Seattle Bubble

Almost a year ago, a family that has accumulated ownership of 13 near-contiguous acres of downtown real estate in the Denny Triangle finally put the whole lot of it on the market.

Mr. Clise is convinced now is the ideal time to sell. The job-market outlook is robust for Seattle, and the office market, with a low 5% vacancy rate for top-quality “Class A” buildings, is hungry for more space, says Michel Seifer, managing director of capital markets for Jones Lang LaSalle, the real-estate-services firm handling the sale.

Yet, there is a possibility that Mr. Clise, age 57, may have missed his window. Increases in the cost of borrowing — with the yield on the benchmark 10-year Treasury note rising to nearly 5.25% last week — could keep some previously active real-estate investors on the sidelines for this blockbuster, but inherently risky, transaction. Mr. Clise says if he doesn’t get the price he is seeking for the land — well into the hundreds of millions of dollars — he could still take it off the market.

Well, as reported by the Wall Street Journal yesterday (subscription), and picked up by the Seattle Times and Seattle P-I today, it looks like they were indeed a bit too late:

In retrospect, Clise said, the family should have begun marketing the property a year earlier, before the credit crisis deepened.
- Seattle Times

“Large real estate deals are not being financed right now,” Clise Properties Chief Executive Alfred Clise said Thursday afternoon.
…
Frank Bosl, a senior vice president in the Seattle office of CB Richard Ellis, said the move makes sense.

“The changes in the financial market are causing the capital for doing deals to be out of sync with the value of the real estate right now,” he said.
- Seattle P-I

Some see this as a portent of a growing trend in commercial real estate, heading into a downturn 12-18 months after residential. Personally I don’t follow commercial real estate really at all, so I wouldn’t attempt to derive any sort of market meaning out of this move.

Does anyone here deal a lot with commercial real estate? Have you seen a significant slowdown there, too? Or was the failure of this deal more a result of its massive size?

Story tip: Deejayoh’s forum post

(Jennifer S. Forsyth, Wall Street Journal, 06.18.2007)
(Jennifer S. Forsyth, Wall Street Journal, 04.25.2008)
(Eric Pryne, Seattle Times, 04.25.2008)
(Aubrey Cohen, Seattle P-I, 04.24.2008)

In theory, there are two factors that affect the price of homes: supply and demand. We’ve looked extensively at the relationship between supply (inventory) and price in the past. Let’s take a look at the relationship between demand and price.

For the purpose of this post, we will measure demand by looking at the relationship between the number of closed sales in a month and the total population. For population, I’ll be using the “Civilian Labor Force” data from Workforce Explorer Washington, since it is reported monthly. Note that the number I’m using is not the number of people employed, but the total number of employable people. For the median price and total number of closed sales, I’ll be using the single-family home data released monthly by the NWMLS. All of the data will be for King County as a whole.

First, let’s have a look at a raw chart of all the data, which is available through early 1999:

Click to enlarge

In order to keep the graph from being an unintelligible mess, I’ve graphed the “1 Sale per X People” as a 12-month rolling average. This smooths out the large spikes that occur due to the highly seasonal nature of home sales. The YOY price change is also a rolling average, but only 6 months was necessary to smooth it out. You can see the raw data for both series in faint dashed lines.

Just by looking at this graph, you can see that there seems to be a relationship between the two—when the number of people per closed sale decreases, the price changes increase, and vice versa. Let’s take a closer look at this by graphing the two running averages on a scatter plot.

Click to enlarge

Clearly there’s some sort of relationship going on here, but with an R² of just over 0.5, it’s not very strong. Let’s take a page out of Deejayoh’s playbook and see what it looks like if we compare each month’s rolling-average sales data with price change data sometime in the future. I looked at 3, 6, 9, and 12-month delays, and found that the strongest relationship was in a 9-month delay:

Click to enlarge

With an R² of 0.81, now we’re talking. But what’s with that trail of dots (that I have highlighted in green) deviating so severely from the pattern of all the rest? Those represent the YOY price change data from the last 6 months, October through March. If we stop the series in September, the R² jumps up to over 0.9.

So clearly there was a strong relationship between demand and home price changes, at least until late last year, when things began to fall apart.

But hold on a minute. Let’s go back to that first scatter plot again. I’ve highlighted the last six data points again in green, and given them their own trend line:

Click to enlarge

Whoa. Granted, 6 months of data isn’t much to go by, but still, R² of nearly 1.0 is pretty hard to ignore. I think this is definitely a trend to keep an eye on. If we make the fairly reasonable assumptions that population will continue to grow at the average rate it has grown the last 12 months and YOY sales will continue to drop at the average rate of the last 6 months, this trend line would result in YOY median price drops approaching 20% by the end of 2008.

I am not saying that is what will happen, although it certainly could. I just find it interesting that the time-delay in the relationship between demand and prices seems to have all but vanished with the recent changes in the housing market. Who knows how long it will continue, and who knows what population and sales will really do. What I do know is that I will definitely be paying close attention to this relationship as the mess continues to unfold here in Seattle.

Sources:
Sales & Prices: NWMLS
Labor Force: Workforce Explorer Washington

It’s been a while since I posted any anecdotal observations, so I think it’s time for a few.

First up, the 8-unit condo/townhome complex in my neighborhood, which we have visited a few times before. Here’s the summary of the action in this complex of eight essentially identical units since 2005:

• September 2005: Unit #5 listed for $274,950 (link)
• October 2005: Unit #5 sold for $280,950 (link)
  18% more than the previous sale just 14 months prior
  +15.5% average YOY
• October 2005: Unit #6 listed for $300,000 (link)
• December 2005: Unit #6 sold for $300,000 (link)
  28% more than previous sale 4 years prior
  +5.8% average YOY
• March 2006: Unit #3 sold for $293,000 (link)
  40% more than previous sale 4 years prior
  +8.26% average YOY
• January 2007: Unit #6 listed for $350,000 (link)
  taken off the market without selling
• April 2008: Unit #5 listed for $360,000 (link)

This latest listing has an asking price 20% higher than any unit in this complex has ever sold for, and 28% higher than this specific unit sold for just over two years ago. We’re talking Kenmore here, which is not exactly “close in,” but not really the boonies either, so this should make an interesting test of how soft the condo market is outside the downtown cores of Bellevue and Seattle.

Personally, I doubt they’ll get more than $320,000, if even that. They may well just pull it off the market when they can’t get their fanciful price. According to Estately, there are 47 condos on the market in the 98028 zip code right now (after eliminating duplicates). This townhome is priced higher than 78% of the competition, and for just $30,000 more, you could get a pretty nice view. Good luck friend, you’re going to need it.

The second anecdotal update is much shorter. Just a quick note to point out that the sellers of my favorite million-dollar home over on Avondale have dropped the price twice now since listing in December at $1,650,000: once to $1,590,000 in March, and again to $1,550,000 a few weeks ago.

They paid $1,275,000 in February last year, and if they don’t get more than $1,385,000, they won’t even make enough to cover agent commissions and excise tax. I have a feeling this will be sitting on the market even longer than the nine months it languished last time.

Update: May 13: Another 60k price drop on the Avondale Albatross, down to $1,490,000. That’s $160,000 in total price drops spread across 150+ days on the market. Coming up quick on that six-month mark…

Yesterday’s P-I had a big front-page story from Aubrey Cohen that seems to be at least partly designed to frighten renters and encourage landlords: Rent at an all-time high — if you can find a place

“There are a lot of apartments available, but the desirable ones seem to rent very quickly,” said Kilbourne, a University of Washington student who must move out of his dormitory by mid-June and is about to start graduate school.

“Seems like you have to find a place within the first day of it becoming available, or it’s gone.”

A new report affirms that apartments are about as hard to find now as they have been any time in the past three decades and rents are on the rise.
…
“Even though rents have increased significantly over the past couple of years, there is still room for more increases because rents have not kept pace with consumer incomes,” Dupre + Scott wrote. “Rents today are still 10 percent to 15 percent below what renters can afford to pay.”

My main problem with these studies released by Dupre+Scott is that they only look at rental properties with 20 or more units. This totally overlooks the market that consists of individual homes and condos being rented out by individuals (as opposed to businesses or institutions). Also worth noting is that as with most real estate articles in the P-I, the graphs and most of the numbers in the article focus on Seattle proper, where rents are naturally higher and vacancy rates lower.

Aubrey does spend some time talking about what the report doesn’t tell us, and exploring why things aren’t shaping up as badly for renters as some were predicting a year ago. I definitely give him credit for not making the piece as one-sided as the headline writer made it out to be.

“Vacancies weren’t lower very often in the past 27 years,” says the report, by Dupre + Scott Apartment Advisors, a Seattle company that tracks the rental market. “Even so, we expected vacancies would be lower by now.”

In March, 4.1 percent of King County apartments and 3.1 percent of those in Seattle were vacant, according to Dupre + Scott.

That’s much tighter than the rates of a few years ago, but up from March 2007, when vacancies were at 3.9 percent in the county and 2.8 percent in Seattle.

One big reason vacancies have started increasing is that the housing slump has all but ended conversion of apartments into condominiums.
…
Inventory also has grown as homeowners rent out homes they have been unable to sell, said Dean Foggitt, a broker at Brink Property Management, a Bellevue company that manages about 600 rentals in and around King County. He said his portfolio of rental houses is up 15 percent to 20 percent from a year ago.

“As far as tenant demand, we haven’t seen that huge increase that we thought we would have, given the slowdown in the sales market,” he said. “What we’ve seen more is people staying put, less tenants giving notice.”

So, as the housing market stalls, rental inventory is actually increasing, which is preventing rents from rising as quickly as expected. That sounds awfully familiar… maybe because it’s exactly what we have been predicting would happen, at least as far back as 2006:

As flippers become unable to sell, and 100%-financed families find themselves unable to afford their homes, it would seem that individual units are likely to come onto the rental market in greater numbers.

King County vacancy rates are at 4.1% (according to the report), which isn’t a super-tight market, but does favor landlords slightly (5% is considered a “balanced” rental market). What I think is also interesting is that vacancy rates have been slowly increasing since late last year. In October the county-wide vacancy was at 3.8%. Even Dupre + Scott is predicting that the vacancy rate will continue rising, up to over 5% by 2010.

Unfortunately, I don’t have enough money burning a hole in my pocket that I’m willing to spend the $130 for a Dupre + Scott subscription, so I don’t have access to the full historical data on local apartment vacancies. However, I was able to find this pdf from the Seattle Times, which shows the vacancy rates for King, Snohomish, Pierce, and Kitsap back through 1997. Here’s a reproduction of the vacancy rate graph (with 2008 data added for King and Snohomish):

As you can see, King County has had lower vacancy rates in six of the last twelve years. Only from 2002 to 2005 were vacancy rates significantly higher than they are now. I’d hardly describe the current rental market as a panic frenzy to find a place that you can barely afford, which is what the P-I headline makes it out to be.

I’d also like to point out Aubrey’s response to some criticism he received for the article over on his blog:

I knew it would happen. I arrived at work this morning to an e-mail from a reader angry about my story on rising apartment rents.

“Gee thanks! I wonder how much more money I will be paying for rent this year because of this article,” he wrote. “I’m sure you’ve made many landlords very happy today.”

I’ve gotten similar responses to previous stories about rising rents in the Seattle area. Some renters have told me landlords included copies of my stories with notices of rent increases.

I know that many real estate professionals blame the media for much of the current sideline sitting among potential buyers.

I hope that stories do have some sort of impact. After all, what’s the point of journalism otherwise, right?

That said, I’m not after any particular outcome. I try to put the best information out there and let readers decide what to do with it.

He has some additional thoughts on the subject, and is soliciting feedback from his readers, so head over there and leave a comment if you’ve got strong feelings on that particular subject.

(Aubrey Cohen, Seattle P-I, 04.21.2008)

Over the weekend, the Seattle Times published an article titled Bad real-estate loans stack up for smaller local banks, about the exposure local banks have to real estate loans. The gist of the article was that many local banks, squeezed out of the mortgage business by the likes of WaMu and Countrywide, had doubled down on lending to local developers - and thus were exposed to the real estate turn down.

Though much of the attention has focused on financial giants like Citigroup, Wachovia and Washington Mutual, many regional banks are heavily exposed to residential real estate.

For instance, construction and land-development loans make up 61 percent of the loan portfolio at Bremerton-based WSB Financial, parent of Westsound Bank. At First Financial Northwest of Renton, parent of First Savings Bank Northwest, virtually the entire billion-dollar loan portfolio is connected in some way to real estate.
…
For several years, that specialization proved quite profitable. Smaller regional banks often posted growth rates and earnings per share that superbanks would have envied.

But now, with home sales slowing, the regionals are seeing more developers fall behind on their loans, and are setting aside larger sums for expected future loan losses.

The article goes on to give examples of exposure at local banks, including Cascade Bank, Westsound Bank, and First Financial.

The implications of high concentrations of commercial real estate lending at small, regional banks has been a topic of discussion over at Calculated Risk for some time. And as they blogged recently, Fed Vice Chairman Donald L. Kohn has warned of the potential implications:

Concentration risk is another familiar risk that is appearing in a new form. Banks have always had to worry about lending too much to one borrower, one industry, or one geographic region. But as smaller banks hold more of their balance sheet in types of loans that are difficult to securitize, concentration risks can develop. Concentrations of commercial real estate exposures are currently quite high at some smaller banks. This has the potential to make the banking sector much more sensitive to a downturn in the commercial real estate market.

One thing that struck me as I read theses two pieces -just a few days apart - is the nature of our local home-building market. Unlike many of the bubblier cities, the “big” builders such as KB, Lennar, and DR Horton have had little or no presence in our market. The biggest builder around here seems to be Quadrant Homes. Yet as Tim has pointed out in previous posts, we have certainly had a something of a building boom over the past 5 or so years inasmuch as supply has outstripped demand.

Is the inference that the Seattle MSA has had more construction driven by smaller regional developers? As a follow on, what might this mean about the portfolios of our local banks in comparison to other areas? Are they even more heavily focused on real estate than say, regional banks in Southern California? It will be interesting to see what articles follow on after this one. I have a sense we may be seeing the leading edge of a new trend.

Note: Once again, if you are looking for data and graphs, this post is not for you.

So much could be said about this issue. One of the most fascinating developments to see unfold and the one theme I keep coming back to is how powerful blogging has been in shaping the mind-set of the public when it comes to the real estate market, both nationally and locally. Not only is it powerful in the psyche of the buying or selling consumer, but also to those who actively work in real estate.

For example, there has been an enormous effort within the real estate community to combat negative housing sentiment. It is understandable. But, I also think that the effort serves two purposes. First, it is to combat a deteriorating market perception for the public. Second, it is to thwart the potential fallout from within the rank and file who work in the industry.

What’s so different about our market correction today than last time?

• Access to information.
• Bloggers vs. NAR. (real estate industry unable to counter bloggers using both video and blogs)
• Bloggers vs. Newspapers.
• Bloggers breaking down data.
• Bloggers sharing news or breaking news.

Rather than have circa 1990 technology to obtain information regarding all things real estate related, today we have what I consider information overload. I can’t keep up with it myself. It’s overwhelming.

Zillow.com, for my money, was instrumental in removing the price curtain from the real estate machine. This forced an entire industry to change or adapt. While people will argue about current value accuracy or Zestimates, the compelling number of immeasurable value is the disclosure of what a property recently sold for. Armed with this information, consumers can make decisions along with their real estate agent as to how to best position offers or whether or not purchasing is best for them at a given time.

In a classic case of blogging for mind share, I see countless references by real estate agents locally and around the country arguing to “put the market into perspective, only 1 percent of all outstanding mortgages are in default.” Quite swiftly, a contrarian blogger responds, that’s “good news, because if it were more than one percent, I can’t imagine how bad things would be. Bear Stearns would be only one of scores of financial players to collapse, and who knows, maybe we will have more to come?”

To conclude:

If contrarion bloggers on Seattle Bubble find that the market has shifted in a positive direction, it could very well be that those very contrarions will lead the charge to a swift and meaningful recovery, one of which could rival anything we’ve seen to date.

And then, The Tim will have a conundrum on his hands. What then to do with the “bubble” part of the title.

S-Crow