Where has all the inventory gone?

Where is the inventory going to come from?

In case you remain unconvinced lack of buyer-occupant demand is the primary obstacle blocking California’s real estate recovery, and instead are concerned by the low housing supply, not to worry. The housing inventory is not about to dry up anytime soon.

When inventory is actually lacking you will observe two reactions:

  • home prices rising for a sustained period, (beyond six months); and
  • positive and negative equity owners listing their home for sale, brought out by rising prices.

Neither is true today. In the current bumpy plateau recovery, home prices rise and fall from month to month, with no signs of a continuous upward recovery. Similarly, distressed sales still dominate the market, as equity levels have not risen sufficiently to buoy traditional sales.

Inventory is not lacking; it is being diminished and replaced every day by over-zealous buy-to-flip speculators, frustrated short sale owners, foreclosure sales and new construction.

Subdivision creation displays a positive trend in 2012 compared to recent years, according to the Department of Real Estate statistical data. There is, it seems, no real shortage in inventory, just a temporary crowding of buyers (in the form of speculators) in the summer of 2012.

Still worried? Take a look at the mammoth shadow inventory which consists of a four-month supply of homes not yet listed on the multiple listing service (MLS), according to the latest report from CoreLogic.

The flood is eminent, but the swelling rainclouds have yet to open up. The lament over bulk sales of REO by federal agencies minimally affects California property sales volume (but maybe prices) since these withdraw property from the sales market, placing them in the rental market for five years minimum.

More significant, Notices of Defaults (NODs), while dropping, remain very elevated. This condition signals continued high levels of short sales and foreclosure sales for several years.

The proof is in the numbers: 54,615 NODs were recorded in California in the second quarter of 2012, down slightly from a year earlier but still elevated, ten times above normal levels. Owners who default are not bringing their delinquent loans current, eventually ending their ownership by short sale or foreclosure.

NODs traditionally experience a spike at the conclusion of a recovery (which we have not yet seen and will not until around 2015-2016), as homeowners give up and walk away from their black-hole assets, impatient that their balance sheets have not yet been lofted into the black by inflation.

Thus, an uptick in strategic defaults should be just around the corner as neighbors learn from neighbors and information makes the rounds, changing thinking and conduct, and diffusing a once taboo behavior.

Driven by high mortgage delinquency levels and NODs, both short sales listings and foreclosure sales (to third-party cash buyers or as resale REOs) will continue to add significantly to California’s housing inventory.

We are now seeing what may be a rise in sale listings by owners with positive equities, though the numbers are modest and are not yet indicative of a sustainable recovery. A majority of these owners, many of them Baby Boomers, hold their property free and clear of any mortgage debt, and are now tentatively releasing their properties on the MLS. But remember, inventory is secondary to what really matters – demand.

Why is it so hard to find homes for buyer-occupants?

Agents might assume buyer-occupants vastly outnumber listings in the MLS inventory since it can be nigh on impossible for their buyer-occupants to close single family residence (SFR) sales due to intense competition from other buyers.

That competition seldom comes from other buyer-occupants. Rather, speculators are distorting the home sales volume picture, making it appear as if inventory cannot keep up with demand.

Speculators acquire a home seeking to flip it for a juicy profit as quickly as possible, nothing more. In Southern California, absentee buyers (a group composed of speculators, buy-to-let investors and renovator contractors) made up 27% of all Southern California home sales in August 2012, and 23% in Northern California, as reported by DataQuick. Big numbers in any market.

In a recent first tuesday poll, 64% of 239 respondents believed the same volume of speculators will still be buying homes at the end of 2012 – the rest believed fewer speculators would be present in the market.

If this level of speculation proves true, buyer-occupants will continue to experience difficulty competing for homes as they’re elbowed out of the market. And if this speculative fever continues, prices will continue to rise into the first of next year.

Ironically, rising prices by year’s end will bring out ever more speculators and further destabilize the market going forward.

Absentee buyers, typically with cash on hand or readily available from private lenders seeking greater risks (yields), make it difficult for buyers who rely on financing contingencies to compete, even if they offer a higher price than cash-buyers.

Offers with fewer contingencies have the edge

Agents are inclined to submit only those offers they have the most confidence will be accepted by the lender (read: all-cash offers or those with few contingencies submitted by speculators).

As a result, these transitory cash-buyers continue to increase: in Southern California, 32% of home purchases were made by cash-buyers in August 2012, up from 29% one year earlier and 27% in 2010 (when sales volume was around 10% lower). Northern California displays a similar trend, with 28% of

For the moment, speculators have driven home sales volume and prices up, giving the appearance that housing inventory is unable to keep up with the momentum of this “rising demand”.

In fact, speculators are not buyers, but merely sellers once removed.

In truth, the sufficiency of willing end users does not support speculator objectives, the end game being a flip for a profit. The current mini-sales volume and price bubble will likely pop when cash players realize end user demand will be far short of what is needed for all of them to turn a profit.

Demand will increase soon, right?

Many optimistic agents and brokers expect homebuyer demand to return to the numbers experienced during the Millennium Boom. Don’t hold your breath. As the “Millennium Boom” moniker indicates, the easy money of the 2000s was just that: a peculiar lender financed “Boom,” the result of the financial accelerator effect and in no way a new paradigm of real estate practice.

The Millennium Boom produced hundreds of thousands of unqualified buyers for California homes. Before this recession is over, upwards of 1,200,000 California homeowners who existed as of mid-2007 will be purged from the market. Many will not buy again, as they:

  • are tenants-by-nature and were never equipped for sustained ownership;
  • have decided against taking on debt, having gotten burnt in the last cycle (this is part of the deleveraging surge we are now experiencing); or
  • are unable to meet the reinstated standards of pre-deregulation lending (a return to mortgage lending fundamentals).

Further, as the number of Federal Housing Administration (FHA) loans continues to decrease in California due to their cost, and the 20% down payment requirement for qualified residential mortgages (QRMs) kicks in (via plans to implement this law currently under development), buyers will trend toward meeting the traditional 20% down payment to fund their purchase. This will delay end user demand until buyers have accumulated sufficient savings to avoid the price reducing effect of growing FHA mortgage insurance premium (MIP) amounts.

So what’s the prescription?

Home sales volume will increase at a steady, long-term rate when the octane of the fuel for end user demand becomes known, a power calculus that:

  • includes buy-to-hold income property investors since they will not be returning the property to the sales market; but
  • excludes those speculators who rent for a year or two to cover carrying costs until they put the property back on the market in anticipation of their ship-of-profits making port.

Credit given to the first tuesday Journal Online — P.O. Box 5707, Riverside, CA 92517.

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3 thoughts on “Where has all the inventory gone?

  1. Great article! Love First Tuesday Journal – it’s awesome to see agents like us putting out the word to both our community and the over all real estate market. Keep up the good work 🙂

    Thanks for liking my “Short Sellers Act Now or Face Big Tax Bill” article. Have a fantastic day!

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