How many buyer-occupants do you now represent who are pre-qualified in writing by a lender based on a verified source of funds?
- 0-1; (41%, 35 Votes)
- 2-3; (36%, 31 Votes)
- 6 or more (13%, 11 Votes)
- 4-5; or (9%, 8 Votes)
Total Voters: 85
The housing market, as with all open markets, is driven by demand – so why is everyone stuck on supply? Part I of this article series discusses the factors preventing buyer-occupants from entering California’s housing market and provides a diagnosis for the housing recovery: buyer-occupant demand.
For an analysis of why the housing inventory appears to be shrinking, see Part II of this series.
Where does buyer demand come from?
Have you heard the news? Rumor has it buyer-occupants are standing in line ready to buy, and it is only California’s low housing inventory that is thwarting their demand for housing (and halting the housing recovery).
A quick lesson in fundamentals: end-user demand, organically originating from those intending to occupy the property as shelter or rent it out for a long-term investment, controls the consumption of housing. If consumers do not want it, the inventory size does not matter.
Thus, inventory (read: supply) has little to do with home sales volume.
In contrast, inventory has everything to do with prices.
Consider the following:
- when inventory is lean, sellers are able to ask for higher sales prices and get their price due to the crowding of buyers competing for each available property; and
- when inventory is flush and buyers are few, buyers are able to pick and choose, cherry-picking as they push prices down.
However, in both circumstances, supply is not the propelling force behind home sales volume. Stated mathematically: no buyers means all sellers and no sales. Last one out, please turn off the multiple listing service (MLS) lights!
How does an agent determine buyer-occupant demand?
First, let’s look at the wrong way to calculate buyer-occupant demand: determining an area’s number of qualified buyers by mysteriously applying its median home price to the median income in that area.
Does median home price + median income = demand?
No! The phantom mathematical abstractions of median prices and median incomes are each essentially meaningless.
When used to set the price a mythical, nowhere-to-be-found median buyer can pay for a median priced home which does not exist, these “affordability” index figures apply to no one property – and no one buyer. In other words, they apply to nothing at all.
Worse, these indexes are used to demonstrate that otherwise qualified people who fall below median income cannot buy a home. Facts: if they have a job and at least modest credit, they qualify to borrow and buy a home somewhere in the market – even if they fall below the arbitrary median income threshold.
So how then do we quantify buyer-occupant demand? The best indicator for homebuyer demand is what price a prospective buyer-occupant (there goes that demand side again) is qualified to pay based on:
- 31% of his gross income (which equals his maximum monthly payment);
- current interest rates for a 30-year fixed rate mortgage (FRM); and
- funds saved for a downpayment.
Then, and only then, can the agent (or the lender) determine the maximum price the buyer can justifiably pay for a home.
With the maximum price for a property in mind and the lender’s (or better yet, multiple lenders’) written approval(s) in hand, the search may begin to locate a home.
Indexes play no role in determining what price a buyer-occupant can pay; it is the lender as the gatekeeper to financing who decides this price for nearly all homebuyers.
Population growth + decreased jobs = fewer buyers
Before demand can increase, homebuyers must be able to pay for a home. This means a steady flow of income in the form of jobs. Even if homes were selling at all-time lows (which they currently are not), no one can purchase a home without an income derived from employment.
Editor’s note – Exceptions exist for those with income in the top 10% of reporting taxpayers (as they own 75% of the stocks held by individuals in the U.S.).
Currently, California needs to regain just over one million more jobs just to return to pre-recession employment levels (population growth will require even more jobs to achieve the same standard of living). Of course, this means many otherwise willing buyer-occupants are now unemployed and not even close to being able to qualify for a home purchase, much less ready to make the leap.
More interesting for future housing demands, our California population is growing 1% annually. That requires perhaps 140,000 additional jobs annually from the December 2007 peak employment until we return to that peak, probably a 9-year span into 2016 as we at first tuesday best calculate.
Meanwhile, the equivalent number of individuals are unemployed and cannot buy a home, but are renting or living with relatives.
Construction will hugely benefit from our population growth, but contractors will have to wait until all the housing is reoccupied and jobs exceed that December 2007 peak number before new housing starts will be much needed.
Again, 2016 seems to be the go-ahead year that jumps out from the figures behind the charts, maybe longer for reason of the shift in housing demand toward urban locations.
The interest rate effect
Let the MLS supply-siders take note: the number of homeowners willing to qualify for a purchase-assist loan is not up – it’s down over the past couple of years.
The cause for much of this hesitation is likely today’s very high real mortgage rates (which has been narrowing toward normal at the end of September 2012).
Rates that lenders have been charging may appear low at a cursory glance: around 3.5% for a 30-year FRM.
While lower than recent mortgage rates, are they still too high based on lender costs and rate setting standards?
Yes! Surprised? Here’s why: the spread between the 10-Year Treasury Note (T-Note) Rate (the rate used as a basis for mortgage lending) and the 30-year mortgage rate was 1.8% during the summer of 2012 (and is currently at 1.6%) — well above the historically standard 1.4% spread. Thus, mortgage money has been far more expensive than it should reasonably be.
The reason: lenders have discovered they can take advantage of low nominal rates (actual rates) (but high real rates) to pad profit through higher margins built into their lending rates.
It’s too simple: lenders sell their newly originated mortgages into the bond market at a low rate (currently around 2.7% and slipping) having lent at an excessive rate. The margin generates a yield spread premium (YSP) that is worth around $10,000 per $100,000 lent at today’s rates. Lenders are confident in the fact that your borrower will still perceive (via the money illusion scam) the inflated rate as “low” when compared to recent history.
However, mortgage money may soon become more accessible due to the Federal Reserve’s (the Fed’s) recent decision to begin purchasing $40 billion in mortgage-backed bonds a month. The market intervention is intended to put downward pressure on the spread between mortgage rates and T-Notes causing it to decrease.
Experts have speculated this may push 30-year mortgage rates as low as 3.25% and 15-year rates to 2.72%.
Editor’s note – In the week ending September 27, 2012, the 30-year mortgage rate for the Western region was 3.36% and the 15-year mortgage rate was 2.71%.
Once this occurs, buyer-occupants will be able to qualify for a larger loan and thus purchase more house, a new reality which both sellers and agents will benefit from.
Rates may be considered “low,” but they should be lower to draw more buyers-occupants into the market. If lenders returned to their historical long-term profit margins, buyers would have mortgage rates around 3% — allowing them to borrow more mortgage money with the same paycheck and inducing more demand for homes from buyer-occupants.
For a discussion of the effect of housing inventory on California’s recovery, see Part II of this series.