Speculations on speculator suppression
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This article outlines the regulations necessary to limit the destabilizing influence of speculative interference in the sale of California single family residences (SFRs) during times of boom or bust.
Speculators shut out buyer-occupants
When buyer-occupants – users – are scarce in a slow resale or recessionary real estate market (called the vicious real estate cycle), speculators provide liquidity – cash – to the market by buying properties from sellers who must sell but cannot find users willing to buy. In exchange for a deeply discounted price, speculators give sellers the means of passing off the risk of waiting for a buyer who will pay a higher price. [For more information on the recent scarcity of qualified borrowers in the real estate market, see the July 2010 first tuesday article, Low-ball offers slow housing sales.]
However, while speculators provide a benefit to the real estate market in a virtuous cycle, when the market is full of users in the form of ready, willing and able buyer-occupants, speculation has the potential to severely disrupt the long-term stability of the real estate market, as affirmed by the recent financial crisis and ensuing Great Recession. The disruption becomes absolute over time as ever more speculators crowd in, causing a buying frenzy environment which pits buyer-occupants and speculators against one another in an inevitably destructive pricing war.
Consider a prospective first-time buyer-occupant looking to purchase a home. The buyer-occupant is ready, willing and financially able with sufficient savings to make a 20% down payment on a property in a specific price range. He enters into an agreement with a selling agent to help him locate a suitable property to purchase.
After a few weeks, the agent locates a house the buyer-occupant wishes to purchase. Through his selling agent, the buyer-occupant makes a full-price offer to purchase the property with a 20% down payment and several contingency clauses to cover financing, inspections and property disclosures affecting value withheld by the listing agent.
At the same time, a speculator views the property and, looking to sit on the property until prices in the market move further upwards (a process known as flipping), puts in an offer directly to the listing agent for a purchase price far less than the buyer-occupant has offered to pay. However, the speculator’s offer contains no contingencies and the price will be paid in cash, promising a quick closing. The distressed seller, seeking a fast sale, accepts the speculator’s offer over the buyer-occupant’s offer. [For more information about the flipping process, see the April 2010 first tuesday article, Flipping: contracting to assign or double escrow the resale transaction.]
The sale is completed and the speculator lets the property sit fallow. The bare minimum of maintenance is completed to keep the property from being vandalized while he waits for the momentum of the rising market (a phase known as the virtuous real estate cycle) to increase the price he can get for the property.
After a few months, the market momentum drives prices upwards as anticipated, and the speculator lists the property for sale at a price much higher than he paid. He sells the property to a buyer-occupant and pockets the profit on the flip. Thus, the transaction withdraws money from the real estate market, depriving the users of the property (the original seller and the eventual buyer-occupant) of that financial benefit — a market zero-sum game.
Alone, the flip of a single property merely diminishes the financial position of the original owner who sells the property to the speculator and the buyer-occupant who purchases his home from the speculator. Both these parties give up money to the speculator in the transaction: the seller since he does not receive market price for the highest and best use of the property — owner occupancy — and the end buyer-occupant since he subsidizes the speculator’s profit when he purchases his home at a higher price than he could have paid to the original seller.
During vicious cycles, sellers need the speculators to break the gridlock of the illiquid market. Speculators are needed until users and lenders are available in sufficient numbers to keep the inventory of homes in the active market between 90 and 120 days, a reasonable time period for agents to make a match between buyer-occupants and sellers.
However, when flipping is allowed to run rampant in a momentum market driven by an abundance of mortgage money, the result is a self-destructive time bomb of bidding wars and over-inflated sales prices. Worse, the rush towards financing encourages misbehavior and inefficiencies which become embedded in every sector of the real estate industry and its supporting service industries.
The latest repercussions of this behavior during the Millennium Boom precipitated the calamitous financial crisis and the ensuing Great Recession. Real estate prices during the boom period were initially driven primarily by the financial accelerator effect of Wall Street Bankers pouring excessive money into the mortgage market in ever greater amounts without regard to the irrational change in value of the collateral (i.e., the real estate). [For more information on the financial accelerator phenomenon, see the April 2010 first tuesday article, Sink or swim? Whether to strategically default on a home loan.]
Speculators leapt into the over-priced, money-flush market. The frenzy of buying and selling created an appearance of market activity which in turn fueled ever more building, speculation and mortgage lending. When defaults from the adjustable rate mortgage (ARM) smorgasbord began to pile up, the party wound down and the real estate market players found themselves staring at a wasteland of bad mortgage debt, underwater homeowners and excessive inventory.
Thus, the seller and buyer-occupants of real estate, real estate licensees, long-term real estate investors and those employed in the industries relying upon a stable real estate market (construction, escrow, title, home inspectors, etc.) must strive to keep the influence of the speculator secondary to the interests of users — the buyer-occupants — at least in rising markets when the need for liquidity is not of concern to any seller.
California’s speculator outlook
The Southern California 23-month yearly average for cash sales is 14.1%. In May 2010, 24.5% of real estate sales in Southern California were cash-only, a tell-tale sign of speculator activity. Earlier in the 2010, the figure was at 40%, while the mad rush to buy and receive a subsidy had ill-informed first-time buyers flocking to buy without governmental protection from the interference of speculators drawn by the subsidy-created frenzy. The rest of the state also continues to experience a higher-than-average level of speculative interference.
While the mid-2010 real estate sales market is slow and flat-to-lower than one year earlier, California can afford to be generous to speculators; they provide a means of keeping the market churning. Buyer-occupant users (and income property investors in low tier properties) are currently not filling the sellers’ need for buyers. But what happens when the virtuous cycle begins and the market heats up, as it inevitably will in the coming years?
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About The Author
Giang Hoang-Burdette
is a licensed real estate agent and the first tuesday Journal Online editor. She is also lead editor for the Forming Real Estate Syndicates, Buying Homes in Foreclosure, Legal Aspects of Real Estate and Tax Benefits of Ownership books.
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More nonsense trying to justify higher taxes and more regulation.
Let the owner accept the offer he determines is best. We don’t need to be “saved”:. Every effort of regulation for the sake of society comes at the expense on one or more of society’s members.
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This really is nonsense. I agree with Patrick. We need less regulations.
The real problem was the lenders all along and we should not be blaming anybody else. They dumped all of their worthless loans into CDO’s and sold them to the foreigners. The tax payers bailed them out so they would not have to buy the CDO’s back. This would make them broke. They are already broke if the government had not let them use phony accounting for now.
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In principle, this sounds good, “reserving” property for first time home buyers. However, the majority of homes are now purchased with very little money down, and it is the first time buyer who really is the problem. In every cycle, insufficient capital invested has been the downfall of the real estate market, as it fuels the desire for more and more transactions without legitimate reason to do them, and ever easier credit, brought about by a continuous “loosening” of the lending criteria. Perhaps a better answer would be to require EVERYONE to put down a minimum amount (10%? 20%?) and remove the government incentives for prices to rise to the level where the homeowner must acquire property at the very limit of his monthly budget in order to make a purchase, and then allowing the homeowner to buy with all someone elses’ money. The common problem here is not too much cash in the market (speculators with cash), but the opposite–too much easy money,and credit that makes no logical sense. Speculators will always exist, but their influence can be easily reduced by simply requiring folks to put enough money down to have something real at risk. That reduces the overall market risk, keeps financing available, and forces the prospective homeowner to wait until he can actually afford the property he purchases, at the same time it suppresses the activities of the speculators, because the home he bought last month for $100,000 can’t be sold $150,000 with “no money down…” it’s the credit on the other end that’s the problem, not the cash entering the market.
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The writer lacks any understanding of how markets work. “Prohibiting” speculation. You might as well just say the government is going to determine who can buy which house, where and at which prices. That works real well (see: Russia, Cuba, North Korea).
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