Source: firsttuesday Journal —
This article explains why speculators — as a distinct type of real estate purchaser — profit disproportionately during a recovery, and what the next speculator increase means for California’s housing market.
Why the spectacle?
A real estate speculator slips into the real estate market, sandwiching themselves between the seller and the end user homebuyer — usually a buyer-occupant or long-term buy- to-let investor.
Their goal is to purchase the home at a discount (their belief) and sell soon after acquiring it for a juicy profit when prices inflate (their expectation). Their gamble is to buy now on the belief prices will increase by 50% or more in two or three years. All this is a bet a profit can be had, after the costs of:
- acquisition;
- carrying costs; and
- selling.
In a normal, healthy housing market, speculator transactions make up roughly 20% of all home sales. However, during the recovery from the last recession, in mid-2013, the number inflated to 35%, decreasing to roughly 25% in 2014 and returning to normal levels of around 20% by 2016 as the economic recovery began to solidify.
Why do speculator transactions rise during times of economic recovery? To answer that, a quick history lesson on speculation is helpful.
Speculation through the ages
The history of real estate speculation in the U.S. can be traced all the way back to 18th century New England. The price of land was rising fast and investors flocked to gamble their fortunes on ever higher prices. The price bubble quickly burst (as bubbles by definition tend to do), leaving those who confidently gambled the most and got in last with nothing. The cycle of boom and bust (and resultant speculation occurring in between) has repeated itself time and again since then.
Speculation has always played a natural role in housing markets, and for good reason. When home sales volume sputters during times of economic chaos, speculators provide the much-needed support of cash providing liquidity in the market by entering as prices drop for lack of consumer will to acquire. But the magnitude of speculation has a habit of increasing to the point of instability, which was the dynamic felt in California between 2013 and 2014.
The role of speculation during the Millennium Boom
The Millennium Boom was caused by a number of contributing factors. However, it was all triggered by Wall Street Bankers and mortgage default levels mortgage-backed bond (MBB) investors never thought would come to be (as erroneously portrayed by Wall Street Bond Rating Agencies). Everyone wanted to believe that homes were, well, golden.
Then, someone on Wall Street became disenchanted with day trading and decided to put some money into MBBs. Soon enough, Wall Street types all flocked in the same direction, funneling money into mortgages, making home financing readily and unquestionably available to all. This rush became a financial accelerator, making it easy for anyone to get a home mortgage at ever greater home prices. All they needed to do was step into a bank and sign on the dotted line, with a real estate agent or builder in tow.
Government deregulation of mortgage products enabled the proliferation of no doc or liar loans with payments hybridized and structured so everyone qualified — at the time of recording. Meanwhile, the Federal Reserve (the Fed) had allowed the economy to grow out of control by pumping money into the economy in late 2001 before the recession had time to work its magic to cool the economic engines.
At the same time, Congress was fast at work deregulating mortgage bankers while government administrative agencies were defanging enforcement staff.
Builders were then able to sell new homes to those hordes of families who had no down payment and could not sustain payments on the mortgages they took out. Negative amortization had become a positive. RIPOFF mortgages of the day comprised “Reverse Interest & Principal for Option Fast Foreclosure.” Thrown in was the ZAP mortgage offering “Zero Ability to Pay” at six months as the qualifying teaser rate adjusted into oblivion. Great fun, until 2007 put end to it
Prior to 2008, it was common practice for builders to actually provide the minimum down payment required by the Federal Housing Administration (FHA) for an FHA-insured mortgage, and eventually conventional mortgages. These mortgages were typically called Nehemiah loans, all part of HUD deregulation from the late 1990s forced into existence by litigious home builders and political influence. As a plus, 80/20 piggyback financing came into vogue, allowing for no down payments.
Sky high optimism
Come 2006, buyer optimism was without a ceiling, and home prices rose higher. In this year — just as prices peaked and began their steep, three-year descent — 81% of surveyed consumers in Alameda County and 75% in Orange County said it was a good time to buy. They erroneously believed home prices were likely to increase, according to the Brookings Institution. It was a case of expectations of ever-increasing resale volume and prices based solely on recent experiences of others, which are only fulfilled when no one is able to buy.
Consumer expectations were improperly based on the price movement of the moment (which was up). Like most, and at their peril, they ignored all other signs (such as falling home sales volume and the yield spread on bond rates) which unmistakably pointed to decreasing home prices by early 2006, with worse to follow.
And so, homebuyers and lenders continued to pour wealth into the failing housing market, not knowing that they would be the last in a long line of speculators to be holding the hot potato. A monumental lack of understanding about real estate itself both generates profits for the lucky speculators — and losses for those less lucky ones.
The role of speculation in 2023-2025
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