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Property speculators are widely viewed by policy makers as dangerous parasites, inflating real estate values until they burst. A new Fed paper finds, however, that not only do house-flippers have a role in housing markets, we may even want to encourage them.
In a working paper released Sept. 20, Duke University economics professor Patrick Bayer and Federal Reserve Board of Governors economist Elliot Anenberg address what they call "The Joint Buyer-Seller Problem." Using data culled from 20 years of real estate sales in Los Angeles, Mr. Bayer and Mr. Anenberg describe the market in terms of "starter homes" and "trade-up" homes. For those looking to sell their property and buy a new one – families with children, for example – the decision of whether to buy a home before or after selling their current one depends heavily on whether the market is a buyer's market (houses are cheap but listings are scarce) or a seller's market (vice versa).
Choosing to hold two houses in a melting market creates a problem: "Such an action would put the household in a position of owning two assets declining in value – but only receiving the consumption benefits from one of them – in a market in which houses are generally taking a long time to sell," Mr. Bayer and Mr. Anenberg explain.
Generally first-time buyers are the ones who come to the rescue by entering the market, enabling the buyer-sellers to ditch their starter homes and buy new ones. After a while, homeowners get more comfortable with the idea of being buyer-sellers, since they're not as worried about being stuck holding two properties if they buy one now – after all, prices are going up, so they might even make some money if prices are rising fast enough to cover the temporary cost of owning two houses. This is also where flippers come in.
Hang on, don't speculators make prices rise too quickly, causing unsustainable booms? Yes, but consider the reason people are willing to jump into property when prices balloon: they're afraid that they'll be priced out of the market if the boom environment lasts. Mr. Bayer and Mr. Anenberg propose a novel response to the problem, beginning with a combination of subsidies for first-time buyers, and taxes on the sales of existing homes. By manipulating the two levers, policy makers can speed the flow of first-time buyers into the market, and alternatively, slow booming resale markets so that the prospect of getting filthy rich by selling your house at an inflated price is offset by the likelihood that you'll end up with a fat tax bill.
Mr. Bayer and Mr. Anenberg's third prescription is the most unusual: assistance for sellers who find themselves stuck in the dreaded two-property zone. It sounds wacky, but they point out that one reason holders of two properties create volatility in a slumping market is that they often can't afford to hold both properties for any length of time, so they are forced to take whatever low-ball offer they can get. That drives prices down rapidly, prompting other sellers to pull their properties off the market, slowing down the pace of transactions and turning a slump into a crash.
The presence of flippers, however, would make it easier for two-property homeowners to sell the first at a modest loss, since the flipper may be better able to hang onto the property until prices begin rising again.
The economists go on to suggest, albeit cautiously, that we should consider policies to make it easier for "market intermediaries" to operate. Subsidies for flippers? That might be a bridge too far.
Dave Morris is a contributor to ROB Insight, the business commentary service available to Globe Unlimited subscribers. Click here for more of his Insights, and follow Dave on Twitter at @morrisdave.