Calling the Housing Market Bottom? Not So Fast…

Courtesy of NAR Research — one of the more valuable things on Facebook — comes this CNBC article on how investors are flooding the residential real estate market:

The number of homes sold to investors more than doubled last year, as rising rents and low-priced distressed properties fueled demand. Investors, half of them using no mortgage, bought 1.23 million homes in 2011, a 65 percent jump from 2010, according to the National Association of Realtors. Half of the homes purchased were distressed properties, that is, foreclosures or short sales (when the bank allows the home to be sold for less than the value of the mortgage). [Emphasis added]

The video above references this explosion in investor interest as well, but goes well beyond that.

This new information from NAR, which the CNBC story references, answers a couple of questions for me on the hot housing market of the past couple of months. As a result, I’m not ready to call the bottom on housing, nor do I think that Renter Nation will pass us by.

Quite a few of my friends in real estate have already called the bottom, and are embarking on a round of marketing to consumers that this is a once-in-a-lifetime opportunity to buy real estate. I would urge them to tap the brakes just a little bit, since credibility is the coin of the trustworthiness realm.

NAR Answers A Puzzling Question

The thing that has puzzled me for the past several weeks is report after report from REALTORS I know and trust that the market is as hot as it’s ever been. In San Diego and Orange County, for example, I’m hearing firsthand account after another that days on market are way down, that multiple offer situations are increasingly common, and that there’s no inventory to be had in certain price ranges. Then we also have respected commentators like Calculated Risk calling the bottom. And NAR has been pointing out that things look really quite decent, despite the slip in February of Pending Home Sales:

Lawrence Yun, NAR chief economist, said we’re seeing the continuation of an uneven but higher sales pattern. “The spring home buying season looks bright because of an elevated level of contract offers so far this year,” he said. “If activity is sustained near present levels, existing-home sales will see their best performance in five years. Based on all of the factors in the current market, that’s what we’re expecting with sales rising 7 to 10 percent in 2012.”

What I couldn’t understand was where all this buyer demand was coming from.

We haven’t seen a fundamental shift in the overall economy or the labor markets in years. Real unemployment rate is almost certainly not the 8.3% or so that is reported. Even a lefty Obama-supporter like Ezra Klein has noticed this. And thinks the real unemployment rate is north of 22%. We haven’t seen significant GDP growth, we haven’t seen major new economy-altering technology introductions (e.g., steam engines, the automobile, the Internet, etc.), and the rest of the global financial market appears to be headed into a storm. We have seen significant inflationary signals, like the price of food and energy skyrocketing, and we have seen other signs that we’re not looking at Morning in America here.

So what accounted for all this frenzied activity?

The NAR report contains the answer, in my opinion:

NAR’s 2012 Investment and Vacation Home Buyers Survey, covering existing- and new-home transactions in 2011, shows investment-home sales surged an extraordinary 64.5 percent to 1.23 million last year from 749,000 in 2010. Vacation-home sales rose 7.0 percent to 502,000 in 2011 from 469,000 in 2010. Owner-occupied purchases fell 15.5 percent to 2.78 million. [Emphasis added.]

Got that? At the same time that we saw investment sales jump 64.5%, we saw owner-occupied purchases (that would be the families buying homes) drop 15.5%.

NAR’s point in releasing this report is to argue against the bulk REO sales being contemplated by the Feds (which is an interesting topic in and of itself, but not the point of this blogpost). But what I see is no sign that the fundamentals of the housing market are anywhere near healthy.


The Thing About Investors…

Because so much of the market activity is being driven by investors. I’m an investor in various things; I suspect most of you are as well. The one thing smart investors do not do is fall in love with any investment. You could be a Mac fanboy to the hilt, owning multiple Mac computers, multiple iPhones, and have lined up to buy the iPad 3 as soon as it was released. But if Apple stock doesn’t meet your financial objectives or your risk profile, there’s no doubt in my mind that you’d be dumping it as fast as possible.

The point is that real estate investors do not fall in love with houses, the way a first-time homebuyer might fall in love with her dream home. They care only about return on investment, taking risk into account. Any change in the financials would see a mass exodus of investors from the market. The CNBC article above notes the risk:

While nearly half of investment buyers said they were likely to purchase another property within two years, housing and mortgage analyst Mark Hanson calls them a “thin cohort” and worries that they add ever more volatility to the current housing recovery.

“They are fickle and volatile. They will go away on the slightest of conditions changes. They also won’t chase prices higher or buy new homes from builders. Lastly, without the heavy flow of distressed supply, there is no U.S. housing market recovery. Distressed sales ARE the market,” says Hanson.

What Hanson means by “fickle and volatile” is simply that an investor might buy a property at Price X, given rents at Y, and taking various risks, fees, regulation, etc. into account. Change any of those factors and the investment might not be worth making.

One of the comments to the CNBC post illustrates the point perfectly:

I looked at several luxury 1 & 2 bed mid-rise condos near a very desirable and hip town square. Prices are half of 2006/7 prices. The mortgage would be low. Yet the HOA fee, property tax and insurance would be more than the mortgage. With the leasing management company fees, my cash flow would be 0! HOA fees are upwards of $300/month, which should be my profit.

I really want to buy one of these now for investment and living in later as my intown residence, but I need to net a profit.

I can’t justify it when I can net $300 buying and renting out a decent house.

Investment is all about the numbers. Change anything where the numbers aren’t as attractive — even something as minor as HOA fees — and investor demand dries up. To an investor, a house is not a home: it’s cashflow + equity. They analyze a house in exactly the same way they would analyze a bond or a stock.

Supply, Demand, Prices

It so happens that a fundamental law of economics is that prices go up when demand outpaces supply. That in turn encourages new market entrants, enticed by the higher price.

The trouble is that for an investor, if prices go up, that changes the financial return calculations… and significantly so. A house worth buying at $200K may not be worth buying at $220K — who knows what that investor’s risk tolerance is, or what his return expectations are?

A home might be the most special thing ever on a block, and a family would kill to be in it. The investor simply wonders if those special things means that he can get higher rent for it, or sell it at future date X for more than he paid, minus taxes, expenses, fees, etc.

Even if house prices don’t change, if rent rates drop (due to the influx of these investor-owned houses now being available for rent), that changes the financial model. Now the investor isn’t interested even if the price remains at $200K, because his cashflow projections are all out of whack.

Any hint of rent regulation, and an investor would have to be a fool, politically connected, or pay such a low price that he’ll still make money under rent control, to even consider buying rental properties.

Tap Those Brakes

For these reasons, and more, I’m thinking that the wise course of action for the working real estate professional today is to be cautiously optimistic. And I would emphasize the caution over the optimism.

When investment sales are up 64.5%, and family buyers are down 15.5%, now does not strike me as the perfect time to be calling the bottom, telling people that Now Is The Time To Buy, or any such thing that could come back to haunt you mere months from now.

Yes, yes, each market is different, national trends are useless, and so on and so forth.  I get it. I know.

But then have a story, backed up with evidence, as to why your local market is different. A city like Houston, TX, where job growth has been extraordinary due to the boom in energy, there are few onerous restrictions on building, and the local economy is strong will have a totally different story than a city like Detroit. So have a story, with local employment trends, local rent rates, local regulatory environment, and local economic trends. Maybe something like this (from the GoodLife Team) or this dated post from Stuart Sutton.

Otherwise, tap those brakes, people. Investors could disappear like the morning dew if house prices rise even a little, or if rent rates fall, or vacancies rise, or some local factory just laid off a couple thousand people, or the local city council starts debating some random wacky rule about tree maintenance or some such.

As for myself, as long as a third of the market is investors, and family buyers are down 15.5%, and we have the lowest family formation rates in decades… I ain’t buying the market bottom story. Not yet.


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Rob Hahn

Managing Partner of 7DS Associates, and the grand poobah of this here blog. Once called "a revolutionary in a really nice suit", people often wonder what I do for a living because I have the temerity to not talk about my clients and my work for clients. Suffice to say that I do strategy work for some of the largest organizations and companies in real estate, as well as some of the smallest startups and agent teams, but usually only on projects that interest me with big implications for reforming this wonderful, crazy, lovable yet frustrating real estate industry of ours.

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