Will the housing buck stop at cash buyers?

Cash may be king in California home sales, but who is the ruling class?

An article in The Los Angeles Times on Tuesday mentions that “all-cash buyers grabbed a record 30.9% share of California house and condo sales in January.”

The source of the information, San Diego-based DataQuick, sent an e-mail Feb. 16 announcing that such a trend was coming.

“Last month was sort of a flashback to January last year: Sales were lousy, but many investors and others looking for bargains stayed active,” said John Walsh, DataQuick president. “They kept working the distress-heavy, lower-cost markets through the holidays, which translated into a relatively high level of investor and cash deals closing” in January.

Walsh also outlined borrower sentiment, buyer sentiment and housing prices in the email.

But what is missing from most reports is the anatomy of this new type of buyer: the cash buyer.

It’s important to know the profiles of the buyside.

Besides, the image of foreign hordes running around Southern California with bags full of cash is an intriguing one. And digging further, it’s not too far from the truth.

One housing analyst is actually on a similar quest.

“I’ve been trying to clarify the definitions with the National Association of Realtors and unfortunately it is a bit murky,” he said. “NAR has said that a cash buyer is anyone who buys a house with cash. To me, that means they have not used a mortgage, but clearly their cash could be made up of other forms of borrowing. In short, it could be both.”

This is what I’ve found to be the breakdown of cash sales in California:

About 20% are a random, one-off purchaser. Typically with a relative in Hong Kong, Shanghai or Mumbai (you get it). These are buy-to-hold, not flippers. They want to be landlords and have the properties produce a steady stream of income.

Another 40% are classified as “mini-institutional.” These are the private firms that are active courthouse steps buyers of foreclosures. They normally deal in “hard cash” and are an entirely local or state entity.

The remaining 40% are “mini hedge funds.” These portfolio massagers already enjoy extensive access to funding, usually from outside the state. They often don’t have an extensive local network, but employ local faces on the ground doing the minimum of work. These are firms with clear return targets and will dump the property as soon as it’s most profitable.

In short, 80% or so of these “cash” borrowers are financing down payments primarily through their own lines of credit.

But this begs the question: What’s the problem then?

It’s not a problem as long as someone is still buying the property.

Nonetheless, Capital Economics is suggesting that cash buying may be an unsustainable trend.

“The fact that the recent rebound in existing home sales has been predominantly driven by cash buyers and investors places a question mark over the sustainability of that rebound,” said Paul Dales, U.S. housing analyst for the Toronto-based firm. “The concern is that there may be a limited pool of such buyers and that first-time buyers will not be able to fill any void.”

Dales mentions that information on trends in Southern California tends to overlap. Investors and cash buyers sometimes fit the same profile, sometimes not.

Since November 2009, the share of existing homes bought by cash buyers and investors has risen to 55% from 31% while that of first-time buyers has fallen to 29% from 51%, Capital Economics reports.

“First-time buyers have played almost no role whatsoever in the recent rebound in home sales,” Dales said.

Consider that credit remains tight, and the cost of mortgages are only going to go up. Larger down payments and higher FICOs are pretty much written in the stone of the future.

“The fear is that at some point the pool of cash buyers and investors will be exhausted,” Dales adds.

But that fear may yet be unrealized. Globalization certainly allows for a much wider investor base to access these housing markets. But, are young professional Americans destined to only rent under foreign landlords? The argument feels alarmist and impractical. Rents will remain stable enough as long as supply and demand is competitive.

Nonetheless, if these cash buyers suddenly vanish, first time homebuyers will not be able to fill the gap.

If this bubble is going to burst, perhaps this time we should know who is behind the pop.

Write to Jacob Gaffney.

3d rendering of a row of luxury townhouses along a street

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