Seattle Bubble

You know that the local housing slowdown is essentially undeniable when even the local TV news starts to pick up the story…

It’s not exactly a slump, but some of the wind has left the sails of the local real estate market. What used to sell in two weeks is now taking as long as 45 days. That’s leading some sellers to employ new strategies.

The multiple listing service reports that in King County, there are about 3,000 more homes on the market this year than last year and they’re staying there longer.

“It’s a buyer’s market. They have so much to choose from,” said Tavis Gaudet. When put up his ‘for sale’ sign, he wasn’t alone.

“There were two signs, one across the street and one up the block,” said Gaudet.

There’s direct competition in his West Seattle neighborhood. Just go a couple of blocks away and you’ll find three houses in a row for sale.

Sadly, what could have been an opportunity for an actual interesting piece that looks at recent statistical trends and actual evidence of where the market is headed turned into nothing more than yet another cheerleading, realtor-advertising puff piece. The article wraps up with encouragement not to worry, and advice that sellers “consult a realtor.”

Update: I just noticed that you guys already started a thread about the King5 report over in the forums. You beat me to the punch.

In other news, here’s an excerpt from an email I just got from a friend that (no joke) became a loan originator about a year ago:

Many of you have watched and wondered about the changes in the housing and home financing market in recent months. There is definitely a shift. Hundreds of lenders have gone out of business and loans are much harder to obtain than in the past. Only agencies that are diversified are able to stay afloat. Many loan originators are walking away from the field because of the financial hardship they are in right now. Here in Washington, the new regulation that calls for the Loan Originator to take a test has caused some to walk away. In fact the swelled number of 15,000 loan originators in Washington is estimated to shrink to 7,000 or less.

In talking with him over the weekend, he expressed confidence that the market would turn around next spring. His reasoning included the usual spring bounce as well as today’s predicted Fed rate cut. While I admire his optimism, I found myself less than convinced.

(Kim Holcomb, King5 News, 09.17.2007)

I’d like to introduce a new statistic to Seattle Bubble: the Distressed Sellers Index (DSI). This is a metric I have been recording since May, and while I don’t have enough data to do year-over-year comparisons yet, given the recent action, I thought it was a good time to bring it in.

The DSI uses an original proprietary algorithm to measure the ratio of listings using distressed language compared to the total number of listings in the Seattle area. It is most definitely not scientific by any means, but rather is provided as a point of general interest.

When I started taking data in May, the DSI sat in the upper 20s. In mid-July, it broke through the 50 mark, and the most recent measure places it at 61. What does a value of 60 mean? Who knows! What is interesting when looking at the DSI is the trend. Increasing values mean a market in greater distress, and vice versa. I would also point out that the seasonal effect that you generally see in most housing market measures is automatically accounted for in the DSI since it is derived from a ratio of total homes for sale.

Here is a graph of the DSI action since I began taking measurements:

Click to enlarge

I’ll probably pop in with an update to the DSI every month or two. It will be interesting to see how this correlates with other available measures and indices out there.

Update: An excellent idea was posted in the comments by reader “on topic”, who asked: “could you track the same index for markets in other stages of their bubbles?” Here is the current DSI for select additional cities as of today:

• Boston: 86
• Las Vegas: 111
• Sacramento: 121
• Miami: 136
• San Diego: 168
• Phoenix: 170

Hot on the heels of an unusually balanced report on the latest NWMLS home sales data, Aubrey Cohen comes back with another piece on the local market, this one full of non-sensical rationalizations for continued price gains.

Ken Kam, of Honolulu, scoped out second-home possibilities during a Seattle visit last month.

“It seems like it’s an up-and-coming and popular place,” he said while looking through a Queen Anne town-house development in which units start above $800,000. “The prices are still lower than in Hawaii.”

Two doors down, Tim Hug and David Hofmann were washing a BMW outside the town house they moved into in June after relocating from San Francisco.

San Francisco’s still more expensive, but Seattle’s catching up, Hug said.

People such as those help explain new Census Bureau data, which show Seattle’s home values rising considerably faster than incomes in recent years.

The 2006 numbers, released Tuesday, show the value of a typical Seattle home is 7.7 times the median household income in 2006 — a 39 percent jump from the ratio in 2000.

Seattle’s ratio of home value to income is higher than the county, state and nation, although that gap has narrowed in recent years.

But Seattle still is far more affordable than cities such as San Francisco, where houses cost 12.3 times the median income, and Honolulu, where they cost 10.7 times the median income. This ratio increased by more than 50 percent since 2000 in Honolulu and more than 60 percent in San Francisco.

That disparity is one reason King County regional labor economist Cristina Gonzalez does not expect much fallout from Seattle’s rising prices on the wider economy.

“Compared to other West Coast cities, they’re not unthinkable yet,” she said.

So, the take-home message is that prices in Seattle are bound to keep rising, because all of the homes will be bought by wealthy people moving here from places where homes are even more ridiculously expensive. I actually buy the ‘rich out-of-stater’ theory to a degree, but I think the effect is fairly limited. Also, doesn’t the theory that wealthy people from more expensive housing markets are propping up our own market directly contradict the claim that Seattle is insulated from the housing bust going on across the nation? When prices drop in San Francisco and Honolulu, wouldn’t the situation reverse itself?

The article does include some balance, but only because it’s really just an Associated Press report with the local cheerleading tacked on. The AP portions are decidely less optimistic:

“We had an artificial economy,” said Brad Geisen, founder of Foreclosure.com, a Web site that lists foreclosure properties. “There was all this wealth created in real estate, and it wasn’t really created.”

Mark Zandi, chief economist at Moody’s Economy.com, likened the current housing market to the dot-com boom and bust a few years ago, when stock prices for many tech companies soared — before some of them ever turned a profit — and then crashed.

“The parallels are quite similar,” Zandi said.

Anybody remember how that dot-com bust turned out for Seattle?

(Aubrey Cohen, Seattle P-I, 09.11.2007)

National Mortgage News reports that Countrywide received an additional $12 Billion in secured financing and that mortgage powerhouse, WaMu, is exiting the warehouse biz. In addition, there are rumblings that Countrywide employees may be suing Angelo Mozillo et. al, complaining that the company allegedly cheated them out of millions by concealing the true health of Countrywide. Inman News is reporting that First Horizon Home Loans is shuttering offices and reducing staff.

Lots of shifting, merging, consolidation, BK’s, and movement going on the the real estate business as this slowdown works through different areas of the country. I would like some insiders to comment on how WaMu’s exiting of the warehouse business will affect loan officers and their customers.

This is a post that I originally wrote for the highly-recommended personal finance blog Get Rich Slowly. As such, the style of writing is more geared toward the audience of that site. However, I felt that the post would be of interest to the readers here as well, so I am re-posting it in its entirety.

Introduction

“If you rent, you’re throwing away your money.”
“Owning your own home is a forced savings plan.”
“Home ownership is an excellent path to build wealth.”

You’ve probably heard statements like these plenty of times. On television, radio, the internet, and in casual conversation. Such sentiments are common in any discussion that involves home-buying and personal finances. It’s common knowledge that buying a home is a better financial move than renting. After all, you’re building equity instead of throwing away your money, right? Well, maybe not quite… Rather than assuming the “common knowledge” on this subject is accurate, let’s take a look for ourselves at some of the financial differences between renting and home-buying.

A Real-World Example

For the purpose of comparing renting to owning in this post, I’ll be using real-world data gathered from my area (NE of Seattle). Although most first-time buyers tend to move from renting an apartment to buying a larger, stand-alone house, as much as I can I will compare apples to apples.

For rent, I located a 3-bed, 2.5-bath, 1,840 sqft house with an attached 2-car garage, on 0.2 acres. Monthly price: $1,495.

For purchase I found a 3-bed, 2.5-bath, 1,850 sqft house with an attached 2-car garage, on 0.22 acres. Price: $424,950.

The two homes are located within two miles of each other in similar neighborhoods, and neither is located on a busy road. We’ll assume that our hypothetical homebuyer is a married couple with $85,000 in the bank to make a 20% down payment. To calculate mortgage payments we will use a recent 30-year fixed interest rate of 6.25%.

Let’s look at how the monthly costs break down (approximately) for our hypothetical potential first-time homebuyer:

	Renting	Buying
Rent/Mortgage:	$1,495	$2,093
Insurance:	$20	$163
Property Tax:	-	$407
Tax Savings*:	-	($327)
Maintenance:	-	$354
Total:	$1,515	$2,690

*: (less standard deduction)

Right off the bat, you see that simply trading straight across from renting to owning results in a 78% more expensive monthly bill. That’s not exactly chump change. With even a slight upgrade from renting to buying (which most first-time buyers are prone to do), you can easily see how the total monthly costs would be more than double.

“If you rent, you’re throwing away your money.”

Common knowledge says that despite today’s large premium, buying a home is a “good investment” anyway. Hey, at least you’re not “throwing away” your money, right? True, the renter in our scenario spends $1,515 every month that they will never see again. I wouldn’t exactly say it has been “thrown away” any more than money spent on any other good or service is “thrown away,” but granted, there is zero financial return on that money.

However, when you take a look at the breakdown of the homebuyer’s monthly expenses, a large amount is money that will never return, either. Insurance, property tax (less tax savings), and maintenance, add up to $517 every month that is being “thrown away.” Even worse is the amount spent on mortgage interest. Consider how much of a mortgage payment is applied toward loan interest throughout the life of a 30-year fixed loan:

Years	% toward interest
0-5	~80%
6-10	~70%
11-15	~60%
16-20	~50%
21-25	~35%
26-30	~10%

In the first five years, approximately 80% of the mortgage payment goes toward interest. That’s an additional $1,674, for a total of $2,191 being “thrown away” every single month by the homebuyer for the first five years. Ouch! In fact, not until the homebuyer has been paying down the mortgage for over 20 years will the amount they are “throwing away” be less than the renter.

“Owning your own home is a forced savings plan.”

As you can see above, if home buying is like a savings plan, it’s probably the worst savings plan on Earth. Would you voluntarily sign up for a savings plan where well over half of the money you deposit in the first 20 years simply vanishes, and from which you can only withdraw money by relocating and paying a 6-9% fee (not on the amount you have “saved” mind you, but on the total sale price of the home)? Of course not. That doesn’t sound anything like a savings plan.

If our potential homebuyer has that $85,000 saved up for a down payment and deposits it along with just half of the monthly savings over buying ($578 per month) into an account at 8% interest, the balance will be nearly $300,000 in just 10 years. That’s a liquid investment, that can be used for whatever you want, no relocation required. Buying a home is not a savings plan. Actually saving money every month is a savings plan.

“Home ownership is an excellent path to build wealth.”

If your goal is to build wealth, you will be much better off investing your money in the stock market than buying a home. While both stocks and housing are cyclical markets, long-term historic trends show that housing appreciates at a rate barely above inflation, while stocks tend to return an inflation-adjusted 7-10%. In our hypothetical scenario, a renter who invested in the stock market with the $85,000 down payment plus the monthly difference between the $1,515 rent and the $2,690 home-buying costs would be over $500,000 better off after 30 years than the homebuyer, assuming 4% average appreciation.

An important thing to consider is that home prices in the United States are just now beginning to correct from an enormous unprecedented run-up in recent years. Despite what those in the business of selling real estate may insist, the correction in housing is still in the early stages. Four percent is most likely overly optimistic for most areas in the next 5-10 years. The only thing we know for sure is that double-digit gains are gone and won’t be coming back any time soon.

Also keep in mind—I mentioned it above but it bears repeating—in order to cash in on any “wealth” you build through your home you will need to sell that home and move. No, “extracting equity” does not count, since that simply results in a larger debt. Debt != Wealth.

Conclusion

For most people buying a home will result in their largest monthly bill (by far), and because they believe that it will bring them wealth or that they are “throwing away their money” if they rent, they often take on a much larger home debt than a prudent budget would allow. It is a real shame when people are driven to get into the housing market because of misplaced notions of imagined financial benefits. Of course, everyone’s circumstances are different, and for some (particularly those that live away from the coasts) the numbers may actually work out in favor of buying.

Don’t misunderstand me here. I am not saying that no one should buy a home, or that my example scenario is a golden standard of truth for all. Don’t take my word for it. Run the numbers for yourself, check out other articles (a small collection is listed below), and do what works for you. I highly recommend the great graphical calculator from The New York Times for comparing the financial aspects of renting and buying. Many people will consider all of the consequences—financial, emotional, etc.—and conclude that buying a home is the best decision. Just don’t trick yourself into thinking it’s a good financial decision if it’s not.

I myself intend to buy a house some day. However when that day comes, I will be buying a house because I want a nice, “permanent” place to live where I’m the boss, not because I think it will help me get me rich.

Additional Resources:

Wall Street Journal: Your Home Isn’t the Nest Egg That You May Think It Is
New York Times: A Word of Advice During a Housing Slump: Rent
New York Times: Is it better to buy or rent? (graphical calculator)
The Motley Fool: The Worst Investment Ever
SmartMoney.com: Renting Makes More Financial Sense Than Homeownership
CNN Money: Stocks vs. Real Estate
Priced Out Forever: Renting vs. Purchasing

Here’s the usual roundup of the NWMLS press release echo chamber for this month. As expected, most of the focus is on price, price, price. As long as the median price keeps going up, expect more of the same.

Bibeka Shrestha, Seattle Times:
Median price for house in Seattle tops $500,000

The median price for a single-family home in Seattle topped the half-million-dollar mark for the first time last month, the latest sales figures show.

That price, $501,000, was up 10.1 percent from last year’s $455,000, the Northwest Multiple Listing Service reported Monday. (Median means half the houses sold for more, half sold for less.)

The report is unwelcome news to those already priced out of the local housing market.

A worker would have to earn $57 an hour — about $119,000 a year — to afford that Seattle home, according to the Seattle chapter of the Urban Land Institute.

The significant drop in the number of sales is not mentioned at all in the Times article, and she only makes a passing comment that “number of homes on the market continued to climb.” Bravo, Bibeka, bravo.

Aubrey Cohen, Seattle P-I:
We’re still buying in Seattle — with caution

As buyers hear about a deflating national home market, they’re being more cautious in Seattle, where prices haven’t declined but the market sure has slowed.

“There are a lot of first-time buyers who are holding onto the belief that the market’s going to change, so they shouldn’t buy,” Windermere Real Estate agent Jim Patterson said at an open house in West Seattle.

Buyers’ reticence and difficulties getting a loan — or at least one with a desirable rate — are obvious in August statistics the Northwest Multiple Listing Service released Monday.

Seattle’s closed sales were down nearly 11 percent from August 2006 — the first yearly drop since February and the largest since October. That was better than the 19 percent drop in King County as a whole and the 17 percent decline across the 19 counties the listing service covers statewide.

Pending sales, which can be a better indicator of recent activity, were down 17 percent in Seattle and 23 percent in King County and the 19 counties as a whole. The number of homes for sale, meanwhile, shot up about 50 percent in Seattle and King County, and 46 percent in Western Washington.

Mr. Cohen wins this month’s coveted “most balanced reporting” prize, by actually bothering to mention the skyrocketing inventory and suddenly-plummeting sales—right at the beginning of the article, even. I love the quote from the Windermere agent, who appears to be implying that “the believe that the market’s going to change” is somehow naïve and foolish, rather than a reasonable conclusion supported by the available data.

Devona Wells, Tacoma News Tribune:
Pierce County home prices up

Otherwise, sales activity in Pierce County – and around the Puget Sound area – looked much like it has for months: More homes for sale with fewer pending and closed sales compared with the same month last year.

Real estate agent Bob Niehl, with Spanaway-based Crescent Realty, said the apparent contradiction between rising prices and sluggish sales can be attributed to the best houses selling at the best prices.

And some sellers who see the state of today’s market are sitting it out, he said.

“A lot of sellers are looking at this and think, why take a beating? If you don’t have to sell, why sell now?” Niehl said.

Ms. Wells’ article was fairly tame, and even highlighted median price declines in neighboring Thurston County. The bottom line down in Tacoma seems to be a market with very unsure footing. Reminds me a little bit of a sputtering biplane, hovering through the air on momentum.

Michelle Dunlop, Everett Herald:
Home sales sag, but prices remain up

The number of homes listed for sale in Snohomish County mushroomed in August amid slow sales, though real estate prices remained slightly above this time last year.

In case there was any doubt the hot market for homes has cooled, consider this: There were almost 63 percent more single-family houses and condominiums on the market last month than a year ago, according to the Northwest Multiple Listing Service figures released Monday. Sales dropped 25 percent compared with the previous year.

And the days of double-digit percentage rises in home prices every year may be gone, too. In August, the combined median price for houses and condos was $352,475, about 4 percent above August 2006.

Awesome. Yearly double-digit price increases may be gone. The article ends with the usual quote from a local agent: “I think it’s a great buyers’ market.” Great, indeed.

Rolf Boone, Olympian:
Home sales see upturn

Thurston County home sales improved in August but the sales totals still didn’t match the record number of homes sold in August 2006, the Northwest Multiple Listing Service reported Monday.

Increases in home and condo sales values also flattened out last month while inventories of unsold homes continued to grow.

Last month, 439 houses and condominiums sold in Thurston County, down from 522 sold for the same period last year, the data show.

Although home and condo sales in August reached a new high for the year, it resulted in a 16-percent sales drop when compared with last August’s sales totals.

The combined house and condo median price remained essentially unchanged in the year-to-year period at $269,000, according to the data.

For those of you keeping score at home, what Mr. Boone is so artfully avoiding stating outright is that the SFH + Condo median in Thurston county actually decreased from last year, to $269,000 from $269,900 last year (and the high of $275,174 in July). Pretty hard to spin that one.

Overall, it’s really getting interesting out there around the Puget Sound.

(Bibeka Shrestha, Seattle Times, 09.11.2007)
(Aubrey Cohen, Seattle P-I, 09.11.2007)
(Devona Wells, Tacoma News Tribune, 09.11.2007)
(Michelle Dunlop, Everett Herald, 09.11.2007)
(Rolf Boone, Olympian, 09.10.2007)