Seattle Bubble

In a discussion this weekend over at RCG, contributor Galen Ward commented that “Home prices will probably be flat until inflation prices back to ‘normal’ levels.” To which I replied that currently “in King County a family making the median household income has just 45% of the income necessary to afford the median-priced home,” and that “For wages to catch up with prices, we would need a median income in King County of $77,000.”

Another RCG contributor, Ardell DellaLoggia, responded with the following argument:

The Tim,

I never understood the median income vs. median purchase price analogy. If, as you say, King County has increased by 70% since 2000, doesn’t the average family then have a large downpayment from the sale of their current home? A “family” is not usually a first time buyer scenario. Most “families” already own a home that they purchased for much less than its current sale price.

When someone factors the income needed to purchase a home, do they assume zero down or 20% down?

If a young couple purchased a home in 2000 for $250,000, that home would now be worth $425,000, using your 70% increase since 2000. Now that they need a larger home, they have a substantial downpayment. Even if their income stayed the same or only moderately increased, if they bought the first home with zero down, they now can afford more as they won’t need a second mortgage.

I attempted to post the following reply this morning, but for some reason it has not shown up yet. Since I’m impatient, I’m posting it here.

Okay Ardell, let’s do some math.

First I’ll look at your hypothetical couple that cashed out a $425,000 home. So they make $175,000 on the sale (assuming they haven’t been cashing out on their equity with a HELOC or refinancing their credit card debt into the mortgage, which in my opinion is a pretty big assumption…), minus commission (assuming they use an agent), minus whatever other fees or taxes there are… Let’s say they walk away with $150,000, which I think is a pretty generous estimate.

Now, you said that they need a larger home, so you know they’re not going to find it at the same price they just sold for, so let’s say the new place they find is $475,000 – again a pretty modest estimate. They put down $150,000, and get a mortgage for $325,000. At an interest rate of 6.25%, their monthly mortgage payment would be roughly $2,000. That is not even considering taxes, insurance, and other costs of owning.

If this family is making the median household income in King County ($55,114), their gross monthly income is ~$4,600. The historical definition of affordable is 30% of gross income. That would be $1,380 for the median family, which is incidentally almost exactly what the monthly payment would be on a $225,000 loan at 6.25% (their old house). However, the $2,000/month mortgage payment is 45% higher than what would be “affordable” for them. For this family to be able to afford $2,000 per month, they would have to be making $80,000 per year, meaning that their current income is just 69 percent of what is necessary to afford the upgrade.

All that said, I also take exception to the way you just totally write off first time buyers. Tell me, how can the market continue to grow if no new buyers are able to join the party? Are you saying that the market is totally sustainable by simply having existing homeowners trading houses back and forth? Who is being sold to when people leave the market (old folks moving into apartments/group homes, death, speculators cashing out, people moving away, switching to renting, etc…)?

For the first time buyer, the above numbers are even worse. Even if you assume they have $81,000 laying around for a 20% down payment on the median $405,000 house, the monthly payment comes out to $2,000, so they’re in the same boat as the family that is “upgrading” and cashing out on their appreciation.

I restate my position that the only way that many (most?) people can “afford” a house in today’s market is through “exotic” financing. Unless mommy buys a house for you, that is. I welcome you to provide actual numbers that show otherwise.

So how about it? Can Ardell or anyone else out there demonstrate a scenario to me where the “average” family in our area is able to reasonably afford a home without “creative” financing or a large cash gift from mommy and daddy?

Our local real estate blog Rain City Real Estate Guide — by realtors, for realtors (my subtitle, not theirs) tackled the topic of a Seattle bubble today. “Eastside Specialist” Chuck Reiling places himself firmly in the “Microsoft will protect us” camp with his post:

The second kind of bubble, let’s call it Type II, seems to occur when there is a limited supply of homes relative to demand, and people start bidding up the prices, i.e. being willing to pay more, in order to get the home they want in the place they want. Jobs and commute times and schools seem to be the big drivers in this. These forces are at work in San Francisco and Los Angeles and San Diego, and they are at work here. In our greater Seattle and east side area, we are blessed with a very strong economy, and continue to enjoy relatively low mortgage interest rates. But we have very restrictive state and local growth management laws and land use ordinances, and building is not keeping up with demand.
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So what should we expect now? First, prices will probably go quite a bit higher. The competition for good houses is intense, and the good economy is feeding good incomes – people are willing to stretch to get the home they want. Second, this ‘bubble’ will probably not burst. Type I speculative bubbles do seem to burst, and they make great news stories. Type II demand-driven bubbles don’t seem to burst, they just seem to pause while the world catches up. Ours doesn’t seem ready to pause yet.

There’s really nothing new there that we haven’t gone over again and again, but it still amazes me that some people really truly believe that Seattle’s current prices are actually justified and sustainable in the long term. The claim that “prices will probably go quite a bit higher” was especially flabbergasting to me. Even with the suicidal financing options out there right now, people are still stretching themselves to the max to afford current prices. What could possibly drive them “quite a bit higher”?

I encourage you to share your thoughts with Chuck in the comments section on his post—just try to be nice, okay?

In other news, I have archived the delightfully witty blog There is no housing bubble!, since the original site vanished from the Internet without explanation a few weeks ago. I miss it already.

Update: RCG contributor Galen Ward chimes in with a post outlining his opinion on the bubble:

I think both sides are taking a foolish black-and-white approach to the bubble question; clearly there are some indicators that there is a real estate bubble, but the consensus seems to be that the risk of home prices plummeting is low. Home prices will probably be flat until inflation prices back to “normal” levels. My concern is that if house prices do pop precipitously, there are going to be serious consequences for home owners and non-homeowners alike.
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…The one argument I do not buy is that our land use laws are making property more expensive; builders are cranking out hundreds units and making loads of money on each unit, meaning they could continue profiting even at lower price levels.

Again I’d like to reiterate my request that my readers exercise civility and friendliness when commenting on these posts.

(Chuck Reiling, Rain City Real Estate Guide, 04.28.2006)
(Galen Ward, Rain City Real Estate Guide, 04.29.2006)

The Tacoma News-Tribune sheds light on a problem with state law that could become more of an issue as foreclosures become more common in the coming years.

"Opportunity knocks!" proclaimed a real estate handbill about a five-bedroom home on two acres selling for $288,750.

But here is what you won’t find on the advertisement for the property on Canyon Road East: State and local government agencies suspect the site, once an illegal landfill, is contaminated with corrosive wastes, solvents and dangerous metals, among other hazardous substances.

The owner — a lender that foreclosed on the property — doesn’t have to disclose that to prospective buyers under an exemption in state law. Yet under state and federal law, anyone who buys the land could be obligated to clean it up.
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In a hot real estate market, buyers might be tempted to waive residential real estate disclosure requirements.

Don’t do it.

Duh. I have to say I still don’t understand how people could get so worked up about getting a house that they would totally waive inspection. We’re talking about the biggest and most important purchase many people will make in their lifetimes, and at the height of the mania last year and in ‘04, people were walking into it completely blind. Thankfully as foreclosures ramp up, the mania ramps down, so regardless of state law, the problem will be self-correcting.

(Susan Gordon, Tacoma News Tribune, 04.26.2006 )

P-I Columnist Bill Virgin makes light of the housing situation in today’s column, titled How to rein in housing prices? It’s simple. The thrust of the article is a sarcastic proposal to make it illegal to profit from the sale of a home. However, he makes some interesting claims that I can only assume he’s serious about…

Folks around here hardly need an invitation to commence remarking about the prices of homes in this market. Wrote one reader: "How can the average price continue to escalate so radically beyond the means of the average household income? I would hope there is some correction on the horizon — though I confess I’ve been amazed that housing prices have continued on the current course for as long as they have."

Amazement is close to becoming a permanent condition around here; for nearly two decades people have been looking at housing prices and presuming that at some point we’d run out of corporate executives or well-paid lawyers or prematurely retired software millionaires to fuel the run-up.

But in two decades, it seems, we haven’t. The median price of closed sales on homes and condominiums was $365,000 in King County in March, according to the Northwest Multiple Listing Service; in Seattle the median price was $407,000, on the Eastside more than $476,000. Each of those numbers reflects a double-digit percentage increase from the same month a year ago.

Obviously there’s enough demand to keep prices as high as they are, and climbing, just as there is still plenty of demand for gas even at more than $3 a gallon.

Okay first off, what is Bill talking about when he says that housing prices have been running up "for nearly two decades"? Even as recently as 2001 housing was still relatively affordable for people making the median wage around here. The real explosion in prices didn’t hit until the easy money started flowing. It is the zero down, interest-only, exotic loan extravaganza (not “well-paid lawyers” and “software millionaires”) that is creating the "demand" Bill refers to, and propelling prices into the stratosphere (relative to wages). When the easy money dries up, the appreciation party will be over.

Secondly, it’s almost as if Bill was reading this blog yesterday, because he seemed to directly respond to the "is Seattle special" question:

Seattle housing prices are going to be higher than other places on the map, given the geographic and regulatory constraints and the attractiveness of the region as a place to live.

It’s true that prices in Seattle are going to be higher than say, Yakima, but that certainly doesn’t mean that the current ridiculously high prices are justified or even destined to stick around much longer. Seattle is attractive, but I hate to break it to you Bill—it’s not magic.

(Bill Virgin, Seattle P-I, 04.27.2006)

The topic of whether or not our area is somehow immune to a bubble was suggested by a reader. I made a very similar post back in September, but readership and participation has grown quite a bit since then, so now would be a good time to post it again.

As markets across the country begin to sputter and slow this spring, here in Seattle inventory continues to be low and prices are still climbing. This of course gives fuel to those that argue that the Seattle area is somehow special, and has unique characteristics that will protect it against any real estate price corrections. Although I agree that Seattle is a wonderful place to live (why else would I be here?), I also recognize that every locale has a list of unique characteristics.

However, I am still an open-minded kind of person, and I know full well that there are lots of people around that look at other markets in the country and see a bubble, but think that Seattle is either not in a bubble or has special protection against a bubble bursting (i.e. – price decreases). So, let’s hear from you. Does Seattle have a secret ingredient that makes it special and immune to a price correction in real estate (Microsoft, Boeing, "limited supply," special desirability, etc.), or are we just behind the curve?