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:
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.
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:
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:
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.
The big local housing story today is a study that was released recently by University of Washington Economics professor Theo Eicher. The thrilling title of the study is “Municipal and Statewide Land Use Regulations and Housing Prices Across 250 Major US Cities,” and it may be found (along with a number of related materials) here.
Rather than just quote the news articles about the study, let’s take a look at the study directly for ourselves. Unfortunately, most of the study is exactly what you would expect from a university economics professor: lots of confusing terminology and complicated math concepts. I’ll do my best to accurately summarize his findings here.
Before we get started, two important factors should be noted. First, that according to the Times write-up, Mr. Eicher “received no outside funding for the project.” So there is no basis to suspect he was influenced toward a specific conclusion by any particular outside interests. Second, the study focuses only on “owner-occupied” housing within the actual city limits.
Here’s the question Mr. Eicher attempts to answer with his study:
What drives the change in housing prices?
Or: Did housing prices increase because of land use restrictions and/or income/population growth?
In order to answer that, he breaks down the components that affect housing price growth in any given city into the following:
common effects*
land use regulations
income
population
population density
*(Such as changes in the national level of unemployment, changes in mortgage rates, or lending procedures, or liquidity in the mortgage market.)
He goes into quite a bit of detail on the effect of each of these factors on housing prices, and the end result is a large table (Table 3) in which he puts a dollar amount on the amount of change due to each variable from 1989 to 2006. The big number that the news reports are attaching to is the total estimated contribution of regulation, which he calculates at just under $200,000 (in 2006 dollars) for Seattle.
Considering what a large percentage of the total increase that $200,000 makes up, it is no wonder that’s what the news is focusing in on. However, in looking at Mr. Eicher’s results, the thing that jumps out to me is that the estimated contribution of the common effects mentioned above is somehow negative over the time period he studied. Unfortunately I couldn’t find a detailed explanation for this in his paper, although I admit that it would probably take me a couple days to look over it thoroughly enough to say that for sure that there isn’t one. It would seem to me that changes in mortgage rates (much lower in 2006 than 1989), lending procedures (much looser in 2006 than 1989) and mortgage market liquidity (much greater in 2006 than 1989) would have a pretty large positive effect on home prices, not a negative one.
Furthermore, while an analysis like this may accurately describe the effect of regulation on the cost of new homes, I would contend that the cost of resale homes is not necessarily always directly tied to the cost of new construction. Yes, the two are related, and there is likely a strong correlation when the housing market is strong and homeownership is increasing. But that’s the problem; during the entire time period Mr. Eicher studied, homeownership was steadily increasing, and for most of the period, housing markets were relatively strong.
I’m not going to try to argue with Mr. Eicher’s obviously well-researched study. If he feels that he has convincing proof that regulations have been that major of a factor in home prices, then those of us without advanced degrees in economics will probably have to take him at his word. However, I think it’s reasonable to ask whether this apparent relationship between government regulations and home prices holds true regardless of overall demand for home ownership. 2006 was essentially the peak of a very long run-up in the housing market. It will be interesting to see if regulation keeps prices propped up as demand drops like a rock.
Update: The Sightline Institute, a green-minded “think tank,” has their own rebuttal of the study up on their blog. It’s interesting, but unfortunately the post seems based entirely on Elizabeth Rhodes’ article in the Times, and not the study itself. As I said above, my two biggest problems are that the study alleges a negative influence on home prices due to the mortgage market, and that the time period encompasses only a relatively strong period of growth for the housing market. None of the other people complaining about this study seem to be hitting on those important points.
Although I have noticed homes dropping off the market in my neck of the woods in Snohomish Co, generally speaking, for semi-serious sellers, early and mid-October is a bit soon to pull the property off the market. I can understand if it was during the full holiday season from a few days prior to Thanksgiving through New Years. But, if you pull out this soon, the potential for back-firing increases if the thought process is “I’ll try again after the Holidays.” Many others will do the same. Maybe a Realtor can chime in on the efficacy of this reasoning.
I have a sense though that some of these homes going off the market today, either by expiring, Realtors giving back the listing, or mutually taking the home off the market, are being replaced by others. No hard Data, but maybe a Realtor can confirm this.
That being said, one of the things I’ll be curious to follow is if inventory as a whole (system wide) drops without replenishment. If we maintain the current inventory levels going forward, then I would guess the region will be in for quite an increase after Jan. 1, 2008. If that happens, then we will see further downward pressure on prices. It is also important to not forget about the underground market of FSBO’s. I read somewhere that this market is roughly 10% of the inventory/sales that are not accounted for by regional MLS statistics across the country. So in theory, there are a lot more homes on the market than reported.
Remember, many agents suggest to their clients that they can try again after the New Year. All these homes that expired or were mutally taken off-market will come back on the market with the same agent or another real estate company. And, all those reading about market struggles across the country who are holding off until after the first of the year are going to be competing with like-minded-soon-to-be sellers. On balance, my sense is that we are going to see a lot more inventory come on the market after the year.
The list price reductions appears to be on cruise control right now, along with incentives for closing cost contributions, rate buy downs, etc..
Over at Rain City Guide, Rhonda Porter mentioned that 30 yr fixed rates are now under 6% again. That is probably going to move some folks to write earnest money checks for a purchase or refinance.
Musings
I went to the Everett Silvertips game last week with Steve Hatloe of very long time Everett business institution Hatloe’s Interiors/Carpet One. Naturally his business is also dependant upon housing and household improving. Prior to the game he asked me about if he was the only one ‘out there’ who thought to himself, “how are people doing it?” I looked back and said, “gosh, that makes two of us. But, since you asked………”
Someone asked me a while ago what it’s like to be in escrow? I said, “like a referee.” We try to make sure everyones obligations are met, but sometimes the referee get’s the ire of one’s temper.
Lenders who previously approved mortgages to people with bad credit, no down payment and little or no documentation of income now are refusing loans if even one of those three factors is questionable. This is true even in Seattle, where homes have so far continued to appreciate.
“I see a number of individuals even in our existing pipeline that maybe a month or two ago were being choosy,” said Adam Stein, president of American Brokerage in Auburn, and the Washington Association of Mortgage Brokers. “Now they’re realizing that maybe they held out too long.”
Lenders had less incentive to screen out risky borrowers during the go-go real estate market of the past few years because they quickly turned around and resold mortgages on the secondary market. And, while home values were increasing fast, borrowers who could not make payments could still sell for more than they owed.
But that’s changed.
In recent months, home prices have declined in much of the country, borrowers increasingly are defaulting, and investors are fleeing from the home market.
A reader going by the name Angie has been making some comments on a couple of posts the last few days that merit further discussion:
…the fact is that in some places in the US all but the very rich have been priced out forever! NYC, coastal southern California, San Francisco, etc, etc. It’s been that way for a long time…but it wasn’t always that way. At some point whatever factors converge, demand forever exceeds supply, and the rest is history.
…
We’re landlocked like SF and the weather is arguably better. The local economy has diversified enough to keep the town afloat consistently. I’ve long thought that the prices here are headed into San Francisco territory–out of reach of the average Jane and Joe once and for all. Priced out forever!
…
I think housing in Seattle really is entering the realm of “permanently unaffordable” to average earners…
…
“Serious limited supply” is exactly what I’m talking about. Unless we get housing density like New York City, there is no way the city of Seattle is going to be able to house all the people who are projected to come here in the next 10 years. Supply is always going to be less than demand.
Angie touches on a number of points that have been discussed here before. The crux of the argument Angie is presenting seems to be that housing supply is not keeping up with demand, and as a result Seattle has crossed a threshold of affordability, reaching a sort of permanently high price plateau. (Angie, if I have mischaracterized your argument, please correct me.)
I have a few problems with Angie’s hypothesis (most of which are covered in the posts linked by Matthew in reply to Angie).
First, I don’t think you can reasonably argue that “supply not keeping up with demand will keep prices rising” while simultaneously ignoring the fact that during the years of highest appreciation, supply exceeded demand. In fact, from 2000 to 2005, an average of approximately 841 housing units were constructed in King County every month. During that same time frame, only 339 new households (net) moved to King County. The increase in supply exceeded the increase in demand (which by the way, was not driven by job growth) by more than double, Seattle was in the midst of the dot-com/9-11 economic fallout, and yet prices increased by a healthy 7% per year (average).
The only explanation for that is easy lending + speculation. If prices were inflated by psychological factors, why would (presumed) economic factors keep them at an already artificially high level? Who is to say that the next 10-20 years of actual “positive fundamentals” hasn’t already been factored into today’s prices, giving them plenty of space to fall back down to earth?
My second issue with Angie’s tale is the assumption that supply will not be able to keep up with demand in the near future (10 years). Consider the 6,000 to 10,000 new condos that will hit downtown by 2010. Drive just a few minutes out of Seattle proper, and consider the dozens and dozens of cookie-cutter housing developments in progress scattered throughout south Snohomish County and east King County. Are there really going to be that many people moving here? Show me the data, because as I showed above, the only hard data I can find shows that construction is exceeding population growth by a good margin. Construction in the Puget Sound seems to actually be accelerating, not tapering off.
Another problem is that Angie’s comments seem to be referring solely to Seattle proper. While the city itself may be somewhat “landlocked,” King, Pierce, and Snohomish counties are fairly well-connected to each other, geographically speaking. Furthermore, outside of Seattle and Bellevue (but still inside the Urban Growth Boundaries) the counties are nowhere near capacity as far as single-family home development goes. Look out your window the next time you fly out of Seatac, and compare the density below to what you see as you fly over the north-east coast, or the south SF Bay Area. There’s simply no comparison.
In my opinion, the easiest way to see that things are seriously out of whack is to look at the price to buy compared to the price to rent. In a sustainable market, the price-to-annual-rent ratio for housing is generally 11 or 12 (source). In King County right now it’s around 24.
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.
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!
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.
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.
First, I don’t think you can reasonably argue that “supply not keeping up with demand will keep prices rising” while simultaneously ignoring the fact that during the years of highest appreciation, 
