Just over 37,000 homes closed escrow in California during August 2014. This is down 6% from the prior month, but more significantly, down 13% from one year earlier when 42,500 sales took place.

August’s decrease continues the downward trend experienced in home sales volume since the second half of 2013. At this time last year, home sales volume had just begun to falter as mortgage rates began to rise and home prices continued up, out of reach.

2014 is on track to end with approximately 400,000 home sales. This is well below the peak year of 2005 when 753,876 sales closed escrow. Prior to the Millennium Boom, 550,000-600,000 homes closed escrow annually.

first tuesday forecasts a weaker home sales volume for the reminder of 2014. This resembles the 2010-2011 experience in home sales volume after the 2009 tax stimulus. 2012-2013 received a similar “stimulus” from speculators who propped up sales volume and prices. Now, as they continue to exit the market through 2014, sales volume will continue to decrease, followed by slipping prices. End users of property have been pushed out of the market by reduced purchasing power, due to the year-long jump in prices and the rise in mortgage rates which persists today.

The bumpy recovery continues, and it’s still a rough ride. California’s housing market needs about 60,000 homes sold monthly to fully recover. That recovery is dependent on 18-24 months of annual California job growth exceeding 350,000-400,000 jobs. The good news is that a full jobs recovery is closer, likely to arrive by the end of 2014.

Other key factors controlling California’s home sales volume follow.

Absentee homebuyers: to hold or to fold?

Absentee homebuyers (speculatorsbuy-to-let investors and renovation contractors) still make up a significant portion of the resale market, though they are leaving quickly. Absentee homebuyers accounted for 24% of Southern California (SoCal) August sales volume, level with the prior month and the lowest since December 2010. August’s absentee homebuyer share is down from 27% one year earlier.

Absentee homebuyers made up 18% of Bay Area homebuyers in August, down from 19% in July and down from 20% one year earlier.

Speculators chase upward price movement, but home prices have topped out and will show signs of slipping once reports for Q3 2014 come in. Thus, real estate speculation and absentee buyers are expected to continue their exodus from the market throughout this year.

Cash purchases (two-thirds of which are made by speculators) represented 24% of SoCal sales volume, just above its four year low experienced in July 2014. This follows a steady descent from 28% a year ago. In a normal market, cash purchases represent around 17% of all buyers, comprised mainly of cash-flush end users.

Bay Area cash sales were 22% of home sales in August 2014, also just above the prior month which saw the lowest share of cash buyers since November 2008. This is down from 24% one year earlier.

Speculators remain motivated to buy only so long as they believe home prices will rise quickly. Expectations of a quick resale have faced the headwinds of falling sales volume since November 2012. The numbers indicate reality has begun to set in. Expect a speculator mass exodus when prices follow sales volume and take a sympathetic nosedive later this year.

The annual increases in the buyer purchasing power index (BPPI) came to an end in mid-2013, dimming the prospects of flipping for a profit. Higher mortgage rates indicate homebuyers are unable to qualify for as much principal as a year ago. Sellers ignore these trends at their peril.

When speculators realize they cannot make a short-term profit as anticipated, they will either quickly leave the market or resort to Plan B to hold for another five years. The inventory they dump (today’s shadow inventory) will need to be consumed primarily by end users and income property investors. However, there aren’t enough of these buyers ready and willing to sustain even the current low sales volume. Thus, expect home prices to begin to decrease most significantly in Q4 2014. The more exaggerated the rise in home prices, the more pronounced the fall.

Jumbo loans: room at the top

Jumbo loans (loans over $417,000) accounted for 32% of SoCal’s August 2014 sales, level with the prior month and the highest share of jumbos since 2007 when jumbos peaked at 37% of all SoCal loans. This is up from 27% a year earlier.

Jumbos financed an astounding 58% of Bay Area sales, up from 57% in July and 50% a year earlier.

Jumbo use has risen statewide as sales of high-tier properties accelerated — particularly in the pricey Bay Area with its greater concentration of new wealth. Despite this increase, jumbo use remains below its 2006-2007 peak, when buyer overreaching maxed out.

ARMs: holding lenders at bay

Adjustable rate mortgages (ARMs) made up 13% of all SoCal mortgages in August 2014. August’s ARM share was down slightly from July and up from 12% a year earlier. While ARM use is well over what it was up until mid-2013, it’s still well below the Millennium Boom peak of 78% experienced in mid-2005. ARM use bottomed at 2% of all SoCal sales in April 2009.

ARM use in the Bay Area was 25% in August. This is down slightly from the prior month and up from the 19% share a year earlier.

Cash transactions in the Bay Area are slipping, a warning that prices are being supported by ARMs. If this trend continues, the Bay Area will certainly be in a bubble and due for a crash-like adjustment in sales volume and prices.

ARM use will remain relatively low statewide until property prices rise more than 5% annually for at least two years. This probably will not happen with today’s price trends. But when it does happen later on this decade, ARM use will increase as agents push homebuyers to overreach on amenity value, appraisers drift away from comparable pricing and, inevitably, lenders relax credit standards. This is unlikely until the next big bubble, expected to occur around 2018-2020.

Re: California August home sales from DataQuick