Seattle Bubble

There are many arguments to be had between the Seattle Bubble housing bulls and bears, but one belief that seems to be commonly shared is that one of the primary drivers of demand and pricing in our market is a steady stream of rich Californians moving up and driving prices up. The bulls argue that our booming market is fueled by a never-ending flow of California equity, and that this situation is unlikely to end because Seattle is just-so-special. The bears point out that, as the California market slows down, so will the flow of emigrants, which will bring this gravy train to an end.

I counted myself more in the latter camp than in the former. But as someone who is always on the lookout for data to support my viewpoint, I was excited to find out that the State of Washington Office of Financial Management publishes an annual population estimate for the state. In this report, they show immigration trends based on license surrenders by major source of population. The chart below, showing the long-term migration trend from California and Oregon, is the one that caught my eye.

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The dips and peaks of California immigration shown on this chart looked suspiciously like the oscillations of our local real estate market. So, I put in a couple of calls to Theresa Lowe, the State Demographer - and soon found myself in possession of the data from which this chart was derived.

From there it was a quick effort in Excel to compare this data to the Case-Shiller Index, the longest running and most accurate gauge of price available for this market. I matched the 12 month rolling total of immigration to the year-over-year appreciation in the index, because looking at annualized data should smooth out seasonal variations. The results of this comparison surprised me.

The left hand side of the graphic below shows California immigration versus home prices. To the naked eye, there does appear to be a relationship. Major peaks and valleys roughly align. However, the right hand side of the same graphic, which uses the same data, tells a very different story. This chart shows a scatterplot of the two time series. As you can see, there is almost zero correlation between the two. The coefficient of correlation is negative 3%, and the R-square is practically zero. Based on this data - there isn’t a slight relationship between the two data series, there is effectively no relationship at all!

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Actually, if you look closely back at the chart on the left- you can see why this is the case. At the beginning of the time series, immigration is still climbing right through the biggest drop in home appreciation. Then for the next 7 years (through 1998), immigration tails off, while the rate of appreciation climbed steadily. Both trended the same way from 2001 to 2006, but more recently immigration has held steady while price appreciation has drastically eroded. The two series don’t move together at major points of change, and for a good part of the series they are moving in opposite directions altogether.

Not ready to give up yet, I thought that perhaps most people are like me - and don’t go to get their licenses immediately after moving. They do important things first, like buy houses. So I experimented with shifting the moving-date data data out further - between one and 12 months. That modification only served to make the explanatory value worse - and if anything, ended up showed a greater negative correlation. (in other words, more Californians equals lower home prices!)

So the relationship between the number of Californians moving here and home price appreciation appears to be a bust. What about immigration at large? I ran the same analysis for all immigration to the state versus home prices to see if that showed any relationship. Here, I found a greater correlation. This time, I got a coefficient of correlation of postive 34% and an R-square of 0.116 - which can be interpreted as “moderate” correlation. There is definitely a relationship, but with such a low R-square -the explanatory value of immigration as a driver of home prices is very low.

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So it appears, at least based on drivers license data (which should include most, if not all, potential home buyers), there doesn’t appear to be that great of a relationship between immigration and home price appreciation - and that old standby that California Equity is driving our market doesn’t appear to have much substance behind it at all.

The “California Equity Locust” appears to be a mythical beast, whose powers are greatly exaggerated.

Edit: The graph below shows how CA immigration compares to a blended CS index for California, built from weighting SF, LA, and SD in the same way they are in the CS 10 city index. As you can see, there is a very strong negative correlation between these two time series, as many readers have commented.

The latest Case-Shiller Home Price Indices data came out yesterday. The data runs a few months behind, so this release covers April. Here’s Aubrey Cohen’s take on the numbers in the P-I:

Seattle continues to defy a national trend of declining home values, but city house price increases are slowing, according to a Tuesday report.

Seattle-area prices for existing houses in April were up 1.3 percent from February and 9.6 percent from April 2006, according to Standard & Poor’s S&P/Case-Shiller Home Price Indices.

Both were the largest increases among the indices’ 20 major metropolitan areas, with Dallas equaling the monthly boost.

Pretty much the standard, rah-rah fluff. Aren’t we special, yadda-yadda.

But wait, there’s more! (Emphasis mine.)

But Robert Shiller, chief economist at MacroMarkets LLC, noted in a statement that Seattle’s year-to-year price increase was down from 17.8 percent in April 2006.“No region is immune to the weakening price returns,” he said.

The Seattle area’s year-to-year price increases have declined for 14 months, and April’s 9.6 percent rise was the lowest since May 2004.

“That is still a marvelous growth rate,” said Maureen Maitland, vice president of index analysis for S&P, in an interview Tuesday. “(Seattle) has held out quite a lot compared with others.”

…

Seattle also may be behind the cycle because the previous tech bust in 2001 delayed its entry into the latest housing boom, she said.

Seattle’s appreciation peaked in November 2005 — 14 months after the 20-city index. Hard-hit cities such as Detroit and Boston peaked in late 2003 and early 2004.

What’s that you say? Seattle may just be “behind the cycle”? Now where have I heard that before? Oh yeah, right here. Over and over.

Here’s another graph that attempts to visualize this theory. This one plots Seattle & Portland vs. Los Angeles & San Diego year-over-year price appreciation according to Case-Shiller. I’ve shifted San Diego and Los Angeles to the right by 18 months in order to roughly line up the period of peak appreciation.

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Those curves sure look similar to me (note: “similar” not “identical”). If Seattle & Portland’s respective housing bubbles play out similarly to San Diego and Los Angeles, next Spring and Summer could be very interesting in the Pacific Northwest.

(MacroMarkets LLC, S&P/Case-Shiller HPI, 06.2007)
(Aubrey Cohen, Seattle P-I, 06.26.2007)

Yesterday I compared King County to San Diego County in order to address some of the reasons we commonly hear that the Seattle housing market will remain strong. The focus of this post is slightly different than Part 1, where I used San Diego as an example to show that certain positive local attributes will not shield us from declining prices. Today’s topics turn the question around, looking at negative attributes of San Diego’s housing market that are presumably lacking here.

Since real estate trends in the Northwest are said to lag California by six months to a year, I’ll be comparing the period of 2000 — 2005 in San Diego County to July 2001 — July 2006 in King County.

The two issues I’ll address were brought up in the comments on Part 1:

Deejayoh: One oft cited argument that you left off (which I hear from my real-estate bull friends) is that “prices haven’t gone up as much here as they have in California” so they won’t go down.

E-sidedave: What about the affordability factor? Back at the peak, affordability in SD was 11%. It has never been that low here.

“Prices haven’t gone up as much here as they have in California” turns out to be an entirely true statement. From 2000 to 2005, the median sales price of Single Family Homes (SFH) in San Diego County went from $260,000 to $575,000—an increase of 121%! King County’s five-year SFH appreciation has been positively tame in comparison, increasing from $268,725 to $435,000—a comparatively paltry increase of 62%.

At face value, the “we haven’t appreciated as much as California (and therefore aren’t as vulnerable)” argument appears to hold water. However, I don’t believe that looking only at total appreciation offers a complete picture. What does offer a much more complete picture (in my opinion) is the affordability question. It makes perfect sense for home prices to shoot through the roof if incomes are experiencing a similar rise, while interest rates hit the floor. That’s how people buy homes: they use their income to pay back a loan. It’s a little thing that I like to refer to as fundamentals.

Before I get into the affordability numbers, I want to point out a few things that I am not attempting to show with this post. I am not making any claim about how affordable either county “should” be for potential buyers. I am well aware that a family earning the median household income is probably aiming too high to purchase a home priced at the median. Whether or not that is a good thing is not the point here at all. I am also not attempting to compare one county’s affordability to another. I’m going to compare each county’s affordability numbers to a different time period in that same county, not to the other county. There is a historical price premium that is paid to live in more desirable areas that can largely be seen in an area’s average affordability index. Highly desirable areas will always be unaffordable compared to less appealing ones.

Keeping those caveats in mind, here is what I am interested in. During the recent ridiculous run-up in home prices, how has affordability in each county changed? In order to find out, I’ll be calculating Tim’s Affordability Index (explained in my soft landing post) for San Diego and King Counties.

Let’s see how San Diego stacks up.

San Diego County 2000
Median Closed SFH: $260,000
Median Household Income: $47,236
Interest Rate: 8.06%
Tim’s Affordability Index: 76.9

San Diego County 2005
Median Closed SFH: $575,000
Median Household Income: $56,335
Interest Rate: 5.86%
Tim’s Affordability Index: 51.8

Yowza! That’s a 25.1 point drop in affordability in just five years, despite interest rates over two points lower. No wonder home prices in San Diego have declined since last year. So what about King County? Surely since our home appreciation has been so much lower, our affordability dropped much less than San Diego, right?

King County July 2001
Median Closed SFH: $268,725
Median Household Income: $53,610
Interest Rate: 7.13%
Tim’s Affordability Index: 92.5

King County July 2006
Median Closed SFH: $435,000
Median Household Income*: $59,500
Interest Rate: 6.76%
Tim’s Affordability Index: 65.8

Apparently not. In fact, King County affordability has taken a larger hit than San Diego County, plunging 26.7 points in the past five years. Although San Diego home prices shot up much further than King County homes, their income also increased 19% to King County’s 11%, while interest rates during the 2000-2005 period took a much more favorable turn than 2001-2006 (2.2 point drop vs. a 0.37 point drop).

So when you look at the complete picture, factoring in all of the home buying “fundamentals,” King County actually seems slightly more poised for a drop than San Diego was last year. Does that mean that we definitely will see a drop in prices? Obviously not, as there are many more factors at work, including the national economy, market sentiment, and acts of God. However, I think we can safely say that there is little comfort to be found (with respect to the housing market) in comparing the Northwest to California.

Sources:
(San Diego County Home Prices: The Real Estate Report)
(King County Home Prices: NWMLS)
(2000-2001 Incomes: American Community Survey)
(2005 Incomes: American Community Survey)
(Interest Rates: Federal Reserve)

*2006 income for King County was (optimistically) calculated by assuming a yearly increase from 2005 to 2006 ($1,130) of roughly 1.5 times the ACS’ estimated yearly increase for 2003-2005 ($745/year).

Since Mr. Kelly did such a poor job of actually comparing the Northwest to California, I’d like to get my own idea of how the two compare. For the illustrative purpose of this post, I’m going to be comparing the regions of Seattle and San Diego. Here in King County, the median home price (condos & SFH) for September was up 8.6% YOY, and down 3.0% from the peak (Aug. 2006). In San Diego, the median home price for September was down 4.4% YOY, and down 8.1% from the peak (Nov. 2005).

Most people would say that an 8.1% drop in 10 months is pretty major. So I have to wonder, what’s to stop that from happening here? Let’s take a look at some of the claims we frequently hear to see if they hold any merit. The purpose of this post is not to discover why prices have dropped 8% in San Diego, but rather to find out if some of Seattle’s oft-cited positive attributes will shield us from price declines.

In Sunday’s article, Mr. Kelly repeated a claim that we have heard over and over again in this debate, that “availability of jobs props up the housing market.” Let’s look at San Diego to see how well that claim holds up. Using unemployment figures from the Bureau of Labor Statistics, we find that the Seattle area’s unemployment rate has fluctuated between 4.1% and 4.8% in 2006. Those are pretty good numbers. So what about San Diego’s unemployment rate? 3.7-4.3% this year. So despite having better “availability of jobs” than Seattle, San Diego’s home prices have tumbled 8%.

What about foreclosures? If Seattle has a low rate of foreclosures, will that prevent housing prices from dropping? Looking again to San Diego, Dustin (of RCG fame) showed us in Monday’s open thread that the current number of foreclosures in San Diego is only 81% of the 1991-2006 average. Doing my own search of Foreclosure.com, I see that King County has 2,043 properties in foreclosure or pre-foreclosure, while San Diego County has 6,180. Using 2005 population estimates, I calculate 1 foreclosure for every 878 people in King County, and 1 foreclosure per 475 people in San Diego County. So while San Diego may not yet be reaching historic highs foreclosure rates, they’re still higher than King County. Thanks to Dustin’s investigation though, we know that historically high foreclosures is not a prerequisite for declining prices.

Of course, there’s always the “desirability factor” that people love to cite, about what a great place Seattle is to live. I agree that this is indeed a great area (otherwise why would I still be living here?), but I think you’ve got a great career as a salesperson ahead of you if you can convince a majority of people that cloudy, sound-side Seattle is more desirable than sunny, ocean-side San Diego.

San Diego has lots of jobs available, low foreclosures, and a highly desirable climate, yet prices there are clearly dropping. I would like to suggest that none of these things will shield Seattle from price drops, despite what the local media may like us to believe.

Update: I’d like to point out SDtoSEA’s comment below. As a San Diego resident, they offer some interesting insights: “Now, SD has brought in significant amounts of both high tech and bio related jobs. We have yet to see any reductions in any area of our economy. It continues to grow. Many companies are having a hard time finding qualified employees.” Sound familiar?

Read A California Comparison, Part 2.