How Speculative Madness Changed the Housing Market

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(WESTPORT, CT) -- It was the summer of 2004.  People were camped out in Hollywood, Florida for the chance to buy one of the 285 units in a condo development called Radius.  All of them sold out in 10 hours - half a year before construction was scheduled to begin.  Many of the units were bought by flippers who intended to put them up for resale before the development was finished, often as soon as the purchase was completed.

This buying frenzy was not confined to the overheated condo markets in Las Vegas, San Diego, Chicago, Phoenix and much of California and Florida.  The following spring, panicked buyers were camping overnight to bid on a $700,000 two-bedroom house in a suburb of D.C.

What had led the American Dream of owning a home to come to this?  It was three essential ingredients.  The housing bubble and its inevitable collapse would never have been possible without (1) hordes of speculators (2) absurdly easy financing and (3) widespread mortgage fraud.  We'll examine the first of these three now and the other two in subsequent articles.

Who Were the Buyers that Fueled the Housing Bubble?

A record 7.7 million existing homes were sold in the United States in 2004.  This was much higher than in any previous year.  How was this possible?  After all, when baby boomers were in the peak years of buying their first home in the late 1970s, fewer than four million existing homes had been sold annually.  Also puzzling is that boomers had been forming new households at an annual rate of 1.6 million between 1974 and 1980 according to the Census Bureau.  During the height of the buying frenzy - 2004 - a mere 720,000 new households were formed.

By 2005, the median price of homes sold in the U.S. had climbed to $220,000 according to the National Association of Realtors (NAR).  In the hottest markets, the median price had skyrocketed to $450,000 in Los Angeles, $300,000 in Las Vegas, $280,000 in Chicago, and more than $500,000 in Brooklyn.

The NAR reported in its Annual Profile of Home Buyers and Sellers that first-time buyers had purchased 40% of all existing homes in 2004.  The Association emphasized that this had fueled the red-hot trade-up market. Yet the median household income of renters was only $30,000 as recently as last year.  Could three million renters with such modest incomes have possibly afforded to buy a first house at these price levels in 2004?  It seems very unlikely.

An important study entitled "Liar's Loan?  Effect of Origination Channel and Information Falsification on Mortgage Delinquency" was published on Columbia University's website in September 2009.  Its database included the complete files for 721,000 loans which had been originated nationwide by a large mortgage banking firm (whose identity the authors did not disclose) between January 2004 and February 2008.  The authors reported that between 2004 and 2006, an average of only 13% of all the borrowers stated in their application that they were first-time buyers.

If the number of renters able to afford homes was rapidly shrinking during the bubble peak, who was behind the frenzied buying from early 2004 to mid-2005?  Put simply, it was speculators.

An article published in the May 2005 issue of Fortune magazine took an in-depth look at this speculative mania that was sweeping the country.  These young speculators were descending on city after city in search of making a killing in real estate.  One of them was a 22-year old who, by selling his first investment property in Las Vegas, had made enough to buy eight more properties in Phoenix with a down payment of 10% on each.  He then purchased another seven houses in Phoenix by partnering with a close friend's father.  Though none of these properties had a positive cash flow, he wasn't the least bit concerned.  His view was that of the pure speculator: "I'm in it for the appreciation."

Phoenix had become a hotbed of speculative buying.  By March 2005, monthly home sales had climbed to nearly 10,000, up 13% from March 2004 and 73% higher than March 2001 sales.  Speculative interest was so great that the inventory of homes for sale had plunged from 23,000 in March 2004 to a mere 3,000 a year later.

Between 2001 and 2005, the median sales price of homes nearly doubled.  According to DataQuick Information Systems, its huge database revealed that nearly 40% of residences had been bought by absentee owners (i.e. investors) in 2005.  In an August 2005 interview with a local Phoenix TV station, the head of Arizona State University's Real Estate Center, Jay Butler, stated that investors were responsible for at least 20-40% of home buying in Phoenix, and possibly higher.

Another couple in their thirties that the Fortune article portrayed had bought five foreclosure houses in Florida in 2002 with a down payment of only $1,000 each.  Home values were soaring and they decided to become full-time real estate speculators.  They moved to Las Vegas in 2003 where other speculators were swarming like locusts.  They bought another seven properties by draining what remained of their savings and then purchased several more by borrowing down payments from family and friends.     

Even cities such as Austin, which had not witnessed the soaring property values that was occurring throughout California, became infested with these young speculators.  One broker led car caravans for out-of-town speculators who saw Austin as the next hot spot.

A young San Francisco couple in their mid-thirties described in the same Fortune article who had purchased a dozen houses in Phoenix sold two of them so they could roll the profits into Austin properties.  When asked whether the housing market was becoming a bubble, the husband replied, "I love all the talk of the bubble.  It eliminates all the chickens."  The broker who led these tours had seen his client base become 80% investors largely because of these out-of-state speculators.

An article which appeared in the Wall Street Journal (WSJ) in January 2007 painted a vivid picture of the speculative fever which gripped nearly all of Florida.  Naples, near Ft. Myers, had become a "hot market" by early 2003.  One Naples real estate agent, who owned 13 investment properties there, told the authors that by 2004, "investors were "scouring every corner of Naples."

Another realtor, mentioned in the same WSJ article, sold his own home in the fall of 2004 to an investor for $435,000, more than double what he had paid for it five years earlier.  He soon sold numerous other properties to her including a duplex for $621,000 in October 2005 which he had bought seven months earlier for only $349,000.  This same investor also bought another house in July for $690,000 which had sold for $275,000 in early 2001.  The next door neighbor told the authors "We were just laughing at these prices.... I grew up here and it's out of control."

During the peak of the speculative bubble in Naples from early 2004 to the fall of 2005, median prices almost doubled from $250,000 to $420,000.  The authors of the WSJ article talked to numerous local real estate agents who agreed that during this period "as many as 50% of buyers may have been investors."

Nearly all of California was full of speculative activity from 2002-2005.  Between early 2002 and the end of 2005, the average price per square foot of homes purchased in Los Angeles had skyrocketed from $200 to $470 according to trulia.com.  Mortgagedataweb.com showed that the average mortgage for homes bought in San Francisco had soared to nearly $670,000 by the middle of 2005.  Monthly home sales in San Diego had risen to nearly 6,000 by March 2004 and listings for sale plunged to only 2,000 a few months later.  In Sacramento, the average mortgage for home purchases increased from $250,000 to $350,000 in a year and a half.   

In a February 2006 posting on the Housing Panic blog, an Oakland, California couple explained that they had decided to sell their modest two-bedroom condo in August 2005 after watching a neighbor's home sell for $665,000, which was $100,000 more than the asking price.  The couple listed their 965 square foot condo for $459,000 and after receiving 8 offers, sold it for $575,000.  Their conclusion was filled with wisdom: "The frenzy of the sale ... was such a freak show that I knew we had to be close to the top."

This gives you an idea of how crazy the speculative home buying had become during the bubble years of 2004-2005.  In the next article, we'll explore how easily nearly all buyers were able to obtain mortgage financing.

 

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