Originally posted on my Housing and Economics Blog on Mar 20 2016
First time home buyers are being pushed out of the market and being trapped on an escalator of rising rents. The American dream for many is being slowly (or maybe not so slowly) suffocated by debt, stagnant wages, and higher income inequality. Competition for entry level housing is only being exacerbated by stiff if not unfair competition from investors and home flippers.
We have emerged from the worst financial crisis since the great depression where home values fell by as much as 50% in some areas, of course the fall was due to irrational exuberance brought on by lack of proper financial regulations in the lending industry which created text book bubble conditions. Still, home affordability fell to a level which should have created an opening for many first time home buyers (those that still had a job) to enter the realm of home ownership, unfortunately to a large extent that did not happen. The Lion’s share or REO (Foreclosed Homes) and short sale homes were gobbled up by well-funded (many all cash) Investors and home flippers who turned those distressed homes into rentals.
Cash is King! It certainly is when it comes to real estate. Sellers are drawn to the quick close and the minimally hassle free transaction of an all cash deal, in some cases sellers are even willing to accept a little less for their properties if it means closing sooner and not having the deal hinge on a make or break appraisal which is required for homes purchased with a loan. Unfortunately, very few first time home buyers are in the position to pay all cash for a home. According the California Association of Realtors (C.A.R) 66% of all Investor transactions were completed with cash. C.A.R estimated overall investor market share for 2015 to be at 26% (down from 39% in 2013).
Since higher end and move up homes in general do not make for good investment properties the majority of the 26% investor market share was at the entry level price point meaning the percentage of entry level homes being snapped up by investors is actually much higher than 26%. Home flipping has even seen a drop off as C.A.R has estimated that as high as 65% of investors are holding on to the properties and converting them to rentals rather than flipping.
Rents in California on average are expected to rise by 4-8% this year making rentals more profitable and renting more expensive. Couple that with a diminishing supply of starter homes and steady investor demand the outlook for millennial first time home buyers is bleak. As rents rise the capacity for first time home buyers to save for a down payment on a home diminishes, this has rippling consequences throughout the overall economy as well, as more income is devoured for rent disposable income falls leading to less spending/economic demand, a drop in home ownership and the accumulation of wealth. This cycle will only worsen as long as rents continue to outpace incomes and rentals become more profitable for investors.