Seattle Bubble

News & discussion about real estate & the housing bubble in the Seattle area.

Seattle Bubble - News & discussion about real estate & the housing bubble in the Seattle area.

Entries Tagged as 'fundamentals'

Renting in and Around Seattle Still the Smart Financial Move

By The Tim on December 3rd, 2008 at 11:26 AM · 80 Comments

Let’s take an updated look at some Seattle-area rent vs. buy comparisons to see if the situation has improved at all since we analyized it last summer. Back then, the real-world example I used compared two similar homes in Kirkland. Total monthly costs for the rental were $1,515, while the home for sale would have cost $2,690 per month—a difference of $1,175 in favor of renting.

For the purpose of our comparison, we will again assume that the potential home buyer or renter is a married couple with enough in the bank to make a 20% down payment and are qualified for a 30-year fixed-rate loan at current rates (5.75%).

In today’s first comparison, I found two homes in Kirkland.

For rent—4-bed, 3-bath, 1,800 sqft house with a 2-car garage. Monthly price: $1,495.
For purchase—4-bed, 2.75-bath, 1,900 sqft house with a 2-car garage. Price: $400,000.

I’m not going to go over exactly how all the values below were calculated, since it has been covered extensively before. If you would like to follow along at home, feel free to download my spreadsheet that will calculate the costs for this or any other set of inputs.

  Renting    Buying   
Rent/Mortgage:    $1,495 $1,867
Insurance: $20 $163
Property Tax: - $383
Tax Savings*: - ($254)
Maintenance: - $333
Total: $1,515 $2,492

*: (year 1 only, less standard deduction)

In today’s comparison, the monthly savings from renting has dropped slightly down to $977. But how does the financial situation change over the next five or ten years? Let’s add a few more assumptions. 1) The house appreciates an average of 1% per year (probably generous). 2) You can invest your cash and get a 2% rate of return. 3) The renter adds the $977 monthly savings to their investment. 4) To realize any cash gains on the house will require paying 6% to agents and 1.78% in excise tax. 5) Interest earned on your cash investment is taxed yearly according to the 25% tax bracket. 6) Rent increases at 3% per year.

Given those assumptions, after 5 years today’s renter would have $145,000 in their investment, while the buyer would net just $91,000 from the sale of their home. After 10 years, the renter has $208,000, and the home buyer that sells will walk away with $141,000.

Let’s run the numbers for another pair of homes, this time closer in, in the ever-popular Ballard.

For rent—3-bed, 1-bath, 2,180 sqft house with a no garage. Monthly price: $2,195.
For purchase—3-bed, 2-bath, 2,100 sqft house with a 1-car garage. Price: $550,000.

  Renting    Buying   
Rent/Mortgage:    $2,195 $2,568
Insurance: $20 $163
Property Tax: - $527
Tax Savings*: - ($433)
Maintenance: - $458
Total: $2,215 $3,283

*: (year 1 only, less standard deduction)

So over in Ballard today’s renter will save $1,068 a month. With the assumptions stated above, after 5 years the renter has $181,000 in the bank, while the buyer gets $125,000 from the sale of their home. After 10 years, the renter has $246,000, the buyer gets $195,000.

I’m certainly not one to say that no one should buy a home ever, but the way things look around Seattle at present, renting for now is still clearly the way to go. Remember that the rentals in my comparison were nice, large houses. If you can stand renting a smaller apartment for a while you’ll be saving even more.

Of course there are always exceptions to every scenario. I’m sure there are people out there today finding amazing deals from highly motivated sellers. If you find such a deal, more power to you. But for most of us, renting in Seattle is still the smart financial move.

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CEPR: Today’s Buyers to Lose Massive Equity

By The Tim on October 30th, 2008 at 9:46 AM · 41 Comments

The Center for Economic and Policy Research has released another report on the prospects for building home equity over the next four years, and much like their April report, their conclusions are not good for current home buyers hoping to build short-term equity.

Despite the collapsing housing bubble and consequent fall in house prices in bubble markets, the prospects for accumulating equity still look grim for homeowners as prices are still far from reaching their historical norm. The relative merits of owning and renting will be affected by the extent to which homeowners can accumulate equity. Even with the general increase in house prices at the same rate as the overall rate of inflation, homebuyers are at risk of facing plunging home values in bubble inflated markets.

Based on calculations that compare the cost of buying a home at 75 percent of the median house price, they predict that current home buyers in the Seattle area will have between -$117,471 and -$123,373 equity by 2012.

Here’s how Seattle’s situation compares to other areas around the country, according to CEPR’s calculations.

Figure 2 shows the updated projections of equity in the 100 largest metropolitan areas after four years for a household buying a home at 75 percent of the median price. Blue circles indicate positive equity, while red circles imply negative equity. The calculations deduct 6 percent of the projected sale price for realtor fees and other selling costs.

CEPR Negative Equity Projection
Click to enlarge

The only metropolitan areas outside California predicted to have a larger amount of negative equity than Seattle are Honolulu Hawaii and Bridgeport Connecticut.

To calculate the projected negative equity, CEPR assumed that the (75 percent of median) house price will adjust over the next four years to a value of 15 times the annual rent (adjusted upward by 33% to adjust for the difference between apartments and houses and then again by 12.6% to account for rent increases). For full details on CEPR’s methodology, download the pdf (which has been added to the Library for future reference).

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CEPR: Maintaining Ownership Makes No Sense

By The Tim on April 11th, 2008 at 12:27 PM · 40 Comments

The Center for Economic and Policy Research came out with another great paper this month titled The Cost of Maintaining Ownership in the Current Crisis

Here’s an excerpt from the summary (emphasis mine):

The collapse of the bubble in the U.S. housing market is creating chaos in financial markets while throwing the economy into a recession. It is also threatening millions of homeowners and renters with the loss of their homes. In recognition of the problems in the housing market, Congress is considering measures that will alleviate the crisis. However, it is important that Congress recognize the full nature of the problem as it crafts legislation.

This paper compares ownership and rental costs in twenty major metropolitan areas. It shows that in many areas, ownership and rental costs are more or less in balance. This means that it might be practical and desirable to craft policies for these cities that are focused on keeping homeowners in their homes as owners.

However, the paper also shows that in many cities homeownership costs are greatly out of line with rental costs. These are cities, mostly on the two coasts, that have seen an extraordinary run-up in house sale prices over the last decade that have not been matched by any comparable increase in rents. In these markets, homeownership costs could easily be double, and even close to triple, the cost of renting comparable units. Paying these inflated ownership costs will take away money that might otherwise be used to pay for health care, child care or other necessary expenses. Similarly, a government that intervenes at these prices will have less money for other needs.

Furthermore, because prices are now falling rapidly in many of these markets, homeowners are unlikely to accumulate equity. In fact, it is likely that many homeowners will end up selling their homes for less than their outstanding mortgage, even if new mortgages are issued with substantial write-downs from the original mortgage. In these bubble markets, government efforts to support homeownership are likely to do little to help homeowners and could leave taxpayers with a substantial bill in cases where homeowners leave their houses with negative equity.

They compare 20 cities, of which Seattle is one. Here are the relevant data tables from the paper with Seattle highlighted.

CEPR: Ownership vs. Rental Costs

Note that yes, Seattle is in bold, which means that they classify us as a “bubble market,” despite what local realtors would like to believe. Also note that even the low end of the monthly ownership costs are more than double the monthly rental costs. This is of course not news, but it’s still nice to have it validated by another source.

CEPR: Equity After 4 Years

Translation: it’s a great time to buy a home in Seattle… if you don’t mind a high likelihood of being $100k under water in a few years.

They conclude the following:

In cities that have seen home price appreciation that has raced ahead of rental cost growth, however, it likely makes little sense to use public resources to encourage or subsidize severely troubled homeowners to maintain ownership. Similarly, it likely makes little policy sense to encourage or subsidize households to become homeowners in the near term as the market goes through a downward adjustment in prices.

All in all, an excellent paper. I suggest you download and read it for yourself. Keep in mind that the CEPR isn’t some “bitter bubblehead,” it’s a serious agency filled with economists and ivy-league professors. Not quite as easy to dismissively ignore.

I have added this paper to the Library for future reference.

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Those Darn Fundamentals

By The Tim on February 23rd, 2008 at 11:42 AM · 117 Comments

This is a little redundant, but that’s why I’m posting it on a Saturday. It’s just a slightly different take on the economic fundamentals that allegedly drive the local housing market. Much of this data comes from the recently-released 2007 King County Annual Growth Report. You can get all these charts and the data behind them in this spreadsheet.

Here’s a chart of local economic fundamentals from 2000 through 2006:

King County Fundamentals: 2000-2006
Click to enlarge

And here—on the same scale—are some measures of the local housing market for the same time period:

King County Housing Market: 2000-2006
Click to enlarge

Here are the fundamentals and the housing market measures all on the same chart.

King County Fundamentals vs. Housing: 2000-2006
Click to enlarge

I realize that posts like this are seen by some as beating a dead horse. The sad thing is that there are still people that believe that home prices are somehow supported by these fundamentals. I wonder if someone that believes this could be bothered to bring out the data that supports such a position.

(King County, 2007 Annual Growth Report, 2007)

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Detailed Study of Land Use Regulations & Home Prices

By The Tim on February 14th, 2008 at 12:58 PM · 57 Comments

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.

US Housing Market 1989-2006
Click to enlarge

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.

(Theo Eicher, University of Washington, 01.14.2008)
(Elizabeth Rhodes, Seattle Times, 02.14.2008)
(US Census Bureau, Homeownership Rates)
(S&P/Case-Shiller, Home Price Index)

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.

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More “Superstar” Nonsense from Lawrence Yun

By The Tim on February 8th, 2008 at 3:15 PM · 51 Comments

Apparently the only necessarily qualification for becoming a “world class” or “superstar” city is to keep on repeating that it is so. That’s the message I’m getting from the latest quotes from the Realtor’s spokesman Lawrence Yun, anyway.

Seattle-area home prices are manageable for typical workers, according to the chief economist for the National Association of Realtors.

“You may even say Seattle is underpriced if you believe Seattle is becoming a superstar city,” Lawrence Yun told area brokers in Bellevue on Thursday. “Seattle is underpriced in relation to other West Coast markets.”

First off, we have addressed this “superstar” or “world class” thing before. If you haven’t read it already, take the time to check out On Luxury Cars and World Class Cities. Also be sure to read P-I columnist Bill Virgin’s take on the world class question. The gist of our argument is that although Seattle is great, and we love it here (really we do), it is not a world class city by any available objective measure. Sorry, it’s just not, and repeating over and over again that it is doesn’t make it so.

When people like Mr. Yun make the assertion that Seattle is a “superstar city,” they never back that claim up with any sort of quantifiable data. There are measurable characteristics that one can use to judge whether or not a city is world class (a good list can be found on Wikipedia), and Seattle simply does not measure up, any way you look at it.

But that’s not my only problem with Mr. Yun’s speech yesterday. He also made a some verifiably false assertions and ludicrous predictions. [Read more →]

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