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The Death Spiral of Move Up Buyers: First Time Buyers Are Not Enough to Save Us

Move up buyers are becoming extinct in California.

With an epidemic of negative equity sweeping the state, we must ask ourselves this question:

Do we really believe that there are enough first time homebuyers out there to turn this market around?

In the bubble years of 2005-2007, buying a house in California was often a "closing cost only" affair.

Buyers used an 80% first loan with a 20% HELOC right behind it, for a neat and tidy 100% loan.

Then they promptly spent their savings "fixing up the house" because after all, they could refinance a year later and the house would belch out another hundred grand.

They also gladly paid $500,000 for a starter home (inland) and $700,000 (coastal).

This, my friends, is the sorry state of our "MOVE UP" buyer market. Clearly they're not MOVING anywhere anytime soon.

Most of us believe the negative equity tipping point (going upside down) is when you owe one dollar more on your house than the value of your house.

Not so.

If the homeowner cannot pay enough to extract a real estate commission, a down payment on the MOVE UP house, AND moving expenses, then the tipping point of negative equity is probably closer to 90%, 80% or even less.

A homeowner with 10% equity knows they are trapped. If you lower the negative equity bar, then this changes everything.

There are far more "trapped" homeowners than most of us believe.

Can they save their way out? You might think so based on how little consumer spending is going on.

Or will they just walk out as another "strategic foreclosure" goes on the books? (Strategic foreclosure = you can afford the payment but decide to dump the house because you are so far underwater)

Either way, it's a LOSE-LOSE for the economy.

Without these existing homeowners active in the real estate market, home prices will not find a bottom.

Here is a death spiral scenario:

Mid to high end house become illiquid assets.
Prices plummet as supply far exceeds demand, and "strategic foreclosures" continue
Banks (to protect themselves from declining values) tighten lending standards further and demand larger down payments.
30% down becomes the norm moving the bar even further away for the trapped
Baby boomers dump the grand houses that characterized their materialistic phase to raise capital and lower expenses.

In previous posts, I have already asked this: "Who will want all of the big houses that baby boomers will be dumping?"

Revision: "that BANKS will be dumping."

Here are my predictions:

Prices will continue to decline for markets that are out of reach for first time buyers.
Smaller houses will cost more than larger houses as low operating expenses and lower property taxes trump outdated mcmansion style living, and the only buyers out there are investors and first timers.
More foreclosures at the upper end of the market.

Written by Janet Guilbault, Mortgage Banker/Broker based out of the San Francisco Bay Area.

Posted by Janet Guilbault California Mortgage Banker/Broker on 10/02/2009 10:02 AM

Comments (50)

Move Up Buyers in the Mortgage / Finance Channel

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50 Comments on The Death Spiral of Move Up Buyers: First Time Buyers Are Not Enough to Save Us

OCT

As a builder specializing in move up buyers, we have not seen any bump in activity as a result of the first time buyer tax credit.

Nearly all 1st time home buyers are purchasing entry level or starter homes. The program was only meant to help the democrat voter base while giving lip service to housing. There is very little walking away on homes in the mid- to high range here. The majority still have plenty of equity and most have integrity. The boomers are a generation that believe in their word and contracts. They also need a place to live. Retired boomers moving in to the area are buying large (2200 - 3500 sq ft) homes- but few mansions.

Janet, I read bankruptcies/foreclosures are including the "wealthy" in growing numbers. The food chain, as we knew it leading from the first time buyer to the move up buyer, broke.

Janet - While I don't focus so much on move up buyers (except for my previous first timers), down here in LA & Ventura counties, the majority of buyers are also investors and first timers (in that order too). Properties under 400k go fast with multiple offers and properties higher than 700k are sitting longer and longer.

Earlier this year, I marketed Fannies DU Refi Plus to my database and did get a few inquiries but back then at 105% ltv, I couldn't help anyone. Even now that they have gone to 125%, which I sent out to my database again, I've now got one client that I am trying to help but even now, I'm not sure I can; the comps are soooo tight.

I don't know what price range your first timers are in up there but around here they are pretty much the 150k-400k range and most of the properties in that price range are being scooped up by all cash investors and a large percentage of first timers are still getting shut out again, just like they did a few years ago when most homes were out of their price range.

While I agree that this market has been a godsend for many first timers, the group of homeowners that have fared the best by this market is by far the investor and I'm not sure that's entirely a good thing. I'd like to see more real homeowners start to benefit from this market than just the all cash investor.

Since I work with a lot of "younger" buyers I've wondered out loud for several years now who boomers thought they would sell those mcmansions to when the time came...the time has come and we are seeing the result.

Donne: First time buyers here are in the same price range. First time buyers are also getting very discouraged.

What is hurting the market is that ALL WE HAVE ARE first timers and investors. Yes I agree the investors are winning and first timers are so discouraged.

But to stabalize prices, we need a move up market that is not frozen.

We can't expect the market to right itself through first time buyers and investors. There has to be movement in the middle and at the top.

I don't expect Boomers to walk away from their homes, so I do agree with most of what you say.

The ones in trouble are not Boomers, but even Boomers will likely sit in their houses and not move, which does not help the market.

The move up market that will harm us is those first time buyers from 5 years ago that now need a bigger house. They are underwater and may just walk away.

Scary, isn't it?

OCT

I know and agree this is a very different situation than I have seen before. Without the move up buyer the mid range and the luxury home are in for a difficult time.

The death was a suicide with some buyers . . . unfortunately.

Hi Janet,
Although most people are not upside down around here - the trend towards smaller homes is very obvious. They cost less to heat, less to cool. Upkeep is more manageable. These homes will start to go up in value even while larger homes will continue to decline in value. The other trend I see - they want top-of-the-line finishes already installed....this probably reflects the difficulty in getting home equity loans for renovations. They know that what they see there is something they will probably have to "live with" for some time to come.

In the past, buyers have traded up 30-60 percent in value/size. I wonder if in this economy buyers aren't comfortable downsizing or moving laterally to less expensive homes?

Time to go back and read "Who moved my cheese?"

Janet, I was thinking about this very thing recently. Just within the last few months have I seen the rise in foreclosures and abandoned properties that were owned by the "mover uppers". I personally have 3 different sets of people who are in the boat you described: Moved "up" and are so upside down that they have no chance of selling and breaking even any time soon.

More renters became homeowners last month but fewer existing homeowners moved up to more desirable homes or neighborhoods even though they acknowledge current home prices are a good value, according to an industry-sponsored survey. Most potential move-up buyers believe homes are more affordable today than in recent months and 69 percent believe the economy is improving

Here's more

Move-Up Home Buyers are Stuck in Neutral

http://www.realestateeconomywatch.com/

Janet most of the first time home buyers I sold to bought vacant homes, most were foreclosures. I can't see where my buyer's purchases helped any move up buyer sell and acquire anything else.

We have been seeing the situation where smaller houses cost more - or at least as much as - bigger houses for awhile now, and seniors feel trapped in their homes even though they have 100% equity. It just goes against their nature to pay that kind of money for a smaller house, and they can't bring themselves to do it!

Janet, your clarity is frightening but true. We started out two years ago deciding that the over-55 contingent was the group with whom our personalities meshed, looking forward to this niche. It became evident fairly quickly that absent the first timer to purchase their existing home, this group was stuck...until their primary residences are in line ($) with the ability of the first timer, no one is going anywhere anytime soon unless the SECOND property is in line with the price drop of the original home... the stragegic defaults are (in our area) beginning to show their presence in all price points, but glaring are the very high end starting to show up on lis pendens reports...it's nothing if not an ongoing shock, this market!

I represent a move-up builder all I can say is we are having to search for that move-up buyer!

Fortunately our area didn't have the boom and bust like California and Florida so the sellers here are not underwater in their homes. However due to the economy move up buyers are staying put. Most I have spoken with are concerned about taking on a bigger mortgage and are making do with what they have. I agree that we need these buyers just as much as we need the first timers but I'm not sure what can be done to give them the confidence to move up until the economy starts improving.

Besides relocation, first time home buyers and investors are all that I personally have been seeing that are buying at the moment. I've also been working with more and more clients who moving down either because of retirement or for financial reasons. As the banks tighten up on requirements, it's making it much harder for first time buyers to afford to get in a house or find a house that doesn't need thousands of dollars in repairs. Over a quarter of my listings sold this year have been to investors who got a deal simply because they had cash and the sellers knew they would get to closing. I'm afraid if this trend continues we are going to start to see market values dropping. Some neighborhoods are already seeing some depreciation.

Janet:

I think your assessment is spot on. As an experienced commercial real estate appraiser in the Bay Area and now Lic. FL real estate broker, our group is witnessing the same. About 75 percent of all real estate activity is coming from first time buyers, downsizers paying cash (foreclosing their existing house while paying cash on someone else's foreclosure), or investors which all feed the lower end of the market.

We are also seeing a record number of landlords walk away from their rental properties as the delta between expenses and the rent collected is too large to absorb in perpetuity. We see several of these scenarios a month.

What's sad are baby boomers wiping out their savings in an attempt to carry their investments during this cycle. Consequently, more and more folks are opting for a strategic foreclosure in lue of completely depleting their savings.

The unemployment rate is another factor. Baby Boomers were willing to hold onto a bad investment in order to keep their credit as many employers now look at credit as part of the hiring decision. However, as the job market looks bleak for high income positions, many Baby Boomers have given up on their credit as they look to downsize and realize that their maximum income potential is behind them.

All these factors lead to a major contraction in the category of large or high end homes. They symbolize the excesses that is no longer in the mindset. Pragmatism is now the common theme.

Lastly, changes in real estate demand will not be evident until we observe significant Rent Inflation whereby the cost to rent a home is close to the carrying costs of owning the same home. This rental equilibrium will be the sign of a healthy real estate market.

Good Morning Rainers.

Aaron: you wrote this:

changes in real estate demand will not be evident until we observe significant Rent Inflation whereby the cost to rent a home is close to the carrying costs of owning the same home. This rental equilibrium will be the sign of a healthy real estate market

That has happened for entry level homes in Calif...that is why everyone here is saying there is no inventory of starter homes. That is why multiple offers are the rule as investors and first time buyers slug it out.

But that is only one segment of the market. If you are not a first time buyer, the chances are you have too much "BAGGAGE" (tacky expression we use in the mortgage office for people who already own real estate and cannot sell or refinance due to neg equity)

Ruthmarie: You wrote:

they want top-of-the-line finishes already installed....this probably reflects the difficulty in getting home equity loans for renovations.

VERY astute and relevant observation!!!! If you barely have enough equity to move on...where ya gonna get the money to rehab???

I agree that small houses with high end finishes in safe urban settings will have an excellent chance for appreciation because across the board, these are the houses people want

(West Coast perspective I will admit)

PS Not to mention baby boomers do not want to spend their retirement years in remodel projects.

Teresa: you wrote this:

I can't see where my buyer's purchases helped any move up buyer sell and acquire anything else.

Move up buyers need to sell. They are more valuable to us as an industry because it creates a chain reaction of multiple transactions:

Move up buyer sells their house
Move up buyer buys another house
Person who moved from that house needs a house

And on it goes. If first time buyer buys a bank owned property that removes on foreclosed house from the inventory of home. And it stops there.

It was one of the reasons I did not like the tax credit for first time buyers. They didn't need any incentive and it did not kick start a chain of sales.

How will the Alt-A mortgage reset wave forecast for Q1 10 be affecting the move-up folks? Will this potentially result in even more foreclosures in that category?

Gabe Gross, RealBird.com

Janet, I was thinking about this just the other day. We have movedown buyers, and first time buyers but the move-up buyer is out of the market right now.

Well does not seem that you have been drinking the kool aid hmmmmnn.?? I do agree with you ... good post

Janet Relax - the same government that allowed the mess with no controls has started to solve the problem. Tighten your seat belt even more Karen

I'm glad things are not so dire here in Massachusetts as they are in California. However, I agree with you that there will be more high end foreclosures. We are definitely seeing a trend toward smaller houses. When oil prices skyrocketed last winter people no longer wanted to pay to heat such large homes.

The trend in the Seattle area is the same, but not so dire. Homes in the $500k+ are just sitting because there is no way for a move up buyer to buy them any more. And with foreclosures increasing daily, this is doing nothing but getting worse. I do not see an easy end to this for a while.

Wow, without all you wise, watching & sharing ARers ... I would never understand half of what's happening in the market. It really is scary.

AWESOME POST - scary headline, but chock full of TRUTH!

The tax credit scam was about as helpful as the cash for clunkers scam. The same forces threaten both the C4C buyer and the Tax Credit 1st time buyer. The 9.8% unemployment figure is just not reality, it's at least a couple percentage points higher than that.

Both of those programs did little if anything for the economy overall. There are smart moves that could change this market fairly quickly but when we have a "never let a good crisis go to waste" administration you can bet that things are going to get much much worse before they get better.

Move your clients down or out of the market completely if possible. Have them stay on the sidelines for a few years. They'll love you for it and be your client for life! The worst is ahead of us, we "ain't seen nuthin' yet".

Just calling it like I see it.

I'm glad some folks "get it". The folks on The Hill and in the WH surely do not.

No move-up market reduces the buyer/seller pool for real estate agents and lenders by about 20-25%

Why doesn't the rest of the world see what we see?

No matter, the money is all gone anyway.

The hardest thing to get in this market is a nice large house. I have 5 kids and one on the way. I want one of these cheap McMansions if I can find one.

Janet - Great post! I live in an area with an overabundance of McMansions and I have wondered for years who's going to want them in a few years? There is a house currently listed for $1,300,000 that the sellers bought for $2,500,000 in 2007! Won't that drag everything down with it.

I guess I'll pile on. I just read an investment report indicating that the banks are sitting on another 1.5 years of inventory that they'll be unloading soon. Add that to the inventory already on the market and we're looking at around 2.5-4 years before we begin to see daylight.

I hope they do something with the 8K tax credit. Extend it and make it for all homebuyers.

OCT

Janet -

The tipping point you mention has ALWAYS been no more than 92-93% of purchase price - discounted for the ordinary costs of sale.

The boom of 2004-2007 was an unprecedented period of appreciation in home values due to terrible public policy mistakes -- one that will - cross your fingers - never be repeated.

Prior to that historic anomaly, a homeowner had to hold their property for at least three years - while the 2-3% historic rate of annual increase had time to erase that 7-8 % gap.

If they paid 10% or more down, there was never a time they felt/were underwater.

But those who brought less than 8-10% equity to their purchase were always underwater for the first few years. Absent a crisis mentality abroad in the land, they were perfectly content with their position in their home during those initial years.

The difference today may be that a lot of homeowners got a new set of expectations in their head during the boom. Now, they think of a home as an appreciating investment. They think if they can only get out the one they're presently in now, they will be free to get into another place and begin that high appreciation all over again soon.

Would that it could be so.

Hi Jim: I am going to agree that buying a home during the boom years was about gaining appreciation and buying before you could no longer afford it.

But I cannot remember a time when people bought pretty much knowing prices are still going down.

I don't hear anybody saying that if you only put 3.5% down on your FHA loan, you could be underwater pretty darn quick.

Buying a house is like buying a car. You go over the curb and you are underwater.

Maybe this will cause buyers to buy for the right reason.

Mike: What if that inventory sits at the upper end of the market? With people unable to move up and the sorry state of the jumbo market, this could be a big problem.

Margaret! Wow! I am in California and those numbers stunned even me. Something that would inhibit a California buyer would be the cost of property taxes on that house.

And also the fact we freeze property taxes to the price you paid for the house.

My house was bought many years ago for under $200k... and I thank my lucky stars every day.

We were having a discussion in the office about property taxes when one of my mortgage friends admitted his taxes are $1700 a month.

I choked.

Geez, Gene, all everyone talks about is how cheap big beautiful houses are out there in Brentwood.

Why can't you grab one?

Gene...sorry I said "out there"...I hope you do not think that sounded like a little bit of Walnut Creek snobbery which was not my intent at all!

Lenn:

I was never for giving the money to the first time buyers. I was never for giving money out at all.

But I honestly agree with you that there would have been far more benefit to have given the money to move up buyers.

I think first timers had all the incentive they needed and that move up buyers create way more momentum.

Yes, I get that.

Pete you wrote:

Move your clients down or out of the market completely if possible. Have them stay on the sidelines for a few years.

What a bold statement to make on a real estate network. I am subscribing to your blog.

PS: Interesting that everytime I have advised a client to "wait" when I answer online questions, I get praise from all around (except the real estate community)

To Gabe who asked about ALT A adjustments.

Somehow we need to get out of the death sprial that starts with foreclosures and leads to declining values.

If those ALT A's could be refinanced into current rates on fixed mortgages that would stop some of the bleeding.

Perhaps we as an industry should loosen guidelines for people with adjustable mortgages and allow them to stay in their houses.

Maybe the tax credit would have been better used by buying down the rates and paying the closing costs for people to do this?

OCT

Very true Janet. I have dealt with a handfull of people who wanted to move up only to realize that their margin of "equity" was not as big as they had figured.

Janet, this is a very astute post and indicative of what is see happening in my market place.

I do work with a lot of boomers, yes the trend for them is "less is more",No Stairs please and they are getting on with their lives in spite of the market.

Linda Metallo, Re/max Impact, Lockport, Il. Listing agent for Lago Vista (for those ages 55+), Lockport, IL.

OCT

You may be correct! Real Estate tends to be local. I would say 50% of my neighbors own their homes outright and have no intention of moving. Odd how different parts of the country are so different. New Orleans is still thinking about a Mall? Few companies want to tranfer people either.

Keep raising the taxes as we can use some new comers. Houses galore under 200k with low taxes.

OCT

First time home buyers buying the vacant foreclosures helps none of us with move up sellers.

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