We have seen many years of financial destruction to millions of homeowners with wave after wave of foreclosures immediately followed by wave after wave of short sales – which was sadly a dramatic improvement. Now, we are hearing and seeing evidence that the housing market is recovering. Over the past couple of years, single-family home sales activity had skyrocketed and prices have risen dramatically. Millions of formerly underwater homeowners are back in the black with home equity once again. And for those underwater… it is now a fraction of the (paper) loss they once faced. Maybe everything is going to be ok.
Admittedly, it is a relief for many who are no longer underwater. But while this is being touted as a healing real estate market, I don’t think it’s that simple. Yes, it is an improvement – but it also includes some rather murky and perhaps dangerous elements. There has been evidence of strong home sales activity, but it’s not because the normal healthy home buying public has returned to buying homes once again. What we have had was institutional investors that were looking to get in early and profit from the bottom end of the market. Further, the institutions stopped buying about a year ago and home sales have been sluggish to anemic ever since. This is why as far as I’m concerned – real estate is not recovering.
There were a number of these big institutional investors, the largest probably being Blackstone, buying both foreclosure properties being sold on the courthouse steps along with typical sales in the MLS from home sellers. They were dominating the market by overbidding. They recognized that it was a bottom, and that the pent up demand would continue once they stopped buying, which would drive prices up. So they would pay more than market value, whereas normally on the courthouse step auction you had small local investors who would fix up a property and then re-sell it to a home buyer. The goal of these small local investors is to buy below market value and allow an opportunity to profit from a “fix & flip” over a short timeframe. In contrast, these well-funded institutions were buying single-family homes to fix and rent for an extended time, while the market recovered.
During this time of aggressive institutional buying, the individual homebuyers would write offer after offer trying to get a house. These homebuyers were simply unable to compete and buy properties because the homes would not appraise for as much as investors were willing to pay. That means buyers could not get a loan for the amount that the institutional investor was able to pay even if they were willing to pay over market value. The institutional investor was willing to overbid because they knew it was at market bottom and that prices would rise beyond that. In fact, what happened for a period of time, was essentially a bidding war between deep pocketed institutions and regular buyers. Once the institutions were done, the regular people would still be there looking to buy, which would drive prices up further. However, at this point prices rose so dramatically that it created a new small housing bubble.
Traditionally, after a market downturn, smaller local investors would buy and rehab a foreclosure then sell it to a homebuyer looking to live in the home. These improved properties go to someone who would own and occupy the home. This helps stabilize the market and is a sign of a true recovery. It has been a common part of any local real estate market. However, with the big institutions willing to pay market value and above, the smaller local investors had been pushed out, unable to compete. This essentially pulled these properties off the market for an extended period. As it turns out in Sacramento, many thousands of single-family homes were sold and converted into rental properties (income properties) to be held and presumably resold at some point in the future.
Institutions are going to do what’s profitable for an institution, not what’s healthy for a community. The problem with what has happened is that these high volume homeowners are a new force affecting the future of housing values. They control a sizable chunk of the market and are going to behave with a pure profit motive, as is their responsibility. But this is something that never existed on this scale in the single-family housing market before.
Compounding the volatility in the marketplace is Washington policy and Federal Reserve activity that treats housing as an accelerator – a gas pedal, if you will – for the US economy. By making cheap money available, it drives up prices as people rush to get unrealistically, or uncharacteristically, low interest rates. Basically, the policy is to use housing as a way to stabilize the economy. While that may have some positive effect on the economy, it manipulates the market when the market is left to return to its normal equilibrium. If prices are driven unrealistically high because of very aggressive interest rates – the very real risk is those prices come back down and again and homeowners lose value.
When you take into consideration all of the self serving forces working in the market, it becomes clear that just because there is activity – doesn’t mean it is healthy or recovering. By educating yourself of the risks and complexities of the real estate market, you are better able to make an informed decision if you are thinking of buying a home.