors anticipated several more years of bank liquidations before prices rose so high that continued acquisition no longer made sense. Unfortunately, lender market manipulations and can-kicking removed this supply, so investors are slowing their acquisitions.
Purchases by investors could be slowing down for several reasons. First, the deals are disappearing. The share of homes selling out of foreclosures and short sales have plummeted over the past year, and prices on a national basis are up by anywhere from 6% to 13%, depending on which home-price gauge is used. Prices are up significantly more in hard-hit housing markets that had offered some of the steepest discounts to investors.
Second, executives of some large investment firms have said on quarterly conference calls that they’ve dialed back their purchases as they focus on improving their operations, including leasing and property management functions.
Investors endured dismal management performance so far. Some indicate this proves widely dispersed properties cannot be managed effectively. This is nonsense. Managing a bevy of single family homes costs more than managing an apartment complex, that much is true. However, the income relative to the cost on single-family homes justifies the increased management expense. Since this industry is new, managers are still establishing efficient management procedures. Those that succeed enjoy good returns. Those that fail will sell out to those who succeed.
Third, the conversion of more homes as rentals could be putting pressure on rents, trimming returns for some investors.
My monthly reports demonstrate the pressure on rents. Riverside County rents are flat, and they have been for the last couple of years. Weak rents flow from the flood of supply, not because of weak economic growth.
Will owner occupants take up the slack?
Investors will curtail buying next year due to high prices. If owner-occupants don’t increase their activities, the housing market will languish under high prices with low sales volumes. Since distressed sales will continue to float in cloud inventory, sales prices will continue to rise, albeit at a slower pace. Economists operated under the theory that owner-occupants would take up the slack from declining investor demand; however, there is no sign this will actually happen. The jobs market is still weak — improvements in unemployment are largely due to more job seekers being classified as out of the workforce. With a weak jobs market, potential buyers are merely the fantasy of hopeful economists and housing bulls.
I don’t think owner-occupants will step up in large numbers, particularly at the bubble-era peak prices of many markets. Higher prices lowers demand unless lenders innovate and kool aid intoxication takes over; neither seems likely. With the policy changes we investigated over the last few days, the market faces uncertainty, and the prospect of rising interest rates will further diminish demand. I believe sales volumes will be flat or perhaps even decline next year, and prices will be volatile.
2004 prices in Irvine?
House prices in much of Irvine already inflated to the peak of the bubble. Super low interest rates and a healthy dose of market manipulation pushed prices higher. The most desirable neighborhoods lead the way, and the less desirable ones lag behind waiting for the substitution effect to push buyers their way. Today’s featured property is priced below its 2004 purchase price. Someone will perceive this a bargain, particularly now that financing amounts larger than this is much more difficult that it used to be.
28 WILLOWGROVE Irvine, CA 92604
$655,000 …….. Asking Price
$760,000 ………. Purchase Price
4/23/2004 ………. Purchase Date
($105,000) ………. Gross Gain (Loss)
($52,400) ………… Commissions and Costs at 8%
($157,400) ………. Net Gain (Loss)
-13.8% ………. Gross Percent Change
-20.7% ………. Net Percent Change
-1.5% ………… Annual Appreciation
Cost of Home Ownership
$655,000 …….. Asking Price
$131,000 ………… 20% Down Conventional
4.52% …………. Mortgage Interest Rate
30 ……………… Number of Years
$524,000 …….. Mortgage
$130,273 ………. Income Requirement
$2,661 ………… Monthly Mortgage Payment
$568 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$136 ………… Homeowners Insurance at 0.25%
$0 ………… Private Mortgage Insurance
$0 ………… Homeowners Association Fees
$3,365 ………. Monthly Cash Outlays
($558) ………. Tax Savings
($688) ………. Principal Amortization
$220 ………….. Opportunity Cost of Down Payment
$184 ………….. Maintenance and Replacement Reserves
$2,523 ………. Monthly Cost of Ownership
Cash Acquisition Demands
$8,050 ………… Furnishing and Move-In Costs at 1% + $1,500
$8,050 ………… Closing Costs at 1% + $1,500
$5,240 ………… Interest Points at 1%
$131,000 ………… Down Payment
$152,340 ………. Total Cash Costs
$38,600 ………. Emergency Cash Reserves
$190,940 ………. Total Savings Needed