42,293 homes closed escrow in California during May 2013. This home sales volume is just 1% higher than one year earlier. This is in keeping with the relatively flat sales volume experienced so far this year, contrary to the monthly increases during the last half of 2012.

The bumpy recovery pattern continues. 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 drifting downward again for lack of end user demand.

As we enter the second half of 2013, expect sales volume to fall below last year’s levels, possibly significantly — a normal market response to the speculator-driven price bounce we just experienced. The next downturn will follow an increase in mortgage rates, previously forecasted to occur in 2015. The Federal Reserve’s recent rumblings may signal a sooner interest rate increase.

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 30% of Southern California (SoCal) May sales volume, up from 28% one year earlier. Absentee homebuyers made up 25% of Bay Area homebuyers in May, up from 24% one year earlier.

Speculators chase upward price movement, but sales volume is now softening and prices will slip next. Thus, the percentage of absentee buyers making up monthly sales will continue to rise until prices start to slip, likely by the third quarter this year.

Cash purchases (two-thirds of which are made by speculators) remained abnormally high in May, representing 32% of SoCal sales volume. This is down slightly from the record high set in February 2013 of 37% and roughly level with one year earlier.

The percentage of cash purchasers in a normal market is around 16%, comprised mainly of end-user buyers. By Fall 2013, cash purchasers as a percentage of total sales volume will drop as speculators react to slipping prices.

Bay Area cash sales were 28% of home sales in May 2013. This is roughly level with one year earlier.

Speculators will remain motivated to buy only so long as they believe home prices will rise quickly. The high 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 take a sympathetic nosedive this November?

Also, the likelihood of a flip in the near future dims each month as annual increases in the buyer purchasing power index (BPI) come to an end in the third quarter of 2013. Sellers ignore these forward trends at their peril.

When short-term speculators realize they cannot make as fast a profit 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.

At the moment, demand from end users represents only half the number needed for a normal 60,000 monthly sales volume. End users currently have difficulty financing home purchases due to overpricing disclosed by appraisers (not agents) and lender down payment and debt-to-income ratio requirements.

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Jumbo loans: room at the top

Jumbo loans (loans over $417,000) in SoCal accounted for 32% of May 2013 sales. This is down from 34% in the prior month and matched 32% one year earlier.

Jumbos made up 48% of Bay Area sales. This is level with last month and up from 37% 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 period is closing

Federal Housing Administration (FHA)-insured loans made up 21% of SoCal mortgage recordings. This is down from 22% last month, and 30% one year earlier.

FHA-insured loans made up 12% of Bay Area mortgages in May. This is level with the prior month and down from 17% 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 among determined first-time homebuyers with low savings and low credit scores.

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ARMs: holding lenders at bay

Adjustable rate mortgages (ARMs) made up 8% of all SoCal mortgages. This is up slightly from 7.9% in the prior month and 6.6% one year ago.

ARM use in the Bay Area was at 15% in May. This is up very slightly from the prior month and up from 14% one year earlier. This movement is insignificant and of no present concern.

ARM use will remain relatively low until property prices rise more than 5% annually over a two-year period. This is not likely to happen in 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 May home sales from DataQuick