Just under 40,000 homes closed escrow in California during July 2014. This is up slightly from the prior month, but more significantly, down 9% from one year earlier when 43,000 sales took place.

July’s year-over-year 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 the jump in mortgage rates persisted 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. This is not due to a lack of demand from end users. However, 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.

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) July sales volume, the lowest since December 2010. July’s absentee homebuyer share is down slightly from the prior month and down from 27% one year earlier.

Absentee homebuyers made up 19% of Bay Area homebuyers in July, down slightly from June and down from 21% one year earlier.

Speculators chase upward price movement, but home prices have topped out and will show signs of slipping once mid-year reports 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) dropped to the lowest level in four years in July, representing 25% of SoCal sales volume. This is down from 26% in June, following a steady descent from 30% 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 20% of home sales in July 2014, the lowest share experienced since November 2008. This is down from 21% in June and 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 their significant decrease 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 July 2014 sales, the highest share of jumbos since 2007 when jumbos peaked at 37% of all SoCal loans. This is roughly level with June and up from 28% a year earlier.

Jumbos financed a whopping 57% of Bay Area sales, roughly level with June and up from 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.

FHA-insured loans: a window is closing

Federal Housing Administration (FHA)-insured loans made up 19% of July SoCal mortgage recordings. This is level with the prior month and one year earlier.

FHA-insured loans made up 11% of Bay Area mortgages in July. This is up slightly the prior month and up from 10% one year earlier.

California’s appetite for FHA-insured loans is waning and is around its lowest level since late 2008. The share of homebuyers taking out FHA-insured mortgages declined quickly in 2012 and 2013, but has since leveled off somewhat. first tuesday anticipates the share of FHA-insured loans will remain around its current, low level through 2018. High (and rising) FHA-insurance premiums make conventional loans with private mortgage insurance (PMI) more appealing, as they ought to be.

The FHA has gradually tightened buyer standards to protect their mortgage insurance fund, with a limited exception for buyers who have very recent foreclosures or bankruptcies. 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 or debt ratios.

ARMs: holding lenders at bay

Adjustable rate mortgages (ARMs) made up 14% of all SoCal mortgages in July 2014. July’s ARM share was down slightly from June and up from 11% a year earlier. While ARM use has increased rapidly in the past year, 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 26% in July. This is down from 27% in June 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 into 2014, 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 July home sales from DataQuick