Seattle Bubble

Over at the P-I earlier this week, Bill Virgin chimed in on the housing mess again with yet another well-reasoned column: Homes are good investments, not slot machines or ATMs.

In the great American sport of finger pointing and blame shifting, a new villain has emerged to explain the mortgage-finance crisis.

The fault, it turns out, lies not with incompetent, deceptive lenders, naïve, speculating borrowers, greedy, reckless Wall Streeters, slumbering regulators, bubble-creator Alan Greenspan or all of the above.

Instead, the root cause is something far more fundamental: the American belief in the value of homeownership.

Or so says an emerging theory that argues that the attributes of owning a home have been, pardon the phrase, oversold, and had the U.S. not been so hellbent on getting people to buy, much of the current debacle could have been avoided.

So now is probably a useful time to review some basics about American attitudes toward homeownership, and whether they did, in fact, contribute to the economy-shaking mess we’re now in:

1. Homeownership is good. Homeownership — for the individual and for society — works.
2. What’s not so good, and what consequently hasn’t worked, are the methods for encouraging homeownership and the expectations of what ownership would accomplish financially for the buyers.

…
Homeownership was also considered a financial virtue, being one of the few ways average Americans could achieve long-term financial solvency. Once they saved up for a down payment on that starter home, they could use the equity they slowly built up, from their own payments, price appreciation and improvements to the property, to move up to larger or nicer homes, to maybe even — and here’s a novel concept today — to enjoy the income freed up by paying off the mortgage.

Which is about the point in our story where the trouble begins.
…
Eventually the markets will correct, although the price of that correction is likely to be steep in lost jobs, houses, savings and economic health. If our present calamity strips away the excesses and false assumptions, and returns an appreciation of the merits of home ownership, that might be one of the few good things to come out of this.

Bill continues to be one of the few in the local mainstream press that actually seems to get what’s really been going on, and where we’re headed as a result of this mess we’ve gotten ourselves into. As usual, you should read the whole article. Kudos to Bill.

(Bill Virgin, Seattle P-I, 03.24.2008)

Sorry no stats or graphs from me, just in the trenches reporting.

Snohomish Co. Update:

My wife is off providing sterling service tonight in Issaquah for clients who are buying/selling a home, (yes, we do business all over) so I’ve got some free time to do a bit of blogging and research.

There are a quite a few homes both listed and FSBO that are short sale candidates. That means that if the existing homeowner were to get an offer, the lender would have to agree to take an amount less than the sum of their encumbrances.

After researching about 15 properties that were short sale candidates, I stopped. What’s the point. The story kind of repeated itself. Basically, the gist of it is that I see home prices “softening” further. Many short sales are in neighborhoods that were recently built in 2004, 2005, 2006, early 2007. 100% financing was the primary type of mortgage on just about all of these short sale candidates. Lots of sub-prime lenders financed these homes, some of which are no longer around. This really is the story that we are going to have to get used to.

If interest rates continue to stay low and prices continue to have downward pressure, those who can buy will be receiving much more house for their hard earned money. So that is the silver lining if you are on the buyers side of the HUD-1 Settlement Statement.

I would love to report that the market in Snohomish Co. is earnestly in the Spring groove for buying but the truth is that the first quarter of the year is coming to a close with sales volumes down YOY , so unless we have quite a change in the credit markets to get things moving along as we enter the prime selling/buying season of April, May and June, it may not be any better than the existing pace we are on.

As it stands, lending requirements have become stringent enough that it is exposing quite nicely how much of the buying in months past really was a function of consumers obtaining mortgages that were setting many up for financial distress. In other words, eliminating the loose lending (I know everyone has read this ad nauseum) has exposed the frenzied market for what it really was—a foundation of quicksand via toxic financing that could only be rescued by ever escalating housing prices. The unraveling of the credit markets, billions in losses and subsequent bail out of Wall Street superfortresses such as Bear Stearns and others (more to come?) shows that on every dollar lost there was an address somewhere in America tied to it.

In January, refinancing did take a very big jump when rates dropped dramatically to about 5% and many people took advantage (those that could anyway).

My belief is that inventory will continue to increase (outpace sales) as some of those listings that were taken off the market in Fall and Winter of 2007 try again this Spring.

In conclusion, the fallout from the mortgage binge and foolish lending is really disrupting markets across the country. It is not different here in the Puget Sound region and I hope the seriousness and disappointment in my tone comes across. Is this really what was intended when we think of the American Dream? I know, I know, it’s just a natural market cycle and I need to get over it.

S-Crow

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.”

When I posted last week’s 61-year home price history, I promised a follow-up on affordability. So, here it is.

Before I get to the chart, here’s a quick refresher on what the “affordability index” is, and what it isn’t. What it is is a simple measure that shows relationship between median home prices, median household incomes, and interest rates. It is calculated by determining the monthly payment (principal and interest) that would result from buying the median-priced home, assuming a 20% down payment and current interest rates on a 30-year fixed-rate mortgage, then comparing that to 30% of the monthly median household income (the standard measure of “affordable housing”). Thus, an affordability index of 100 means that the median household would pay exactly 30% of their monthly income toward the mortgage of the median-priced house. Above 100 is more affordable, while below 100 is less affordable.

The affordability index does not take into account lending standards or exotic mortgage availability. It also does not necessarily indicate that an area is overpriced if the affordability index is below 100. More desirable areas are inherently less affordable. No reasonable person would expect housing in Bismark, ND to have the same affordability index as New York, NY. What is somewhat instructive however, is comparing the affordability index of a given area to that same area’s affordability index in the past. How convenient then, that this is exactly what we are doing with this post.

What you see below is a graph of the Affordability Index for King County from 1950 through 2007. For ease of reference, I’ve overlaid the graph of inflation-adjusted home prices on the right axis, so you can see how the two relate. I want to note though, that when calculating the affordability index, actual home prices are used, not inflation-adjusted prices.

Click to enlarge

From 1950 to 1970, while home prices more or less just kept up with inflation, affordability was sky-high, reaching peaks as high as 227. Of course, it shouldn’t come as a real surprise that when home prices began to jump up in the mid ’70s, affordability dropped like a rock. Of course, home prices are only part of the equation. Affordability tanked from 1976 to 1981 not only due to a leap in home prices, but an even more extreme spike in interest rates. On the following graph you can see the other two components of the affordability index: median incomes and interest rates.

Click to enlarge

I should point out that pre-1971 interest rate data is quite difficult to find, and I was forced to make my best estimate based on a chart of 30 Year FHA Mortgage Rates. Also, I believe that sometime during the period that is displayed on the graph, the “standard” mortgage shifted from a 15-year to a 30-year term. I couldn’t locate any data on historical mortgage standards to back that up, but maybe one of our resourceful readers can. Even with the ridiculously high interest rates of the early ’80s, the long-term average of the affordability index through the ’80s and ’90s comes out to 101.9. Here are the averages for each decade since the ’50s:

• 1950s: 160.6
• 1960s: 194.6
• 1970s: 178.4
• 1980s: 97.4
• 1990s: 106.5
• 2000-2007: 89.7

The affordability index for 2007 stood at 72.5, which is 29% lower than the 1980-1999 average. To get back in line with long-term trends, the affordability index would have to increase by approximately 40%. This could happen through increasing incomes, falling home prices, or falling interest rates. Lower rates seems fairly unlikely, so I’m predicting that it will be some combination of the first two, with the emphasis on the falling home prices.

This analysis may remind you of Deejayoh’s excellent post that compared disposable income, interest rates, and home prices from 1985 through 2007. The data is slightly different, but the conclusion is largely the same. Today’s home prices are seriously out of whack with long-term trends.

Sources:
(Home Prices: see this post)
(Household Income: US Census Bureau)
(1950-1970 Interest Rates: Financial Forecast Center)
(1971-2007 Interest Rates: Federal Reserve)

The Washington Center for Real Estate Research has released their data for the fourth quarter of 2007, and it finally has some good news for home buyers. According to the WCRER calculations, home prices in Q4 dropped 7% from the previous quarter ($472,000 to $439,000), which naturally edged the affordability index up slightly to a still-anemic 72.4.

Here’s a graph of their data on “Median Resale Price” and “Housing Affordability Index” since 1994, when they first started collecting data:

Click to enlarge

There’s really not much more to say about this data, as it just confirms what we have known for months; that home prices in King County are finally retreating. News reports and real estate agents are likely to latch onto the minuscule increase in affordability and trumpet it as proof that “now is a great time to buy.” When price declines have only just begun and affordability is still only 65% of its 1994-2003 average, now is definitely not a great time to buy.

The inspiration for this post is from the existing homeowners, prospective homeowners and allied real estate professionals that have corresponded with me and commented on this blog over months past to the present.

I’ve learned and received much more than I’ve provided on this blog I assure you, but the common theme I’ve come away with is that consumers want authentic advice and to trust the people who are assisting them with their real estate endeavors. They want value and to know how real estate professionals will earn their business. The following is what consumers want:

Dear Real Estate Professional,

• I want to be treated like a partner, not a “lead” or a means to an end.

• I want relevant information, fast and accurate.

• I want to know why I shouldn’t buy a particular home and why I should.

• If my objective is to build equity, I want solid advice based upon my ownership horizon.

• I want to know exactly how my agent is being paid and by whom.

• I want to know if my mortgage broker’s company or my agent’s brokerage firm has any financial interests in the referrals they give me for third party providers (mortgage, escrow, title, insurance, etc….). I want to know these disclosures at the start of our working relationship, not when I’m signing my loan or closing papers.

• I want to know how my mortgage broker is being paid or if any of the associated fees are duplicate in nature or unnecessary.

• I want my best financial and personal interests to be looked after in my transaction.

• I want to know exactly what the market conditions are. I don’t want to learn about the market conditions from other sources after the fact……

…..Three factors caused this decade’s housing boom to spiral upwards: 1) a run-up in home price valuations that spurred a high sense of urgency in home buying and selling; 2) poor lending practices, which caused many homebuyers to secure loans that they ultimately couldn’t afford over the long term; and 3) speculative purchases of homes also increased, with buyers investing in real estate with the hope of a quick return-on-investment.

• I want to know what the benefits and detriments are of entering into a multiple offer situation.

• I want to trust you.

• I want to know if there is an incentive of any kind, financial or other benefit, from a seller to you (my agent) and how it impacts me.

• I want my agent to be responsive, authentic and collaborative with everyone in my transaction.

• I want to work with a professional.

• I want you to anticipate potential problems before they occur, not react to them as they are upon us.

• I don’t want to receive my loan documents to sign at the very last possible moment.

• I don’t want to pay for inexperience at the same rate as I do for an experienced professional.

Comment Add on’s:

• I would like choices in the service levels I would like to receive/purchase.

If you do this you for me you will have my business for life and I won’t have to go here when I decide to sell, buy or refinance again.

Sincerely,

Consumer