Raiding the Nursery: How Quickly Will Sacramento Real Estate Recover?

What will it take to shock the Sacramento real estate market back to life?

Behind the mask of false bravado and feeble optimism worn by industry insiders who think wishing can make things true, there is an undercurrent of worry. Let’s face it. The patient is ill. What will turn things around? In a word, affordability.

It’s pretty clear that we chucked the idea of affordability in the early 2000’s as home prices and incomes parted company. People bought homes they couldn’t afford with loans that offered low initial payment but blew up after a couple of years. The speculative fever that ensued was supported by low interest rates, easy-qualifying loans and 100% financing. Builders responded by flooding the market with new homes geared to the move-up market, at prices affordable mostly to those who had previously experienced windfall profits. Then the music stopped, and all the chairs were gone.

So here we lie. Too much inventory, too few buyers. Sales are slow at every level, though Sacramento real estate prices have retreated to mid 2004 levels. Despite sellers’ attempts to get in front of the decline, buyers pitch low-ball offers on everything. I attended a recent auction featuring the last 6 homes in a 220 unit Elk Grove subdivision. The seller, a national home builder, was able to unload only 3 of those 6 homes even at steeply discounted prices. What’s the problem? Again, affordability.

The key to finding our pulse again lies with the first time home buyer. Only they can unlock equity for would-be move-ups. But have we raided the pipeline during the last few years? I found this article on freeERISA.com. It’s kind of a summary of observations made by bubble bloggers, who can seem prone to hysteria and hyperbole. But distilled in this fashion, the thoughts are pretty compelling. I pasted one section, but go read the whole article if you have time.

Demand for Homes

Among professional economists and media analysts who believe the U.S. housing market is near a bottom, few have identified expected sources of increased demand. Bloggers paint a picture of demand across four segments: 1) first-time buyers; 2) second-home (vacation) buyers; 3) investors/flippers, and 4) traders.

Although traders account for the majority of existing home sales, they have little impact on the supply-demand balance because they sell one home to buy another. As the market has cooled in late 2006 and 2007, investors/flippers have become scarce on the buy side. Vacation buyers remain plentiful, but bloggers believe this segment will dump more net supply on the market than it absorbs over the near term.

That leaves the most pivotal segment of all, first-time buyers, who provide liquidity for traders, investors and flippers. In normal markets, demographic trends suggest that about one million first-time buyers per year flow through the pipeline, with an average age of first purchase in the early 30s.

However, bloggers believe that there are fewer qualified first-time buyers available today than there should be because “the pipeline was raided” in the buying frenzy of 2004-2006. Many first-time buyers were lured into an overheated market with easy credit, even though they weren’t qualified to buy. Now, having been steered into costly subprime mortgages, a growing number face foreclosure. With their credit in tatters and tighter credit standards in place, this “lost generation” of former homeowners may not be able to re-enter the buyer pool for years.

U.S. Census data supports the view of a depleted first-time buyer pipeline. Homeownership rate among householders less than 25 years old increased from 21.7% in 2000 to 25.7% in 2005. Bloggers believe it will take several years to rebuild the pipeline of qualified first-time buyers to a normal level. They also believe professional economists and analysts have consistently and inexplicably missed the importance of the depleted first-time buyer pipeline in trying to explain why buyer traffic has been so thin this spring. It isn’t the weather!

So the market will return to normal when the fundamentals or income and price once again realign. I’m guessing that happens when prices reach mid-2003 levels. With first-time buyers having to qualify on real income—no more liar loans—prices have a little further to fall for that to happen. Just my opinion of course.