Seattle Bubble

Forbes just loves to frame their articles around lists. You may recall Seattle showing up frequently on previous such real-estate-related lists, such as Best Places to Flip a Home (#1), Richest Cities In The U.S. (#8), Best Cities For Jobs (#34), and Most Overpriced Places In The U.S. 2005 (#1). Well, lucky us, we made yet another Forbes list: America’s Most Stable Housing Markets (sort of like picking out the warmest hangouts in Antarctica).

Nationwide, home prices are falling, sales are sluggish and the number of foreclosures is mounting. Ask any economist and you’ll hear that things are bad, and likely to get worse.

Unless you live in Seattle, where the market is slowing but fundamentals remain strong.

“Fundamentals remain strong” appears to be nothing more than code for “prices haven’t fallen… yet.” Here in Seattle, things aren’t yet “bad,” but they are almost certainly likely to get worse. I guess being “barely ok, and likely to get worse” is enough to catapult us to the top of the list.

The Emerald City has experienced strong price appreciation over the last six quarters, and that’s expected to continue in the new year, though at a slower pace. In addition to a very low housing inventory and a strong sales rate…

Wait, did he just say “a very low housing inventory”? That’s a riot. And while sales have been slowing YOY for 21 of the last 22 months, I will grant that through July, it could still be described as a “strong sales rate.” July’s sales were higher than every year outside of 2003-2006. Of course, with the tightening mortgage market, sales in August came to a screeching halt, coming in lower than any August since 2001… but we’ll let that slide, since Forbes probably isn’t working off of data that current.

…there are few non-conforming and high-risk loans on the books than in other cities, which means the area will likely see fewer defaults in the coming months than the rest of the country’s markets.

Really? I suppose with a statement as vague as “than in other cities,” it’s true. But the list of qualifying “other cities” is frankly pretty short. We’re right up there with most of the other cities that started experiencing increasing foreclosures once the appreciation music stopped. For more on the loan picture, check out this and this.

To arrive at our list, we teamed with Moody’s Economy.com to develop three prediction models based on a range of factors that affect how prices move. These include, among other things, the state of local economies, new construction contracts, foreclosure rates, local credit markets, sales rates, affordability and inventory.

[From the slide show:]

Median home price:$395,000
Annual price change from 2006: 8.9%
Projected price change to 2008: 3.09%

Moody’s Economy.com sure seems to be fickle with these predictions. Just last month CNN reported on “an analysis conducted by Moody’s Economy.com” that showed prices in “Seattle-Bellevue-Everett” declining 2.9%.

Also, it’s not at all clear from the article what specific geographical area they’re referring to when they say “Seattle.” It’s definitely not just the city of Seattle, where the median home price sat at $439,000 last month. It’s also apparently not King County, where the median is $415,000. My best guess is that they’re using some combination of King, Pierce, and Snohomish counties—which makes the prediction of continued price increases seem even more unlikely to come true.

In related news, the author of this piece and the previously-featured “Best Places to Flip a Home,” Matt Woolsey, contacted me after my post about that article:

I came across your blog while looking for information on Seattle real estate and I must say a lot of the analysis looks great. Your apparent desire to punch me in the face regarding the flipping story is of some concern to me for my next visit to your city, but I nonetheless will continue to follow your site. For future consideration, you should know that all of our stories are comprised of data driven analysis

For the record, my comment that I would “really like to gut-punch these reporters” was tongue-in-cheek. You have nothing to fear in Seattle, Matt. Well, not from me, anyway. I can’t speak for anyone that giddily jumped into the market to flip a house after reading that article, only to find that the time for flipping in Seattle is long gone…

(Matt Woolsey, Forbes, 10.01.2007)

A thought (actually I LOL) just popped into my brain moments ago after reading all the quotes and comments over the last few weeks both here and at Rain City Guide, particularly since mid August when the liquidity crisis hit. This is meant to have fun on the Blog a bit, but I’m also sincere. “Who is going to be Tim Ellis’ Realtor when he decides it is time to buy?” I thought.

Tim Ellis (”The Tim”) is probably among the very top informed first time homebuyers when it comes to market knowledge, housing economics and mortgage finance…..and how to build those handy Genie Lifts we see all over the place on construction sites.

There have been many instances where Seattle Bubble readers have purchased over the last year. Today, I met another at our office. Thanks for supporting small authentic independant escrow firms (not owned by real estate broker, mortgage broker, title company or any other financial services business). So, when The Tim decides it is time to buy a home, I wonder how he is going to qualify the market knowledge of the Realtor (and Loan Officer) he works with, provided he utilizes a Realtor’s expertise. Working with a knowledgeable Realtor is advantageous, but, my understanding is that consumers rarely REALLY interview the individual assisting them in a very large purchase.

From my recent observations

Some of the consumers are leveraging the market conditions in their favor:

• watching time on market of subject home they are interested in
• being represented (buyer agency)
• closing costs paid by seller
• negotiating price down
• shopping for best service & price for third party services involved:
  • inspectors
  • repair contractors
  • title insurance
  • escrow service (those who finalize and close your transaction)
  • mortgage loans
• Use of rebates by individual Realtors or other’s such as Redfin.

Continuing with my premise

One the one hand, a Realtor working with The Tim will probably be easy because he may have all his ducks lined up and ready to go. He will probably have financing already approved prior to jumping into the fray.

On the other hand, Realtors talk quite a bit about how difficult it can be to work with an “engineer” type buyer: those dang-gum-number-crunchers!. In addition, will he be a “marked” man, tongue-in-cheek, as a contributor to the demise of a local market and the idea that if enough people say we are in a Bubble, then mass psychology may start the self fulfilling prophecy? After all, Economist Robert Shiller was at it again today indicating that the unraveling of the market could be the worst since The Depression. Psychology is certainly a factor: we heard no objections when the media continually talked up the market and today it is quite a different story.

So who will be Tim Ellis Realtor? How would you qualify those service providers involved in your purchase? What questions would you ask of a Realtor to find one that is experienced, knowledgeable and works well with you representing your best interests?

National Mortgage News reports that Countrywide received an additional $12 Billion in secured financing and that mortgage powerhouse, WaMu, is exiting the warehouse biz. In addition, there are rumblings that Countrywide employees may be suing Angelo Mozillo et. al, complaining that the company allegedly cheated them out of millions by concealing the true health of Countrywide. Inman News is reporting that First Horizon Home Loans is shuttering offices and reducing staff.

Lots of shifting, merging, consolidation, BK’s, and movement going on the the real estate business as this slowdown works through different areas of the country. I would like some insiders to comment on how WaMu’s exiting of the warehouse business will affect loan officers and their customers.

This is a post that I originally wrote for the highly-recommended personal finance blog Get Rich Slowly. As such, the style of writing is more geared toward the audience of that site. However, I felt that the post would be of interest to the readers here as well, so I am re-posting it in its entirety.

Introduction

“If you rent, you’re throwing away your money.”
“Owning your own home is a forced savings plan.”
“Home ownership is an excellent path to build wealth.”

You’ve probably heard statements like these plenty of times. On television, radio, the internet, and in casual conversation. Such sentiments are common in any discussion that involves home-buying and personal finances. It’s common knowledge that buying a home is a better financial move than renting. After all, you’re building equity instead of throwing away your money, right? Well, maybe not quite… Rather than assuming the “common knowledge” on this subject is accurate, let’s take a look for ourselves at some of the financial differences between renting and home-buying.

A Real-World Example

For the purpose of comparing renting to owning in this post, I’ll be using real-world data gathered from my area (NE of Seattle). Although most first-time buyers tend to move from renting an apartment to buying a larger, stand-alone house, as much as I can I will compare apples to apples.

For rent, I located a 3-bed, 2.5-bath, 1,840 sqft house with an attached 2-car garage, on 0.2 acres. Monthly price: $1,495.

For purchase I found a 3-bed, 2.5-bath, 1,850 sqft house with an attached 2-car garage, on 0.22 acres. Price: $424,950.

The two homes are located within two miles of each other in similar neighborhoods, and neither is located on a busy road. We’ll assume that our hypothetical homebuyer is a married couple with $85,000 in the bank to make a 20% down payment. To calculate mortgage payments we will use a recent 30-year fixed interest rate of 6.25%.

Let’s look at how the monthly costs break down (approximately) for our hypothetical potential first-time homebuyer:

	Renting	Buying
Rent/Mortgage:	$1,495	$2,093
Insurance:	$20	$163
Property Tax:	-	$407
Tax Savings*:	-	($327)
Maintenance:	-	$354
Total:	$1,515	$2,690

*: (less standard deduction)

Right off the bat, you see that simply trading straight across from renting to owning results in a 78% more expensive monthly bill. That’s not exactly chump change. With even a slight upgrade from renting to buying (which most first-time buyers are prone to do), you can easily see how the total monthly costs would be more than double.

“If you rent, you’re throwing away your money.”

Common knowledge says that despite today’s large premium, buying a home is a “good investment” anyway. Hey, at least you’re not “throwing away” your money, right? True, the renter in our scenario spends $1,515 every month that they will never see again. I wouldn’t exactly say it has been “thrown away” any more than money spent on any other good or service is “thrown away,” but granted, there is zero financial return on that money.

However, when you take a look at the breakdown of the homebuyer’s monthly expenses, a large amount is money that will never return, either. Insurance, property tax (less tax savings), and maintenance, add up to $517 every month that is being “thrown away.” Even worse is the amount spent on mortgage interest. Consider how much of a mortgage payment is applied toward loan interest throughout the life of a 30-year fixed loan:

Years	% toward interest
0-5	~80%
6-10	~70%
11-15	~60%
16-20	~50%
21-25	~35%
26-30	~10%

In the first five years, approximately 80% of the mortgage payment goes toward interest. That’s an additional $1,674, for a total of $2,191 being “thrown away” every single month by the homebuyer for the first five years. Ouch! In fact, not until the homebuyer has been paying down the mortgage for over 20 years will the amount they are “throwing away” be less than the renter.

“Owning your own home is a forced savings plan.”

As you can see above, if home buying is like a savings plan, it’s probably the worst savings plan on Earth. Would you voluntarily sign up for a savings plan where well over half of the money you deposit in the first 20 years simply vanishes, and from which you can only withdraw money by relocating and paying a 6-9% fee (not on the amount you have “saved” mind you, but on the total sale price of the home)? Of course not. That doesn’t sound anything like a savings plan.

If our potential homebuyer has that $85,000 saved up for a down payment and deposits it along with just half of the monthly savings over buying ($578 per month) into an account at 8% interest, the balance will be nearly $300,000 in just 10 years. That’s a liquid investment, that can be used for whatever you want, no relocation required. Buying a home is not a savings plan. Actually saving money every month is a savings plan.

“Home ownership is an excellent path to build wealth.”

If your goal is to build wealth, you will be much better off investing your money in the stock market than buying a home. While both stocks and housing are cyclical markets, long-term historic trends show that housing appreciates at a rate barely above inflation, while stocks tend to return an inflation-adjusted 7-10%. In our hypothetical scenario, a renter who invested in the stock market with the $85,000 down payment plus the monthly difference between the $1,515 rent and the $2,690 home-buying costs would be over $500,000 better off after 30 years than the homebuyer, assuming 4% average appreciation.

An important thing to consider is that home prices in the United States are just now beginning to correct from an enormous unprecedented run-up in recent years. Despite what those in the business of selling real estate may insist, the correction in housing is still in the early stages. Four percent is most likely overly optimistic for most areas in the next 5-10 years. The only thing we know for sure is that double-digit gains are gone and won’t be coming back any time soon.

Also keep in mind—I mentioned it above but it bears repeating—in order to cash in on any “wealth” you build through your home you will need to sell that home and move. No, “extracting equity” does not count, since that simply results in a larger debt. Debt != Wealth.

Conclusion

For most people buying a home will result in their largest monthly bill (by far), and because they believe that it will bring them wealth or that they are “throwing away their money” if they rent, they often take on a much larger home debt than a prudent budget would allow. It is a real shame when people are driven to get into the housing market because of misplaced notions of imagined financial benefits. Of course, everyone’s circumstances are different, and for some (particularly those that live away from the coasts) the numbers may actually work out in favor of buying.

Don’t misunderstand me here. I am not saying that no one should buy a home, or that my example scenario is a golden standard of truth for all. Don’t take my word for it. Run the numbers for yourself, check out other articles (a small collection is listed below), and do what works for you. I highly recommend the great graphical calculator from The New York Times for comparing the financial aspects of renting and buying. Many people will consider all of the consequences—financial, emotional, etc.—and conclude that buying a home is the best decision. Just don’t trick yourself into thinking it’s a good financial decision if it’s not.

I myself intend to buy a house some day. However when that day comes, I will be buying a house because I want a nice, “permanent” place to live where I’m the boss, not because I think it will help me get me rich.

Additional Resources:

Wall Street Journal: Your Home Isn’t the Nest Egg That You May Think It Is
New York Times: A Word of Advice During a Housing Slump: Rent
New York Times: Is it better to buy or rent? (graphical calculator)
The Motley Fool: The Worst Investment Ever
SmartMoney.com: Renting Makes More Financial Sense Than Homeownership
CNN Money: Stocks vs. Real Estate
Priced Out Forever: Renting vs. Purchasing

For those of you that are interested in more lengthy reading, a new paper by Robert Shiller (as in Case-Shiller) was released this weekend: Understanding Recent Trends in House Prices and Home Ownership (pdf).

Here are a couple of money quotes:

It does not appear possible to explain the boom in terms of fundamentals such as rents or construction costs. A psychological theory, that represents the boom as taking place because of a feedback mechanism or social epidemic that encourages a view of housing as an important investment opportunity, fits the evidence better.

…

Within the United States, the current boom differs from prior booms in that it is much more of a national, rather than regional, event.

Here’s a great chart that summarizes the foolishness of any argument that home prices are supported by “fundamentals”:

Enjoy.

I’m weary of hearing that the sub-prime market is or was a small portion of the pie in the Puget Sound Region. Certainly, there are many prime conventional loans that were made. But the idea that the originations of sub-prime loans being reduced or eliminated will have a less than meaningful impact is just not reality.

Is Legacy Escrow Service, Inc. the only escrow company in the area that closed a lopsided amount of home loans and refinances that were sub-prime vs. traditional conventional transactions? Was Legacy Escrow Service, Inc. the only company working with loan officers in the sub-prime arena? Hardly. We are a small fry compared to the volume of more established companies and title insurers.

As I mentioned over at RCG, how can I explain away the fact that our refinance volume is down about 70% YOY and that is not due to working with only two loan officers. We worked with scores of LO’s, as any escrow firm does. It means that with the sub-prime market essentially relegated to the “intensive care unit” due to Wall Street liquidity problems and the severe delinquency rates reported, the loan officers that sent work our way are doing significantly less originations. And that “Domino” has squarely hit escrow and ancillary real estate service providers in the rear end.

Seventy one percent of the purchase transactions closed by our office in 2005 alone was 100% financed (largely 80/20 with pre-payment penalties, etc..) and while the number dropped as 2006 went forward we did not see a healthy decline in 100% nothing down purchase transaction until 4th Quarter of 2006. Don’t forget that in EVERY single 100% nothing down transaction our office closed, the purchase price was increased to offset closing costs paid by the seller on behalf of the buyer due to their loan program. And to really make you super dizzy, a few of those were increased AFTER being involved in multiple offer situations. The 100% loan programs played a very central role in housing price escalation. And they will play a central role in making many of these homeowners renters again—-but that is just one fellow’s opinion.

Regarding the sub-prime loans in the region, Jillayne Schlicke remarked in a recent comment:

That’s because Eliz Rhodes was looking at only Seattle and the Eastside.

I have always said that the entire Puget Sound area has been populated with upwards of 8 to 9,000 loan originators whose sole income was only originating subprime: Starting from Pierce, up through King and Snohomish, if you add all three counties in together, there has to way more subprime loans that what she originally stated several months ago.

These folks never learned how to originate prime, conforming, A paper conventional loans and never wanted to learn because they could make so much more money shafting people into a subprime loan due to the high yields being offered by investors.

The cool map is only for the year 2005. Would love to know their data source. My guess is that it came from Firstam/CoreLogic

Jillayne’s comment inspired this post. But the question remains: If our small business was doing a large volume of closings with sub-prime terms, how many did First American, Chicago Title, Pacific Northwest Title, Old Republic, The Talon Group, TransAmercia/Land Title, Fidelity Title, Stewart Title and all the other escrow firms close? I suppose the market will tell us.

The good news is that to an extent, Seattle is certainly not experiencing the problems I witnessed in New England a week or so ago.

“It was an idiotic decision to buy in Massachusetts. I should have bought in Seattle.”- my brother as he was taking me to the airport.