Home Sales: Don't Be Deceived by First Time Buyers

I am reading posts on blogs and Seeking Alpha and columnists asserting that vigorous activity of people buying their first home at distressed prices is an indication of the bottoming of the real estate market. Do not be deceived! I was VP at NVR, which at the time (1986-1990) was the nation's largest home builder and is still one of the nation's largest, and certainly best managed in terms of P&L and balance sheet (primarily because they do not buy land but instead buy options that they exercise when an NVR customer contracts to buy a home on the lot). I learned a great deal about residential real estate there. And here is one of the most important lessons:

Residential real estate is a food chain. Somebody buys their first home and the seller of that home takes their equity from the pay-down of their mortgage and any appreciation in the house and uses that money to buy their first time move-up home. When they buy their first move-up home, the people they are buying from takes their proceeds and buys their second move-up home. And so the chain continues. Great.

But take a look at the people getting great deals on their first homes today. From whom are they buying their houses? From the bank or mortgage company or maybe from a distressed seller. Neither the bank nor mortgage company is going to use their money to buy a move-up home and they are not going to fuel the food chain. The distressed seller in some cases may go buy another house, but the chances of that happening are not great and therefore their sale does not get the food chain moving except in a few cases in a very nominal way.

In other words, when you look at an increase in people buying their first homes, and somebody tries to use that as "proof" that the market is bottoming, don't believe it. Look instead at the sale of the first- and second- move-up homes .... when that increases it will be an indication that the food chain is really going and that the bottom is real.

Comments

[Repsonsible Citizen]

Spot On Congrats !
You wont hear that kind of intelligent explanation on CNBC , just Kudlow and Crammer ranting about how good things are happening .So BUY BUY BUY Now NOT!!

2009 Apr 06 12:04 PM

[Moon Kil Woong]

Good points, like stock if you watch capital inflows and capital out the door you will notice there is far more wealth destruction than capital to cover for it. As for new wealth into this segment... forget about it.

Sadly, unlike most assets, this game the queen must run to stay in place because it is the most loved place for States, cities, and counties to feast upon to sustain themselves making you a net looser unless your hous appreciates at least 3% even with these low inflation rates. If you actually don't ouright own it then add in bank taxes and you will be scratching your head. How can net inflows to this market cover everyone sucking away equity out of it?

That is a good question and one pundits argue that in most cases home equity investment is not really an investment as it is a standard of living. In most cases it doesn't even pay for itself (cost exceeds appreciation).

2009 Apr 06 12:38 PM

[ArkansasAngie]

Until banks sell property valued with rent equivalents, there won't be a bottom.

2009 Apr 06 01:01 PM

[William Cowie]

The equity in a primary residence is still a good investment, and here's why: On a $300,000 house, let's say you put down 20%, $60,000. If the home appreciates only 10% ($30K), that's a return of 50% on your equity. Granted, there are costs and expenses that come out of that, but both the interest and appreciation are tax free (unless of course you're fortunate enough to own a few million dollar homes).

So, at the lower end, home equity investment is still not bad. If you're very wealthy and own a few million dollar homes, that may not be as true, for Joe Plumber it still is. Wait, what am I talking about? Joe Plumber is probably the millionaire with several big homes...

2009 Apr 06 01:04 PM

[Mad Hedge Fund Trader]

There is more trouble. The Manhattan residential market is now in free fall, after holding up better than every major market in the country for years. Rents have fallen up to 25% since the Lehman bankruptcy in September, dragging down condominium and co-op prices almost as fast. Hardest hit have been units priced in the $1-$2 million range that appealed to up and coming Wall Street traders. This class of newly unemployed former owners is now fleeing the Big Apple en masse. The stratospheric end of the market, the mega mansions and penthouses with those fabulous Central Park views and live-in nanny suites in the $30 million on up range, are still holding up. With industry job losses this year expected to exceed 100,000, expect this downtrend to continue.

2009 Apr 06 02:04 PM

[Carousel]

The San Francisco Chronicle had an article on Sunday about the lack of prosecutions and an assertion that this credit crisis is not real. The writer said that it's a deep recession from too much debt and too much debt-financed consumption but that the idea that it's because consumers and businesses can't borrow more is a lie devised by the banks to justify handing them a lot of money that they aren't going to lend to consumers and businesses anyway.

Check it out: www.sfgate.com/cgi-bin...

2009 Apr 06 02:41 PM

[HardwoodFlooring]

Great point I never thought of.

Still, there are some fundementals of the market that are important. The inventory needs to be seeped-up. If this is the first move in that direction that is waht it needs to be. You're right- don't get bullish on housing yet.

Still the statistics are amazing that are out there: 50% of the people in this country don't have a mortgage. Of the other 50%- 75% have been in their home 10 years or more.

Is back to the future so bad- here I'm talking about real incomes and real home owenrship. The fundementals of that principle still hold true. We are in the 3 rd year of the hosuing downturn. Home equities got pulled first. Then the housing crisis hit- late 06 and early 07. There was a head fake on housing in the middle of 07 and the rest has been pure deteriation. We are now at sub 500,000 units of sibgle family homes. The market will have to increase by 100% to get back to what all determine is 1mm units- which is the sustainable level for single family homes. Will this happen immedaitely-no. Will it happen eventually- yes. Can we wiat pateintly until it does and then hope that we get somethign that looks more reasonable than what Wall Street builders like KB, Toll, NVR and the rest stuffed down our throat- we all can't wait.

The truth is the big builders said- "we can do it cheaper and we can do it better and don't worry about a bubble because we have inhouse market research and economists who do better forcasting than the "mom and pop" spec builders". That is until Wall Street needs it's quarerly earnings number then we toss that out to meet that number. Then when they got Wall Street to right the notes it was all baked in the cake from then on and now we are choking on it. But that is the past.

The truth is we are cycling out. It will look different in the future thank g-d. Remodel will surge this summer. Some new housing will start- not by Toll, KB et al but by Mom and Pops. Then we will ease in to some nice normal buidling like we had from 1995-2000.

So we are getting first time buyers to buy up the overages in the market- great. Sure these homes are owned by the banks- people walked away or were tossed out as horrible as that sounds. But I think your missing the point- the inventory has to be cleared and they are getting awesome pricing on a great investment.

2009 Apr 06 03:16 PM

[Tony Petroski]

To the author: Thanks for this silly bit of cold water. OK sophisto's. Yeah we know, we are entering the 2nd great depression and don't be fooled by any good news. Keep telling us that.

Yes we know that buying distressed property (I just sold one) won't generate as much upside as it did a few years ago with these first-time buyers. On the other hand, a recovery has to start somewhere. Go on a year-long vacation and come back when things are rolling along.

2009 Apr 06 06:04 PM

[Windsun33]

Distressed homes in Phoenix - at least in some areas - are on the way back up. Granted, some of those were selling at 55% to 60% less than their original price back in 2007. But ex-$500k homes that were selling for $225k a month ago are now going for $260-275K.

Some of it may be bottom fishing, there are - or at least were - some real bargains out there, but the fact that RE agents are showing a lot more homes than even just two weeks ago might be a leading indicator. Phoenix was one of the first areas to crash and burn, so it may also be one of the first to come back - especially with the exodus from Californias' recent massive tax hikes.

2009 Apr 07 10:40 AM