I am reading an increasing number of posts on blogs and on Seeking Alpha as well as articles by mainstream media columnists asserting that vigorous activity of people buying their first home at distressed prices is an indication of the bottoming of the real estate market.  Do not be deceived!  I was VP at NVR, which at the time (1986-1990) was the nation’s largest home builder and is still one of the nation’s largest, and certainly best managed in terms of P&L and balance sheet (primarily because they do not buy land but instead buy options that they exercise when an NVR customer contracts to buy a home on the lot).  I learned a great deal about residential real estate there.  And here is one of the most important lessons:

Residential Real Estate Is A Food Chain.  Somebody buys their first home and the seller of that home takes their equity from the pay-down of their mortgage and any appreciation in the house and uses that money to buy their first time move-up home.  When they buy their first move-up home, the people they are buying from takes their proceeds and buys their second move-up home.  And so the chain continues.  Great.

But take a look at the people getting great deals on their first homes today.  From whom are they buying their houses?  From the bank or mortgage company or maybe from a distressed seller.  Neither the bank nor mortgage company is going to use their money to buy a move-up home and they are not going to fuel the food chain.  The distressed seller in some cases may go buy another house, but the chances of that happening are not great and therefore their sale does not get the food chain moving except in a few cases in a very nominal way.

In other words, when you look at an increase in people buying their first homes, and somebody tries to use that as “proof” that the market is bottoming, don’t believe it.  Look instead at the sale of the first- and second- move-up homes …. when that increases it will be an indication that the food chain is really going and that the bottom is real.