The Wall Street Journal
12 June 2013
Double-digit home-price gains from San Francisco to Detroit to Miami have some aspiring home buyers racing back into the market.
But buyers, beware.
The housing market may not be as strong as you think.
Sure it’s tempting to want to lock in a low interest rate and take advantage of lower home prices before they rise further.
But it may make sense to take a breather before you buy a home and wait for prices to drop, as institutional investors might be inflating home prices.
Namely, Wall Street investors are scooping up homes in bulk, and there’s considerable concern this is inflating prices in certain areas of the country—and pricing individuals out of the market in general.
These institutional investors have been spending billions of dollars buying up single-family homes en masse. In 2012, institutional buyers purchased about 138,540 of both distressed and non-distressed homes in the U.S., or about 3% of all sales, according to RealtyTrac. It estimates institutional buyers purchased 32,355 homes in the U.S. in the first quarter of this year, or about 3.5% of home sales.
That may sound like a small amount of purchases, but in certain markets institutional investors are taking a larger stake. For example, institutional buyers accounted for 5% and 8% of sales in Arizona and Nevada, respectively, so far this year.
And some of the hottest markets for big corporate buyers from 2010-2012 are seeing some of the biggest price jumps this year—Phoenix, Las Vegas, the San Francisco Bay Area, portions of Florida and elsewhere.
There are concerns we may be headed for another bubble in areas where housing-price gains may not be sustainable, especially if unemployment remains high, interest rates start rising, selling prices peak and investors quickly unload their holdings in bulk, depressing home prices.
“I’d discourage a client from buying in an area with a lot of institutional action in that there might be some uncertainty as to the institutions’ plans with the property,” says Brian Frederick, a financial planner in Scottsdale, Ariz.
Add in a small supply of homes for sale—thanks in part to regulations that limit the pace of foreclosure sales and underwater sellers who owe more on their mortgages than their houses are worth and are holding out for even better prices—along with pent-up demand from people who have been waiting to move until they’ve felt more economically secure and tight lending standards—and you’ve got the makings of some frustrated, and maybe over-eager, would-be buyers.
Home prices in March were up 10.2% from a year earlier, the largest annual gain since prices began to fall in 2006, according to the Standard & Poor’s/Case Shiller national home-price index. Some of the largest gains were in markets that experienced the biggest declines during the foreclosure crisis—the very places that have attracted some of the most intense institutional interest.
This institutional buying activity has boosted the housing market and may be good (at least in the near term) for the overall economy. These buyers are typically purchasing foreclosed homes that require considerable renovation—creating jobs for local contractors and pumping up sales at home-improvement companies.
Partly because the housing market varies so widely by geography, Stefan Hilts, director at Fitch Ratings, cautions against making a blanket statement about whether or not we’re in the midst of another bubble.
But price gains in certain markets, especially in some areas of California, are a potential cause for concern as some “fundamentals” aren’t keeping pace with gains, he says.
“Still-high unemployment is our biggest concern,” he says.
Plus, some institutional investors are already starting to sell their properties.
Institutional investors will eventually sell the homes they’ve purchased at bargain prices and rented out but they’re unlikely to dump homes onto the market en masse, says Jed Kolko, chief economist at Trulia, a real-estate website. “They don’t want to trigger a price drop either,” he says.
Mr. Kolko adds that buyers in markets where inventory is very tight would be “thrilled” if investors decided to put some of their homes up for sale.
Even though prices have risen sharply in the past year, they’re still relatively low. Home prices are still down by 28% from their 2006 peak—about where they were in 2003.
These low prices coupled with still-low mortgage rates makes buying more affordable today than it’s likely to be six or 12 months from now, Mr. Kolko says.
And with about 26% of all homeowners nationwide underwater in their mortgage and another 850,000 actively in the foreclosure process, according to RealtyTrac, there’s plenty of shadow inventory to keep a lid on prices.
“Do not rush into it and stretch yourself financially to buy based on an irrational fear that if you don’t buy now you will miss out on the opportunity to buy ever,” warns RealtyTrac vice president Daren Blomquist.
He anticipates more homes becoming available as early as this fall in the form of shadow foreclosure inventory in some markets as well as in the form of non-distressed sellers who decide to list their properties because prices have risen enough for them to justify doing so.
No matter what the market conditions, the purchase of a house needs to be viewed primarily as a home with any investment consideration being a “distant second,” says Erik Davidson, deputy chief investment officer at Wells Fargo Private Bank.
“Progress toward other financial goals—an emergency fund, retirement, college fund, etc—shouldn’t be waylaid in the pursuit of the goal of owning a house,” he says.
It’s wise to have a down payment of 20%—to avoid paying for private mortgage insurance—and plan to live in the home for at least five years, says Stan Humphries, chief economist at Zillow, a real-estate listings company.
First-time buyers should also explore how much it will really cost to own, says Edward Kohlhepp Jr., a financial planner in Doylestown, Pa.: “They often forget about the costs of things like insurance, maintenance and renovations.”
He also advises people who know they’re going to buy within a year to keep their down payment out of the stock market. “There’s no place for risk with your home’s down payment,” he says.