Speculators are Much Different Than Investors

A recent article on CNNMoney.com stated that, “Experts say jump in cancelled orders for new homes is latest sign of how investors inflated the real estate market recently, and how the market is due for a downturn.” It really troubles me to see them use the word “investors” in that context. Here’s why.

What builders have been seeing in the hot markets–Phoenix, Las Vegas, etc.–in the past few years is speculators that come in and gobble up housing using the assignability clause and other methods in the real estate contract. These aren’t investors, though. These are speculators, pure and simple.

What they are/were banking on is the greater fool theory. Whip everyone into a frenzy that real estate prices will go up forever, take a profit as quickly as you can and move onto the next deal. It could be argued that the very speculators that have been involved with the builders are the ones who have set artificially inflated housing prices into motion. That is, where a consumer previously would buy a property for X, with X having the builder’s 8-18% profit margin built in, the consumer is now purchasing for Y–the X price the builder had the property on the market for and the extra 10-20% for the speculator.

And the comparables keep rising because the same houses are turned over and over with the consumer getting stuck on top. In essence the comps used to justify the increased price are basically worthless to begin with.

For example, if you had a mini new-construction neighborhood with 10 houses in it, the builder sells House A to a speculator for $500,000 dollars. He then sells House B to the same speculator for $510,000. Since the only comp in the neighborhood is the first one, it could be successfully argued to an appraiser that supply and demand, plus normal price appreciation in new neighborhoods, justify the 2% increase. So, House C now sells for $520,000 using the comps from House B, and this continues until all 10 homes are under contract to one or more speculators.

Now it is time to resell.

The last house sold in the neighborhood, House J, brought a price of $590,000. So, with normal appreciation, the original House A sells for $600,000–a tidy profit of $100,000 dollars. This is the same house the consumer could have bought for $500,000.

The market may indeed be cooling off in many over-heated areas, but it’s speculators, not investors or consumers, who will feel the greatest effects.