Nearly 33,000 homes closed escrow in California during March 2014. This is up 28% from the prior month, but more significantly, down 13% from one year earlier when nearly 38,000 sales took place.

March’s 13% year-over-year decrease continues the downward trend experienced in home sales volume throughout the second half of 2013 and thus far in 2014. At this time last year, home sales volume was still high, riding the wave of low interest rates. However, increases in both home prices and mortgage interest rates stifled upward movement in sales volume by year’s end.

2013 ended with 446,419 home sales, roughly level with the 449,059 home sales in 2012. Home sales volume remained down by around 40% from the peak year of 2005 when 753,876 sales closed escrow.

first tuesday forecasts a slightly weaker home sales volume for 2014 than experienced in 2013. This reflects the 2010-2011 experience in home sales volume as it occurred 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 in 2014, expect sales volume to decrease and prices to slip in the absence of sufficient end user demand due to slow job creation and high mortgage rates.

The bumpy recovery continues — but the ride is getting rougher, and the duration frustrating. 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 2015.

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

Absentee homebuyers: to hold or to fold?

Absentee homebuyers (speculatorsbuy-to-let investors and renovation contractors) remain high. Absentee homebuyers accounted for 27% of Southern California (SoCal) March sales volume, down slightly from the prior month and down from 31% one year earlier.

The percentage of homes sold in SoCal as flips also decreased to 5.3% in March from 6.1% in the prior month and 6.3% a year earlier.

Absentee homebuyers made up 21% of Bay Area homebuyers in March, down from 24% in February and down from 27% one year earlier.

Speculators chase upward price movement, but sales volume has been softening for the past year. Home prices are beginning to slip in 2014 and are expected to continue their descent throughout this year. Thus, expect absentee buyers to comprise a smaller percentage of monthly sales further into 2014.

Cash purchases (two-thirds of which are made by speculators) remained abnormally high in March, representing 29% of SoCal sales volume, down from 31% in February. However, cash sales decreased steadily in 2013, down from 35% a year ago. 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 trend downward well into 2014, as speculators abstain in reaction to slipping prices.

Bay Area cash sales were 25% of home sales in March 2014. This is down from 28% in February and 31% 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. Speculators are already on their way out of the market. Expect a mass exodus when prices follow sales volume and take a sympathetic nosedive. Prices have already begun to slip in 2014.

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 soon 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 prices to remain level to down through 2014.

At the moment, end user demand is half of what is needed for a normal 60,000 monthly sales volume.

Jumbo loans: room at the top

Jumbo loans (loans over $417,000) accounted for 30% of SoCal’s March 2014 sales, the highest share since 2007 when jumbos peaked at 37% of all SoCal loans. March’s jumbo share is up from 27% in the prior month and up from 24% a year earlier.

Jumbos financed a whopping 53% of Bay Area sales, also the highest since 2007 when it was 59%. This is up from the 49% in February and up from 43% a year earlier.

Jumbo use has risen statewide as sales of high-tier properties accelerated in 2013 — particularly in the pricey Bay Area with its greater concentration of new wealth. Despite this increase, jumbo use remains below its peak in 2006-2007 when buyer overreaching maxed out.

FHA-insured loans: a window is closing

Federal Housing Administration (FHA)-insured loans made up 18% of March SoCal mortgage recordings. This is down slightly from the prior month, and down from 23% one year earlier.

FHA-insured loans made up 9% of Bay Area mortgages in March. This is down slightly from the prior month and down from 12% one year earlier.

California’s appetite for FHA-insured loans is waning: FHA-insured loan use is around its lowest level since late 2008. first tuesday anticipates the share 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.

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 13% of all SoCal mortgages in March 2014, nearly twice the 7% share one year earlier. While ARM use has increased rapidly in the past year, it’s still down from the Millennium Boom peak of 78% experienced mid-2005. ARM use bottomed at 2% of all SoCal sales in April 2009.

ARM use in the Bay Area was at 26% in March. This is up from 23% in February and double the 13% 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 later 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 March Home Sales from DataQuick