It’s been nearly two years since I looked at the soft landing question with respect to affordability in a post titled Seattle Soft Landing: Do The Math. Since then, the affordability picture has changed, and we at Seattle Bubble have done a lot more research into historical data, so now seems like a good time for an update to this subject.
For a detailed explanation and graph of the affordability index over the past 55 years, please refer to this post.
First, let’s take the 15-year average of the affordability index from 1985 (just as insane interest rates were beginning to taper off) through 1999 (just before the current real estate bubble got rolling). We’ll call that Seattle’s baseline affordability, which comes in at 109.6.
The most recent complete quarter is Q4 2007, in which the affordability index stood at 70.3. This is slightly improved from the third quarter, when it was at an all-time low of 63.3 (yes, that’s even lower than when interest rates were over 15% in 1981).
For affordability to have dropped 35-40% in less than a decade, one of these two statements must be true:
- The Seattle area has become considerably more desirable, as compared to other cities.
- Real estate in the Seattle area has become considerably overvalued.
A clear example of the first scenario is in the late ’70s to early ’80s, when affordability dropped from 175-200 down to the new baseline around 100. I believe that it was around that time that Seattle made the transition from big town to small city. Has Seattle undergone another such change since 2000? It’s possible, but given the fact that so many other cities around the country have experienced a similar plunge in affordability over the same time period (despite record-low interest rates), the evidence seems to point to the second statement being a better explanation.
Working off of that assumption, it is reasonable to conclude that for the bubble to completely correct, affordability should return to somewhere near its previous baseline. For the sake of argument, let’s say that Seattle is going to return to an affordability index of 100 (which allows for some increase in the desirability factor). The soft landing scenario says that prices will just “level off” or increase less than 5% a year until incomes catch up to support current prices. When we last looked at the plausibility of this concept, we calculated that it would take 15 years or more of level prices for a soft landing to fully play out.
Let’s take another look at what a true soft landing would look like here in King County. Here are a few possible scenarios:
Scenario A
Yearly Home Appreciation: 0.0%
Yearly Income Growth: 3.0%
Interest Rate Growth: 0.25 pts/year
Interest Rate Max: 6.50%
Affordability Index = 100 in: 13 years
Scenario B
Yearly Home Appreciation: 2.0%
Yearly Income Growth: 4.0%
Interest Rate Growth: 0.25 pts/year
Interest Rate Max: 6.50%
Affordability Index = 100 in: 18 years
Scenario C
Yearly Home Appreciation: 1.0%
Yearly Income Growth: 3.0%
Interest Rate Growth: 0.25 pts/year
Interest Rate Max: 7.25%
Affordability Index = 100 in: 22 years
Scenario D
Yearly Home Appreciation: 2.0%
Yearly Income Growth: 3.0%
Interest Rate Growth: 0.50 pts/year
Interest Rate Max: 8.00%
Affordability Index = 100 in: 50 years
Wow, none of those look all that inviting. But what if the “soft landing” is load of malarkey? What if prices really are going to drop significantly? How long would it take to get back to an affordability index of 100?
Scenario A
Yearly Home Appreciation: -5.0%
Yearly Income Growth: 3.0%
Interest Rate Growth: 0.25 pts/year
Interest Rate Max: 6.50%
Affordability Index = 100 in: 5 years
Scenario B
Yearly Home Appreciation: -10.0%
Yearly Income Growth: 3.0%
Interest Rate Growth: 0.50 pts/year
Interest Rate Max: 7.50%
Affordability Index = 100 in: 4 years
Scenario C
Yearly Home Appreciation: -15.0%
Yearly Income Growth: 3.0%
Interest Rate Growth: 1.00 pts/year
Interest Rate Max: 8.00%
Affordability Index = 100 in: 3.5 years
Looks like a much quicker way for the system to correct itself, don’t you think? After running the numbers again, I still believe that the “soft landing” theory is garbage. It’s not happening anywhere else, and I have seen no evidence to suggest that it will happen here.
For those of you that would like to play around with different scenarios for yourselves, I have updated the Seattle Bubble spreadsheet with the latest data to allow just that. Download the Excel 2007 version here, or the Excel 2003 version here. Look for the sheet titled “Soft Landing.”