To all those vociferous quibblers who proclaim the elixir to the real estate market’s ills is supply, listen up! While sales volume is temporarily propped up by speculators snatching up inventory, this is but a mini-boom in reported sales, and does not paint a picture of market realities one year hence (2013 and beyond as we ride out this bumpy plateau recovery).
Changes in the availability of real estate inventory, known as supply, inversely affects the price of property. Worse, in a recovery era of zero-bound interest rates as we have today, the market is not driven by supply – it’s driven by demand.
This truism will soon be felt around 2013, when the current speculator-fueled mini-boomlet subsides and the hot money finds somewhere else to park itself.
Organic indicator of demand
Before the level of buyer demand can be properly gauged, the factors which create demand must first be determined.
The only real indicator of long-lived organic demand is the end user of a property. Every builder of subdivision homes knows speculators are the death of his expansion into the next stage of development since they are not users, but usurpers.
The end user of a property is a buyer who will take personal possession of the property for a considerable length of time, as would a collector. Thus, the end user most frequently takes the form of a buyer-occupant, one who purchases property for use as shelter for his family or business, and takes steps to retain the property as a store of his wealth for as long as it serves the purposes of his occupancy.
In addition to buyer-occupants, long-term investors are also a key player in demand. Long-term investors purchase a property with the intent of renting it out to tenants to produce a steady income flow, a process also known as buy-to-hold. Thus, they are collectors at heart.
As with buyer-occupants, duration of possession is the key factor determining whether they are an end user of a property. It is purchases by these end users which reflect the true level of organic demand in a market – everything else is noise, temporary distractions and fluctuations which attempt to extract profits from the market, transitory actions devoid of any actual demand for the item being offered, i.e., long-term possession of the property.
Speculator activity is not any part of demand
Speculators are not in the real estate game to acquire property for their long-term investment or shelter. Quite to the contrary. Like a day trader, they have no demand for the property, and similar to commodities dealers, do not take possession of it. They demand only the temporary use of title to the property as a tool to extract money from the market before the ultimate end user enters the equation and takes possession.
While the property is in the temporary hands of the speculator, it is effectively pulled from the market and unavailable to those who have an organic demand for it. Remember, speculators still have to find an end user buyer to purchase the property. Thus, the property will be returned back to the market for sale, as it was before, though offered at a far higher price. Thus, inventory is deceptively reduced below the level of demand.
Speculators never intend to hold the property for the long-term, their involvement is kept to the shortest duration they can by design, much like a catch-and-release fisherman immediately returning his catch back into the water for the end user: the fisherman who will catch then actually eat the fish.
In terms of real estate parties, the speculator is more genetically similar to the role of a seller than that of a buyer. Even though the speculator purchased the property from the seller, what he is essentially doing is stepping into the shoes of the seller, a title he will officially don himself as soon as possible (immediately on a quick flip, or within about three months for a renovator).
Thus, the speculator isn’t really buying the property from the seller, the seller is merely assigning the speculator the resale task of locating the ultimate occupant-buyer at a not-too-distant future date, the buyer being the only party who actually has demand for the seller’s property. The speculator is a surrogate seller.
Thus, to acquire the sense of demand, you must look for the percentage of all sales which are going to an end user, not those reported sales maligned by the parking of property with an intermediary. With this rubric in mind, it is clear that lack of demand, not supply, is the real long-term obstacle blocking California definitive ascent out of this economic morass.
Life-cycle of a speculator
The activities of a speculator are not synonymous with demand for real estate, and the second shoe of their distorting presence in the market is still to fall. When this time will come will be the subject of future conversations.
Speculators rely solely on an upward oscillating market to turn a profit on their investment. This means that in this bumpy plateau recovery, flippers will have a very long time to wait before a consistently rising market turns a sufficient profit to warrant selling at the dollar figure originally intended.
Thus, speculators who bought cheap property hoping for a quick flip at a higher price will have to adjust their modus operandi once they realize that prices will remain unstable through 2015-2016. Thus, these speculators will rely on their default fallback plan: hire a property manager (broker), rent the home and collect some income until they are able to unload the property on someone else. In this way, they will become landlords-by-necessity, a position which is not in any way consistent with their desired purposes for taking title to the property (or their skill set).
However, unlike before the Lesser Depression, they will find the market will not gain sufficient traction as quickly as the hit-and-run investor would like to resell at a profit (and function as a 1031). In their impatience, as soon as they sense even the remotest bump in the market, speculators, acting in improvised unity, will all try to sell their investment-turned-sour properties at the same time. This collective activity will likely occur within one or two years time.
This sudden flood of failed investment properties will be the second shoe to drop, and again exert downward pressure on the market. Ultimately, end user buyers must return at roughly double or triple the pace they╒re at now to begin soaking up some of this excess inventory as it again saturates the market.
Credit given to the first tuesday Journal Online — P.O. Box 5707, Riverside, CA 92517.