41,118 homes closed escrow in California during July 2013. This is 22% higher than one year earlier. July’s boost is a reversal of the downward trend in sales volume experienced since November 2012. However, the upward leap seen in July will not likely continue, due to increases in both home prices and mortgage interest rates.

The bumpy recovery pattern continues, and the ride is getting rough. Home sales volume rose in 2009, fueled by end users clamoring after tax credits. Then, in 2010-2011, home sales volume fell back for lack of all types of buyers. It rose again in 2012, driven by speculator interference. And now we see it trending downward again for lack of end user demand (in spite of July’s one-month jump).

As we continue through the second half of 2013, expect sales volume to fall below last year’s levels— a normal market response to the speculator-driven price bounce.

California’s real estate sales volume 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. We are nowhere close at this point in the recovery, but likely will be around 2016.

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Other key factors controlling California’s housing market sales volume follow.

Absentee homebuyers: to hold or to fold?

Absentee homebuyers (speculators, buy-to-let investors and renovation contractors) accounted for 27% of Southern California (SoCal) July sales volume, roughly level with one year earlier. Absentee homebuyers made up 21% of Bay Area homebuyers in July, down from 23% one year earlier.

Speculators chase upward price movement, but sales volume has been softening and prices will slip next. Thus, the percentage of absentee buyers making up monthly sales will continue at today’s high level until prices start to slip, likely in the fourth quarter of 2013.

Cash purchases (two-thirds of which are made by speculators) remained abnormally high in July, representing 29% of SoCal sales volume. This is down from the record high of 37% set in February 2013. In a normal market, cash purchases represent around 16% of all buyers, comprised mainly of end-users.

The percentage of sales attributed to cash purchasers will drop by the end of 2013, as speculators react to slipping prices.

Bay Area cash sales were 24% of home sales in July 2013. This is down from 28% one year earlier.

Speculators will 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. Will reality finally set in when prices follow volume and interest rates, and take a sympathetic nosedive this fall?

The annual increases in the buyer purchasing power index (BPPI) came to an end in June, dimming the prospects of flipping for a profit. Sellers ignore these trends at their peril.

When short-term speculators realize they cannot make a profit as soon as anticipated, they will quickly leave the market. The inventory they leave behind (today’s growing shadow inventory) will be consumed primarily by end users and income property investors. However, there aren’t enough of these buyers to sustain current sales volume. Thus, expect sales prices to remain level to down through and beyond 2014.

At the moment, demand from end users represents only half the number needed for a normal 60,000 monthly sales volume.

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Jumbo loans: room at the top

Jumbo loans (loans over $417,000) in SoCal accounted for 28% of July 2013 sales. This is down slightly from the prior month, when jumbo loans made up a higher percentage of SoCal’s home sales than at any other time since August 2007, when jumbo loans consisted of 37% of sales.

Jumbos financed 51% of Bay Area sales. This is level with last month and up from 39% a year earlier.

Jumbo use has risen statewide as sales of high-tier properties have accelerated — particularly in the pricey Bay Area — since 2009. Despite this increase, jumbo use remains far below its peak in 2006-2007.

FHA Loans: a window is closing

Federal Housing Administration (FHA)-insured loans made up 19% of SoCal mortgage recordings. This is down from 20% last month, and 28% one year earlier.

FHA-insured loans made up 11% of Bay Area mortgages in July. This is roughly level with the prior month and down from 16% one year earlier.

FHA-insured loan use across California is at its lowest level since late 2008. first tuesday anticipates the percentage of FHA-insured loans will steadily drop, hitting a bottom of 4% of loan originations around 2018. High (and rising) FHA insurance premiums make conventional loans with private mortgage insurance (PMI) more appealing, as they ought to be.

FHA buyer standards have also been tightened at this point in the recovery. Nonetheless, FHA-insured financing remains popular as a loan of last resort for determined first-time homebuyers with low savings and less than ideal credit scores.

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ARMs: holding lenders at bay

Adjustable rate mortgages (ARMs) made up 11% of all SoCal mortgages, up from 6% one year earlier. SoCal ARM use in July was the highest it’s been since July 2008, the heart of the recession. ARM use made up 13% of all SoCal sales in July 2008.

ARM use in the Bay Area was at 19% in July. This is the highest level of ARM use since August 2008 when ARMs made up 21% of all transactions. Cash transactions in the Bay Area are slipping, a warning that prices are being supported by ARMs. If this trend continues into 2014, the Bay Area will clearly be in a bubble and due for a crash 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 the current price bounce. When it does, ARM use will increase as agents push homebuyers to overreach on amenity value, appraisers drift away from comparable pricing and lenders relax credit standards.

Re: California July Home Sales from DataQuick