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Diminished Demand Cooling One-Time Real Estate Hot Spots

The retreat of large single-family home investors, a dearth of first-time homebuyers and shifting lending rules could down-throttle a housing recovery in markets hit hard by the foreclosure crisis.

Frenetic sales activity in 2013 drove average home prices up more than 20% in Las Vegas and Sacramento, more than 18% in San Diego and nearly 15% in Phoenix, according to the CoreLogic Case-Shiller Indexes report, which covers more than 380 U.S. markets.

Now, just as rising prices are luring more homes onto listing rolls, demand is slipping in some former hot spots, says Van Davis, president of brokerage operations at ZipRealty (ZIPR), an online real estate platform.

After surging during the housing boom, the Las Vegas, Phoenix, Sacramento and San Diego markets — among others — all in varying degrees served as poster children of the foreclosure crisis but then staged partial comebacks.

Markets In Flux

However, in April median sales-price growth slowed year over year to an average of 8% in San Diego and 9% in Phoenix, according to ZipRealty. While appreciation in Sacramento and Las Vegas stayed quite strong — up 20% and 17%, respectively — it still represented a moderation in price growth, a trend that Davis expects to continue as supply gradually increases.

"What's really missing is the first-time homebuyer," he said. "They're the ones who give other homebuyers a way to move up. Investors filled that gap, but now that they have backed off, there is a hole in the market.

Large investors that have bought single-family homes to rent out include Blackstone Group's (BX) Invitation Homes, American Residential Properties (ARPI), Silver Bay Realty Trust (SBY) and American Homes 4 Rent (AMH) .

Rising prices are another key culprit in once hot markets, which "overcorrected" amid investor demand and historically low interest rates, notes John Burns, CEO of John Burns Real Estate Consulting. Entry-level buyers today face monthly payments 30% to 40% higher than 18 months ago, he adds.

"Young people thinking about buying a home are in sticker shock," Burns said. "They're hesitating.

Less Urgency

A rising number of homes for sale in some locales is diverting attention from the cooling demand.

The National Association of Realtors generally considers a six-month supply of homes a "balanced" market. Yet many metro areas are still well below that mark because they're coming off all-time inventory lows. As a result, a modest increase in the number of homes added to a for-sale block creates the appearance of a spike, Burns says. In Sacramento, 8,495 homes were listed for sale in April, up 42% from the 5,974 homes listed a year earlier, according to ZipRealty. San Diego had 6,717 homes for sale, a 38% increase over the 4,879 a year earlier. Inventory today is running about a third of what it was in 2007.

But a relative lack of buyers means that homes stay on the market longer, making the supply seem to be rising faster than it is, says Michael Orr, director of the Center for Real Estate Theory and Practice at Arizona State University's W.P. Carey School of Business. That's the case in Phoenix, where demand is at its lowest since 1999, he adds.

There were 25,586 homes for sale in Phoenix in April, a 55% rise from a year earlier, according to ZipRealty. But homes being listed for the first time in April, traditionally a peak home-selling month, grew by only 2% year over year.

What's more, sales of single-family homes in Phoenix fell 20% in March from a year earlier to 7,062 homes, according to Orr's latest monthly housing report.

"We don't have a lot of new listings coming along," Orr said. "But if you have low demand, the ones that do come along start piling up.

He agrees with Davis and Burns on some of the dynamics in once hot markets. The bulk of investors have left, he says. And first-time homebuyers, who historically have accounted for about 40% of home sales, are driving only 25% of the activity as millennials display a stronger preference for renting, he adds. But Orr also sees a lack of demand among move-up buyers. The sluggish economy forced many owners to delay maintaining houses now for sale, and potential buyers don't want to pay high prices for a fixer-upper, he says. With demand down, buyers also lack a sense of urgency to sign a contract. It's especially true if they're already in a home with a low-payment mortgage, Orr adds.

Regulatory Restraints

More than one in four homeowners in Arizona's Maricopa County went through a short sale or foreclosure in the last few years, Orr says. It prevents them from obtaining a conventional loan under Fannie Mae (FNMA) and Freddie Mac (FMCC) rules for up to seven years, depending on the circumstances. But getting out of the so-called penalty box may not be enough to move those people into the market.

"I don't how you would feel psychologically about homeownership after you've been through a foreclosure," Orr said. "You may be put off by the whole thing.

Changes at the Federal Housing Authority are having a similar effect. One FHA program generally provides loan insurance to homebuyers who've gone through foreclosure, after a three-year wait.

In January, however, the agency cut the size of single-family loans that it would guarantee as specified by the Housing and Economic Recovery Act of 2008, which anticipated such adjustments as housing recovered. FHA loan limits fell more than $75,000 to $271,050 in Phoenix, $112,500 to $287,500 in Las Vegas, and more than $151,000 in San Diego to $546,250.

The change has affected the buyer who's undergone a foreclosure and wants to move his or her family out of a rental and into a bigger home, Burns says. "Many people used the FHA program to get back into the market," he said. "That buyer has disappeared."

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