The level of actual buyer-occupants in sales volume is the critical indicator of long-term demand, not total sales volume.
For a critical analysis of the supply-side paradigm and a discussion of artificial speculator influence on demand, see Part I of this article series, It’s the demand, stupid!
Obstacles confronting the end user
At the prompting of government incentives, the national homeownership rate during the Millennium Boom increased from the traditional 64% to an apex of 69% in June of 2004 . This was the same moment the Federal Reserve (the Fed) commenced raising interest rates to structure an economic slowdown.
This 6% increase consisted mostly of tenant-by-nature subprime borrowers who were lured into homeownership from the sidelines, enticed by the government-engineered mirage of the American Dream. These same individuals were rudely expelled from the housing market after the bubble burst, their tenuous grasp on homeownership broken, as was predestined.
During this Lesser Depression, California’s homeownership rate followed a similar trajectory, down to 55% in 2011 from 56% in 2012, from a 60% peak in 2006.
Where have all the buyers gone? Speculators are currently crowding the market, giving the false impression that demand is up and the real estate market has grown hot once again. However, their interference is merely creating a temporary aberration in sales volume of single family residences (SFRs), not likely to last beyond 2012.
Speculators have more in common with a seller than a buyer, as the seller essentially assigns the speculator the task of locating a later buyer who will occupy the same property. Thus, the speculator limits his position in ownership to the right to re-sell the property – the instant he can locate that user-buyer. As a result, speculators are surrogate sellers, who by design will put the property back into the MLS inventory hoping for a quick flip (and a juicy profit).
Like the seller before them, the speculator is then tasked with finding a buyer for the property (who will pay more for the property than the speculator). Thus, speculator activity is not an indication of demand. Worse, speculators will soon dump their properties en masse back into the market as soon as they realize prices will not be rising quickly within a couple of years.
Thus, stated more specifically: where have all the organic, end user buyers gone – those who will occupy the property as their residence or own it as income property for long-term investment purposes?
The obstacle blocking user-buyers (and therefore demand) is multi-faceted:
1) Recent foreclosure is perhaps the most virulent infector of buyers. Foreclosed homeowners, and those with the negative effects of a short sale blemishing their credit report, must suffer a period of financial penance, during which their access to home financing is severely limited, marked for exile as if by a scarlet letter.
Editor’s note – 90% of individuals who file for bankruptcy have access to some type of significant of credit within 18 months of their filing. 75% of individuals who file for bankruptcy have access to unsecured lines of credit after 18 months.
During this period of arrested access to credit, the buyer cannot purchase a new property with purchase-assist financing, and thus cannot create demand for housing. These buyers must first become tenants and sit on the sidelines until this period of financial stasis has passed, and only then reenter the home ownership market.
Thus, this massive segment of the California population is essentially refused entry back into the real estate game until they’ve spent the appropriate time in the penalty box, much to the detriment of the broader recovery (and agent fees). These recently foreclosed individuals may be desirous of properties, but are incapable of purchasing until they emerge from the baptismal waters.
And there are plenty more foreclosures to come. The current number of trustee’s deeds recorded, the first stop of the foreclosure process, is still 50% higher than the peak experienced in 1996 near the end of that recovery period, a point we have not yet begun to reach. Thus, California has a considerable amount of time to go, somewhere in the vicinity of four years – well into 2016.
2) The upgrade market is hindered. In order for the vast majority of owners to upgrade their property, they must first be able to sell their current property. With an estimated 2.5 million homeowners underwater in California, this simply is not an option – unless they are able to negotiate a short sale with their lender (after which they would still have to contend with the FICO score stigma described above).
The restrained trade-up market not only affects underwater owners, but also those with little to modest positive equity. Those with a loan-to-value (LTV) ratio just below 94% (100% less 6% in transactional expenses) are reluctant to sell until prices rise, as the cash proceeds they would realize on the sale would be di minimis, essentially wiping out whatever money was drained into the house during their years of ownership.
Thus, no-equity homeowners are left with zero funds for a down payment on a replacement home and are unable to reenter the market as buyers.
These types of buyers must be warehoused, seasoned with age like a fine wine before they can be harvested to reenter the ownership market. Try 15 years in the barrel with no likely help from asset inflation, apart from the standard consumer price inflation of around 2% annually based on wage increases of potential buyers.
3) Decreasing labor force participation (LFP) rates and a stubbornly low employment rate. With little demand for labor, there is correspondingly little demand for housing. Without employment, purchase-assist financing is next to impossible to obtain as unemployed borrowers will never pass muster with lender’s re-discovered loan qualification standards. Thus, the documented unemployed, and those who have given up looking for employment in comparable numbers, cannot contribute to demand.
4) Competition from cash-purchase speculators. Of the limited supply of end user buyers, many intending to purchase a property are outbid by all-cash investor purchasers, negating (at least temporarily) the organic demand the end user commands.
Speculators typically have financial weight in the form of instant cash or hard money loans to throw around when submitting an offer. As a result, they are able to offer sellers a more seamless closing as there are no financing contingencies and the physical condition of the property is of lesser interest to them. Thus, these speculators swoop in and thwart the dictates of real demand, even if an occupant- or investor-bidder presents a higher bid, but with the typical and necessary financing contingency.
Ultimately, the speculator gets the property with the hopes of selling it back to a buyer (perhaps ironically the same buyer he entered into the bidding war with) at a higher price.
Conjuring demand, in theory
With the deficit of demand we’ll soon experience once speculator interference subsides going into the second half of 2013, what external changes can be enacted to summon demand from end users?
Fundamentally, before buying a home, buyers must first be employed. There can be no demand
Consumer confidence and collective optimism must also return. Just as the paradigm shift of this Lesser Depression upended the erroneous belief in ever rising real estate prices, buyers everywhere must get over the trauma of recent homeownership losses and be given a reason to regain their trust in real estate ownership. While recent memory may still be tattooed with visions of plunges in equity, or worse, foreclosure, confidence must (and will) be restored.
Again, time will be needed to get there.
Conjuring demand, in practice
Make sure your buyer knows that purchase-assist financing is available. Though lending conditions have tightened and returned to a state closer to lending fundamentals (read: documentation of income, sizeable down payment), there are still plenty of mortgage funds to be had. After all, lenders are in the business of lending – it is their very function to do so.
Thus, get your buyer pre-approved (not to be confused with pre-qualified) for financing with multiple lenders before looking for qualifying properties. In this way, your buyer is able to show a seller he is a bona fide purchaser, not simply a casual looky-loo.
Work with families who have a demand for real estate (buyer-occupants and long-term income property owners), not speculators who are more aligned with supply side thinking (as are lenders).
As discussed above, an income is needed before anyone can purchase. Thus, go where the jobs are and you will find greater demand.
If the sale is contingent on the sale of the buyer’s existing property, your job will be infinitely more difficult. Thus, instead of upgrade buyers, focus your FARMing campaign on first-time buyers (Generation Y). First-time buyers do not suffer under the yoke of an impossible, hard-to-sell property, and are ideally poised to make their first purchase.
Poach tenants, utilize the internet and social media to reach out to this fickle class of buyer. Become an expert in the wants and needs of this particular demographic. Talk details, facts and technicalities with these buyers – they are looking to make a deal, not engage in idle companionship such as Farcebook and Twit.
Increase your visibility. Set up kiosks in areas of heavy foot traffic such as malls and at large public events.
Lastly, get sellers to lower their prices. If they really want or need to sell their properties, they must abandon their sticky pricing misconceptions, otherwise they’ll be stuck in their houses forever. Lower prices is the inexhaustible tinder of actual demand. Do not be confused by the surges of speculators that temporarily disrupt the market and pricing, leaving only wreckage behind.
Ask amongst your colleagues and you will likely learn of the ultimate moral of this story: the one who dropped the price got the buyer.
Editor’s note – This is true even during the surges in momentum, such as the one we have seen in the first half of 2012 (similar to the one before it in late 2009 into early 2010).
It’s not about listings dear reader, it’s about buyers
The story of supply is only applicable when interest rates are in long-term decline and the economy is doing well, as demonstrated so clearly over the past 30 years since 1980. However, in the recovery era of zero-bound interest rates and onto steady long-term increasing rates, just as cash is king, demand is the narrative driving this real estate story.
Welcome to the Demand-Driven Economy, folks. Regardless of how many listings you have, nothing is going to sell unless you have users who want them, but for the short periods of speculator driven conditions against which we presently have no barriers.
Until an understanding about the realities of demand is attained, your career will be stunted for the next ten years as you chase down infertile listing leads when you should be sniffing out willing and able homebuyers. Don’t wait until another 1980-, 1990- or 2000-type recession and the booms which followed, as you’ll be left waiting (and poor) for quite some time – probably 30 years for the interest rate cycle of upward moving rates to play out.
It is an industry truism that post-1980 real estate cycles have lasted between seven to ten years. Grab a comfy seat – this recessionary cycle includes a financial crisis, and is going to be a long one. This time, prices cannot go up (at least not yet) as the zero-bound interest rates cannot go down to bolster prices as they did in the 30 years past.
Demand (read: end user buyers) is the directional solution to the real estate starfish puzzle of the post-Boom paradigm. Listings over the coming years will grow stale and die on the vine with no sufficient volume of demand to acquire the listed properties. Find a buyer and your life will be greatly simplified.
Brokers take note, the next time you want to give accolades to a high-performing salesperson in your office, don’t single out the agent who got the most listings, applaud the one who brings in the most buyers – this is the agent that will collect the most fees and drive the most business.
Have you listed a buyer this week?