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Are housing investors creating a new bubble? Cash purchases cloud outlook for market

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Housing has emerged as the brightest spot in the economy this year, but some analysts are questioning whether the market's recovery is built to last.

Home prices, sales and construction have increased sharply in the past year after six years of relentless declines, suggesting a classic recovery and adding fuel to a broader economic expansion. For the first time since the Great Recession, the housing sector started adding jobs in areas such as construction over the past few months in a sign of a dramatic market turnaround.

But a close look at the numbers reveals that much of the housing activity is driven by abnormal conditions stemming from the housing crisis.

Much of the pickup in sales and prices has been powered by investors who, convinced that the market is bottoming, are scooping up bountiful supplies of distressed and foreclosed properties at bargain prices and often paying with cash.

With investors targeting lower-priced homes that they intend to purchase and rent out, they have been crowding out many first-time buyers who are having difficulty getting mortgage loans and are at a disadvantage when competing with well-heeled buyers. Cash sales to investors now account for about one-third of all home sales, according to the National Association of Realtors.

Although rock-bottom interest rates on mortgages and low home prices undoubtedly remain strong attractions, traditional buyers are encountering other formidable obstacles.

Mortgages are difficult to obtain because banks want to lend only to the most creditworthy customers and are demanding down payments of at least 20 percent on any loan that doesn't have government backing.

Homeowners who are underwater or close to it can't come up with down payments of that size, while first-time buyers may have to save for years to come up with the cash if they don't get help from relatives or friends.

"The recovery in housing prices seems to be disconnected from traditional economic drivers," said Christopher Whalen, managing director at Carrington Investment Services, who estimates that about one-third of Americans who would have qualified for mortgages in 2006 can't get them today. People of ordinary means, unlike investors, can't buy homes without credit because they hardly have the cash for down payments much less the entire costs of the properties.

Political leaders and investors need to take note, he said.

"The weak rate of participation by homeowners in the home price rebound is a concern, and one which is underscored by the lack of bank credit creation" since the recession. "In a normal housing cycle, the creation of new home mortgage credit would be growing in tandem with rising home prices, but the current rebound is anything but normal."

Spot shortages

For buyers who are able to overcome the credit obstacles and enter the market, other hurdles await.

Many are encountering shortages of homes for sale in the District and some other areas, but not for reasons characteristic of a healthy market. Home prices are 30 percent below their 2006 peaks in most regions, leaving nearly one-quarter of homeowners underwater on their mortgages and unable to sell their homes without losing money.

The shortages of homes for sale in the most desirable neighborhoods may give the appearance of robust conditions, with buyers queueing up to make bids, but analysts say appearances are deceptive.

David Stockman, a former Reagan budget director and Wall Street investment banker, is convinced that the market is not what it seems.

He blames the ultra-low interest rates engineered by the Federal Reserve, which he said has encouraged investors to enter the housing market in droves with the goal of making easy money on low-priced homes and then quickly heading for the exits when interest rates reach more normal levels. It has created at least a temporary bubble in some markets, he told the Daily Ticker recently.

"We don't have a real, organic, sustainable recovery," he said. "In a world of medicated money by the central bank, things aren't what they appear to be," he said, noting that some of the sharpest, double-digit gains in home prices and sales recently have been in formerly distressed markets such as Phoenix and Las Vegas, which were devastated during the housing market collapse and have had a glut of foreclosed properties.

"It's happening in the most speculative subprime markets, where massive amounts of 'fast money' are rolling in to buy, to rent, on a speculative basis for a quick trade," he said.

Blackstone, a leading investment firm, has spent $3.5 billion buying single-family homes in nine markets in the past year and is expected to buy another 15,000 units this year. Other investment firms active in buying up houses are Colony Capital LLC and Two Harbors Investment Corp.

"As soon as they conclude prices have moved enough, they'll be gone as fast as they came," Mr. Stockman predicted.

The investment activity has obscured the fact that first-time buyers and trade-up buyers are largely missing from the market, he said, though these types of consumers are essential to ensuring that the market keeps rising under more normal circumstances.

Young potential homebuyers can't find jobs, are weighed down by staggering loads of student debt and are unable or unwilling to buy homes, he said, while baby boomers are looking to trade down to smaller homes rather than trade up to larger ones as they approach retirement.

Investors fuel boom

An analysis by CoreLogic, a real estate information firm, bears out Mr. Stockman's point that the 8 percent rise in home prices in the past year has been fueled by investors diving into formerly depressed markets such as Phoenix and Las Vegas, where hedge funds and other investor groups have been most active in snapping up foreclosed properties.

Home prices shot up at double-digit rates in the past year in areas targeted by investors — 23.2 percent in Phoenix, 15.3 percent in Las Vegas, 13.4 percent in Atlanta and 13.8 percent in Detroit — as investment funds entered the market en masse.

In addition, CoreLogic found that individual investors — who sometimes pay in cash but also obtain mortgages to buy homes — have been driving up sales and prices in other markets, most notably Los Angeles, San Francisco and San Diego, which experienced price gains of 12.1 percent, 17.5 percent and 9.8 percent respectively in the past year. Miami is another market where sales to investors, domestic and foreign, likely drove up prices by 10.8 percent in the past year.

The robust sales gains, primarily in the South and West, in turn fueled a jump of 8.1 percent in home prices nationwide, the fastest since the top of the housing bubble in mid-2006, according to the S&P Dow Jones home price index. But markets not flooded with investors, including New York and Chicago, experienced more subdued gains of 0.6 percent and 3.3 percent, respectively.

"The markets have been uneven" because of the concentration of investors in a handful of areas, said Sam Khater, an analyst at CoreLogic.

Individual investors usually have been much bigger forces driving up the market, he said, though they are less visible than the big investment funds. Individual investors purchased 600,000 homes last year — far more than their institutional brethren.

Hope springs eternal

Despite worries that investors, not homeowners, are driving the market, many economists remain optimistic that the housing revival is real and here to stay.

Federal Reserve Chairman Ben S. Bernanke frequently touts the rebound of housing as one of the central bank's main accomplishments in driving interest rates to historic lows in recent years. The rates on 30-year fixed-rate mortgages used by most consumers have been below 4 percent since the Fed started purchasing Fannie Mae and Freddie Mac mortgage bonds again last fall.

Patrick Newport, an economist at IHS Global Insight, said the Fed's extraordinary easing is bearing fruit and, coupled with slow but steady job growth, is providing fuel for a lasting recovery in the housing market.

A drop in distressed sales, apparently as investors absorb much of the supply, is allowing home prices to firm up, enabling indebted homeowners to regain some of their lost wealth, he said. The Fed estimates that the value of homes nationwide increased $1.4 trillion last year, adding substantially to the principal source of middle-class wealth that was drastically depleted during the housing market collapse.

Higher home prices lifted 1.7 million homeowners above the underwater mark in 2012, according to CoreLogic.

Mr. Newport noted that higher home prices also are boosting property tax receipts for strapped state and local governments and making it more profitable again for developers to build homes and hire construction workers, producing dividends for the broader economy.

To many analysts, the influx of investors may not seem normal, but it has served an important purpose: It provided a jump-start to the market by prompting more traditional buyers to worry that they will miss the bottom in prices and interest rates if they don't act soon.

"Expectations are starting to play a role," said Mr. Newport. "Potential home buyers are entering the market now instead of later because they are afraid that prices will shoot up if they wait. Their expectations, which can become self-fulfilling, will magnify price increases in some places as housing markets improve," creating a kind of virtuous cycle that is replacing the vicious downward cycle that prevailed in housing for years.

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