The speculator: not just any investor

Purchasers of real estate can be divided neatly into two categories:

  • end users of property, including buyer-occupants and long-term investors; and
  • speculators, who own the property short-term, sandwiching themselves between the seller and the end user in order to make a profit.

Speculators (also known as hit-and-run artists, hot money handlers, drive-by dealers, parasites and sandwichers) are distinct from long-term investors mainly in terms of duration of investment. Long-term investors rely on rental income as a stream of revenue to make their investments worthwhile. For speculators, on the other hand, rental income is an added bonus, but not a necessary part of their short-term investment plan.

The end goal for speculators is to make a profit on the resale (after transaction fees and the carrying costs associated with owning the property), which will ideally happen as quickly as possible.

Will anyone play with speculators?

Home builders historically will have nothing to do with speculators, as they create competition for the builder’s next home sale. On the other hand, builders are very willing to sell to long-term investors, such as those mom-and-pop investors who are interested in earning rental income as part of their retirement plans.

In contrast, lenders will gladly deal with speculators. Lenders may impose higher rates and require a larger down payment for all non-occupant homebuyers. However, this isn’t such a big deal for speculators because they wield cash.

Investors will often syndicate others’ cash to fund their investments, promising quick, high returns to their investors. This high amount of liquidity allows them to pummel buyer-occupants in bidding war situations, allowing the speculator’s inventory of homes to grow ever larger while end users are left empty-handed.

The speculator problem

Most media outlets confidently blame speculators for the low inventory and home pricing anomalies experienced since late-2012. first tuesday has quite often pointed to speculators as a destructive force, snatching homes from the feeble grasp of end users.

But not all non-occupant home investors are detrimental to the housing market. In fact, in a recovering housing market, speculators can provide a needed boost in sales volume when end users lack the willingness or ability to support home sales. Further, in a normal, healthy housing market, all absentee buyers transactions make up roughly 20% of all home sales. However, mid-2013 is not a normal market by anyone’s standards.

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Speculations on the speculator spectacle

Today, speculator transactions make up around 50% of all homeownership turnovers, including grant deed sales and trustee’s sales. The sheer magnitude of speculation occurring today has thrown the housing market off balance, slashing the multiple listing service (MLS) inventory and pushing home prices beyond sustainable levels.

The result? A false optimism in the housing market’s performance. Many will point to the speculator-influenced price jump as evidence that many recently underwater homeowners have been pulled permanently out of negative equity. But within nine months after speculators leave the market, prices will fall and these homeowners will return to their underwater state.  Remember mid-2005 into early 2006?

And how do we know that speculators will exit the market? It all comes back to end user demand (and, in relation, job growth).

The speculator’s main clients (besides other speculators) are end users of property. However, the number of willing and financially capable end users is not anywhere near what is needed to match the speculator acquisitions today. Jobs and inflation-adjusted income still remain well below pre-recession levels. What’s more, both factors are decelerating, a wrong direction in any market.

When homes begin sitting longer on the market (and they have already begun to do so in mid-2013), speculators will begin to get the hint that end users are not ready to repurchase speculator acquisitions anytime soon.

First one, then two, then the whole flock will scurry away, dumping their inventory on the MLS en masse.  When? Within the next 36 months, and most likely sooner, as mortgage rates will not soon return to the 3.5% level seen earlier this year.

Agent advice

Agents can prepare for this mass exodus by first confronting the reality: speculators are not here to stay. Second, they can invest their time in finding willing and able end user homebuyers and sellers.

For agents representing sellers, try to avoid overpricing your listing. As more sellers decide to jump on the bandwagon, those few homes that are sitting too long on the market today are way overpriced — frequently at 50% over the latest comparable sale. Speculators will gobble up any inventory they can get their hands on, but even they are not that stupid.

For agents representing buyers, you will need to get creative. As speculators have created the current low-inventory situation, it will be difficult to locate a home that both meets all of your buyer’s needs and falls within their price range.

So look beyond your local MLS for potential listings. Door knock or cold call likely homes and let the homeowners know you have an interested and motivated buyer. This will allow you to skip the likely bidding war and close at a price acceptable to your buyer.

Remember: not all investors are speculators. Those who rely on short-term market momentum for their profit are speculators. Expect to witness their exodus in a few short months, by the fourth quarter of 2013.

Related articles:

The great gamble: real estate speculators decoded

Homebuyer beware: the real estate game lacks fair play