Seattle Bubble

A while back (September 2006, to be more precise) the Seattle Times published a 22-year “analysis” of King County home prices, which essentially came to the conclusion that Seattle would be immune to the home price drops that were beginning to occur elsewhere around the country. Their graph of local home prices going back to 1984 was interesting, but I was frustrated by two things. First, that it was not adjusted for inflation, and second that it did not go back further.

A while later, I had a lengthy email conversation with local mortgage company owner Steve Tytler, in which he made the following claim:

Home prices in the Seattle area follow a very predictable pattern: 2-3 years of rapid appreciation followed by 4-5 years of virtually no appreciation. I call it a “stair step” pattern. Prices jump up, flatten out, jump up again, flat out, and so on. You will never see a major housing price crash here.

I wanted to do the research to find out whether or not Mr. Tytler’s claims hold water, and to improve upon the Seattle Times graph, but with reliable home price data from the NWMLS only going back to 1993, I was in a bit of a jam.

Thankfully, Mr. Tytler pointed me toward a source of home price information that goes further back than the available NWMLS reports we have previously relied on at Seattle Bubble. The Central Puget Sound Real Estate Research Report (originally known as the Seattle Real Estate Research Report) has been publishing local housing market information every six months since 1946. After doing some digging I discovered that the UW Special Collections has a complete set of the reports going all the way back to the beginning.

So, after more than a few Friday afternoons spent at the UW pouring through the old reports and hours spent merging the old data with the modern NWMLS data and adjusting for inflation, I have come up with the following graph. The red line shows inflation-adjusted median single-family home prices (in 2007 dollars) from 1946 through 2007. The gradient area depicts the year-over-year change in home prices.

Click to enlarge

Looking at home price data this far back shows us a few interesting things. The first thing that jumps out at me is how flat the graph is from 1946 through about 1969. It would seem that as far as home prices are concerned, the early to mid 1970s was when Seattle made the transition from small town to real city. As such, I don’t think we can really gain any useful information from looking at home price patterns pre-1970.

The second thing I notice is that from 1969 to the present there have been three periods where prices have declined for more than a year:

• 1969-1975 (6 years) - Total Drop: 21%
• 1979-1985 (6 years) - Total Drop: 20%
• 1990-1992 (2 years) - Total Drop: 5%

In fact, if you look at the graph from 1968 to 2000, it actually seems to support Steve Tytler’s “stair step” theory. The only problem is that there’s a spike from 1997 to 2000 that—if the stair-step pattern were to continue—should have been followed by 7-9 years of declining and/or flat prices. Instead, after a very short breather, prices only begin to skyrocket even further up.

Let’s look at the three “steps” from 1968 to 1997.

Step 1:
Jump: Fall ‘68 to Spring ‘69 - 11% in 6 months
Drop: Spring ‘69 to Spring ‘75 - -21% in 6 years
Peak to start of next big run-up: 7.5 years

Step 2:
Jump: Fall ‘76 to Spring ‘79 - 71% in 2.5 years
Drop: Spring ‘79 to Fall ‘85 - -20% in 6.5 years
Peak to start of next big run-up: 9.5 years

Step 3:
Jump: Fall ‘88 to Fall ‘90 - 41% in 2 years
Drop: Fall ‘90 to Fall ‘92 - -5% in 2 years
Peak to start of next big run-up: 6.5 years

So we’re looking at an average run-up of around 2 years, followed by a dropping/flat period of about 7.5 years. Now look at the present “step.”

Step 4?
Jump: Spring ‘97 to Spring ‘07 - 93% in 10 years

So, the current run-up has basically lasted five times as long as any previous spike in King County. All other factors being equal (which of course they aren’t), one could logically conclude that the upcoming period of dropping or flat prices will also last five times as long as previous steps, meaning we would be looking at 32-48 years of flat prices on the horizon.

Do I really think we’re facing 30+ years of flat prices? Probably not. Notice that previous year-over-year price declines have never exceeded 5% for more than a year and a half. We could easily correct for this extra-long run-up by having just 3-5 years of price declines in the 5-15% range, sparing us the 35-year stagnation. Personally I think that’s a lot more likely. In any case, I’m just presenting you with the facts. You decide how you want to interpret them.

Sources:
(1946-1992 Home Prices: Seattle Real Estate Research Report)
(1993-2007 Home Prices: NWMLS)
(Misc. Price Data: Seattle Times)
(Inflation Data: Bureau of Labor Statistics - Consumer Price Index)

I’d like to take a little time to address a few things that keep coming up here and elsewhere in online real estate conversations that are starting to bug me. So that’s what I’m going to do.

Doom and Gloom Apocalypse Fun Time

First up is the incessant refrain that anyone predicting a decline in house prices is forecasting “doom and gloom” and/or a “housing apocalypse.” How do lower prices translate to “doom and gloom”? Isn’t it a good thing that people will actually be able to afford to buy a house without entering into a self-destructive financial death trap? Are falling gas prices “doom and gloom”? What about falling flat-screen TV prices?

When the cost of something falls, it is a good thing that leads to greater affordability and frees up money for people to spend on other things. Apparently I’ve got it backward. To me, a rapid escalation of prices leading people to make extremely risky financial decisions and putting them in a situation where all they can afford to do is pay the mortgage (if that) is “doom and gloom.”

Convenient Opinion Boxes
This is one I see a lot on blogs, and I’m sure I’m even guilty of it as well: stereotyping opinions. For example, someone comments that they don’t think prices will fall 20% next year, so someone else labels them as a “housing cheerleader” that doesn’t think prices will fall at all, ever. Or on the other side, someone remarks that they expect prices will continue to drop for the next year and therefore don’t intend to buy right now, and the response is something to the effect of “renting forever is stupid.”

The fact is, you can’t put people’s opinions into convenient boxes. The fact that I don’t intend to buy a house right now does not imply that I think nobody should ever buy a house. Likewise, someone who doesn’t have a problem buying now doesn’t necessarily think prices will keep going up.

Let’s try to avoid making assumptions about people’s opinions based on one or two comments. The discussion is much more productive when we actually address what people are really saying, not what we imagine they might say if they were a certain “type of person” that we assume them to be.

“Won’t you feel silly…”
Lastly, it has been said that if prices “only fall 20%,” won’t I feel so silly, because that would put them back at 2005 levels, which is when I started the blog, tee hee hee.

Of course I won’t feel silly. First off, what did I say when I started the blog? Did I claim that prices were going to plummet from their current levels? Did I predict fifty cents on the 2005 dollar? Nope.

Here’s what I did say:

One thing I do know for certain is that the recent trend of rapidly increasing property values (double-digit increases year-on-year) cannot possibly continue indefinitely. If it did, eventually everyone would be priced out of real estate. There has to be a slow-down sometime, and I think it’s coming fairly soon (within the next 3-5 years). I don’t know if it will take the form of a leveling off of values, or a slow decrease, or a sudden decrease (bubble bursting), but I know it is coming.

By not buying a home in 2005, I have been able to pay all my debt (which was 90%+ school loans), purchase two cars with cash, give generously to charity, and build up a decent amount of savings—retirement, stocks, and enough liquid cash to live over a year with zero income. Why would I feel silly about that?

Furthermore, prices retracting to their 2005 levels in 2008 does not really mean that prices were “flat.” When you account for inflation, it’s actually a decline. In fact, according to the Bureau of Labor Statistics inflation calculator, just to keep up with inflation, a home in 2007 would have to sell for 7.6% more than it did in 2005. You can’t ignore three years of wage increases and savings built up by renting.

That being said, my guess is that prices will fall by at least 20%. I suspect that they will fall further, but even if 20% off the peak is the lowest they go, it still makes far more sense to buy at 20% off the peak with sound financing in 2008 than it would have to buy for the same price with a shaky loan in 2005.

Back to Business
So there you go. Now that I’ve gotten those things off my chest, we can get back to the business of bashing real estate agents and mocking home sellers. (It’s a joke, people.)

As I’m sure you all know by now, yesterday the Federal Reserve cut the benchmark interest rate again. While this move will no doubt feed the false hope for a speedy end to the housing slump, there is likely nothing the Fed can do that will stop the bubble from deflating.

However, when I step back and look at the big picture, I can’t help but be a bit concerned about the effect the recent rate cuts will have on my dollars. Over the past year, the value of the dollar has already fallen over 10%, with the steepest declines immediately following the September Fed cut of 50bps:

Click to enlarge

Meanwhile, the government is reporting mild inflation in the 2-3% range, but when calculated using the method from 1980, we’re actually sitting on over 10% inflation.

Click to enlarge

So on the one hand, you have the government telling us that basically everything is fine, the economy is humming along nicely, inflation is under control, and housing—while definitely a bit of a drag right now—is sure to pick back up soon. On the other hand, you have bloggers and economic commentators that see us moving toward hyper-inflation and dollar “destruction.”

I’m not trying to be alarmist here, because frankly, I don’t follow this big picture stuff closely enough to have a good handle on what is really going on. However, given the unimpressive recent record of “economists” and government mouthpieces when it comes to predicting the direction of housing and the economy, I’m inclined to believe that the bloggers may be closer to the truth.

So let’s say that extreme inflation / dollar devaluation is indeed around the corner (or already upon us). What do we as financially responsible, saving individuals do to avoid having our savings become worthless? Socking away all the money we’re saving on rent into a 5-6% CD doesn’t do much good if inflation is 10% (or higher). Knowledge is power, and if we have the knowledge of major economic changes headed our way, we should use that to our advantage. The only question is how.

I don’t have any good answers here. I’m just thinking out loud, and hoping to spur a discussion that can be productive for all of us. So, what are some answers?