Seattle Bubble

Now that prices are undeniably dropping in Seattle, a common refrain from real estate salespeople is that “you can’t time the bottom,” or “you can’t predict the future,” implying that you should go ahead and just buy now, because we’re probably at or near the bottom already, and if you wait you’ll be sorry.

This is an interesting line of reasoning, but while it is true that no one can know with certainty what the future holds, blindly making a gut decision based on our lack of knowledge would be foolish. Instead, we can and should consider the different possibilities and base our decision on a rational analysis of what we do know.

So let’s look at three different possibilities for where prices might go from here, and look at what it would mean if you buy now versus if you continue to rent a while longer, waiting for either two years, or six consecutive months of price increases before you decide to buy, whichever comes first.

Scenario A: We’re not at the bottom yet. Prices continue to decline, eventually bottoming out at summer 2005 levels in the summer of 2010. Prices begin to inch up slightly through the end of 2010.
Scenario B: We’re at the bottom, but we’ll be here for a while. Prices stay more or less flat through 2010, increasing no more than about 1% per year.
Scenario C: We’re at the bottom. Prices begin to increase again, rising 5-7% YOY through 2010 and beyond.

Click to enlarge

In our hypothetical scenario, let’s say that you are looking at a $450,000 house, you have the 20% down ($90,000), can afford a fixed-rate 30-year loan, and your alternative is to rent for a monthly cost of $1,500 (increasing 5% per year). There are comparable houses for sale and rent right now in Ballard that fall within these specifications, so I think they’re reasonable.

Scenario A
Buy now: Your total monthly costs are around $3,000. The value of your home decreases around 15% by 2010. If you have to sell, agent fees and excise taxes will eat up most of the $30,000 that remains of your down payment. If you don’t have to sell, who cares what it’s worth—enjoy your house and the (mostly) fixed payments.

Rent for now: Your rent increases to $1,650 per month by 2010, and if you save the extra money you would have put into the mortgage every month, and invest your $90,000 down payment at 5%, your savings has increased to $125,000 by that time. You see the prices start to increase again, and after six months of steady increases, you decide that now is the time to buy. Houses that would have formerly sold for $450,000 are now $380,000, allowing you to put down over 30%. Your total monthly costs are around $2,300 at 6% interest, $2,500 at 7%.

Advantage: Rent for now

Scenario B
Buy now: Monthly costs are $3,000. The value of your home stays more or less flat through 2010. If you have to sell, you’ll get back about $70,000 of your down payment after agent fees and excise taxes. If you don’t have to sell, who cares?

Rent for now: Rent goes up to $1,650, savings to $125,000. You decide to finally take the plunge on that house, and you can get one for $455,000 that is just like the one you were considering before. Your total monthly costs are around $2,750 at 6% interest, $2,900 at 7% interest.

Advantage: We’ll call it a wash (depends on future interest rate)

Scenario C
Buy now: Monthly costs are $3,000. The value of your home increases around 12% by 2010. If you have to sell, you get to pocket over $115,000. If you don’t have to sell—well, you know the drill.

Rent for now: You save six month’s worth of payments before realizing that prices are already going up again. Homes that were $450,000 are now $465,000. Your down payment investment has gone up slightly to $99,000. Your monthly costs are around $3,000 at 6% interest, $3,150 at 7%.

Advantage: Again, more or less a wash (also depends on your interest rate)

Of course, I don’t personally believe that all three of those scenarios are equally likely, but even if they were, there still is no real benefit to buying now. Even if we’re currently at the bottom and prices start climbing relatively quickly starting now, you’re really no worse off for waiting six months to find that out.

The biggest factor that makes this a feasible strategy is the continued large discrepancy between rents and home payments. I’m sure a skilled real estate salesperson could concoct some scenario in which waiting out the market right now is a foolish financial move, but based on this analysis of three fairly reasonable possibilities, I’m comfortable recommending that course of action for the time being.

Here’s an interesting comparison.

As of December’s Case-Shiller data, prices in San Diego County have fallen nearly 20% from their November 2005 peak. As of last month, their median price for all homes sold (single-family and condos) was $415,000 (source: San Diego Union-Tribune).

In the Seattle area, December’s Case-Shiller put prices off 4% from their July 2007 peak. Last month the median price for all homes sold in King County was $395,000 (source: NWMLS).

Now, if you listen to the so-called real estate “experts” around here, they will tell you that prices here in Seattle are just going to “plateau” and stay flat for a while, before continuing their ever-upward journey to the stars. On the other hand, no one in their right mind believes that San Diego’s price drops are over yet, given the continued severity of the foreclosure problem down there.

So let’s project the rest of this year for King County and San Diego County based on two allegedly reasonable assumptions:

1. King County home prices will remain flat through December.
2. San Diego County home prices will continue to decline, at roughly half the rate they have dropped in the last six months.

Here’s what that would look like:

Click to enlarge

If those two predictions were to hold true, homes in sunny San Diego will be seven percent cheaper than here in King County by the end of the year. I’m probably just ignorant of how super-great-awesome the Seattle area truly is, but to me, that doesn’t seem very likely. I predict that if such a turnaround does take place, it won’t last long once people realize that they can move back to California and buy a home for less money than in Seattle.

Please vote in this poll using the sidebar.

2007 Revisited
It’s that time of the year again. As the calendar rolls over, the real estate predictions start rolling in. But before we get to the predictions for 2008, let’s look back at 2007.

My own guesses as well as predictions from most of the frequently-quoted local real estate insiders were covered in this post from last January, save for Steve Tytler, whose predictions are covered here. Let’s see how we all did.

The Contenders:

• Bill Riss, chief executive of Coldwell Banker Bain
• Randy Bannecker, consultant housing specialist for the Seattle-King County Association of Realtors
• Glenn Crellin, director of the Washington Center for Real Estate Research
• Matthew Gardner, local land-use economist
• Steve Tytler, owner, Best Mortgage
• Tim Ellis, editor-in-chief, Seattle Bubble

You can go back to the post to see the full context of all of our predictions. However, for this post, I have condensed everyone’s predictions into a convenient table format for your convenience:

And the person whose predictions most closely matched the 2007 outcome was… Tim Ellis of Seattle Bubble! Steve Tytler gets the honor of being the only other person to be at all accurate, with his generic prediction of a “big increase” in inventory and a general reduction of buyers.

Note that the final reported median price change was almost exactly in the middle of my estimated range of -5% to +3%. And although my inventory and sales forecasts were the closest of the bunch, reality was unbelievably even more extreme than my predictions. So I either got pretty darn lucky, or after one year of following the market in my spare time, I had a better sense of where it was headed than the majority of those whose very livelihood is the market.

2008 Prognosticated
So that brings us to the 2008 forecast. First up, let’s check out what some of the same local real estate insiders are guessing this year:

Glenn Crellin:

Year-to-year drops should continue “for a little while,” said Glenn Crellin, director of the Washington Center for Real Estate Research at Washington State University. “I think that the next several months are still going to be challenging, but it’s a little hard to tell,” he said, adding that he also expects interest rates to increase during most of the year, potentially wiping out any savings gained by waiting.

Glenn also made some more specific predictions for the Pierce County market in a Q&A with the Tacoma News Tribune.

Matthew Gardner:

For 2008, Gardner is predicting anywhere from zero appreciation to home prices falling as much as 5 percent. “Do I think we’re going to see pain next year? Yes, I do. If there’s some glimmer of hope, it’s the fact we didn’t get terribly overbuilt because of the expense of land,” Gardner says.

Steve Tytler:

I expect home prices to drop about 10 percent to 20 percent over the next year or so, and then the housing market will flatten out with very little appreciation or depreciation for a few years.

Dick Conway:

Conway anticipates average Puget Sound-region home prices will decline less than 1 percent next year, and sales will be down about 5 percent, before rebounding in 2008. “Given that we had a pretty good run-up in prices, some downward adjustment shouldn’t be surprising,” he says.

It would appear that after being so off base with last year’s optimistic forecasts, most of this year’s predictions are a bit more down to earth. The general concensus seems to be price declines of up to five percent. As with last year, Mr. Tytler is the most bearish of the bunch, and will probably be the most accurate as well.

The Tim’s Predictions
Personally, I’m expecting to see a continued surge in inventory, with year-over-year increases between 10% and 25% throughout much of the year. As prices stagnate and drop, the number of “must-sell” homes will only increase. Furthermore, when public sentiment shifts from “buy now or be priced out forever” to “sell now or be stuck there forever,” listings will continue to increase further.

Sales will probably continue their slide as lending standards continue to tighten (regardless of which direction interest rates go). I would guess that sales will be down at least 5% to 15%. Think of it this way: The record sales that we saw in 2005 and 2006 were basically just the housing market borrowing sales from the future. Well, the future is here, and the debt must be repaid.

I do not expect prices to drop like a rock, but I think that 5% is the minimum drop we’ll see in the median, not the maximum. I’d put the range at -5% to -10%.

So there you have it. Your doom and gloom for 2008. I may be way off base, but at least I’m willing to stick my neck out there and give it a guess. I have yet to see any signs that the market is “bottoming out” or at any kind of turning point. 2007 was the turning point, and we’re pretty plainly headed down into 2008. I don’t expect this mess to work itself out before the year is out.

What say you, the readers?

In my perusals of real-estate blogs this morning, I ran across a link to Housing Predictor, a site which has recently published a forecast for the top and worst performing housing markets in 2008. Housing Predictor describes their business as follows:

We examine more than 20 micro market characteristics in each market place, including income levels, employment trends and changes, school enrollment, business trends, regional political influences, real estate sales history and current housing market velocity. The factors are all considered to come up with each local market forecast.
All of the information is gathered from hundreds of independent sources the staff develops without bias for the real estate industry to issue the forecasts.
Today Housing Predictor is consulted by the nation’s foremost investment houses, mortgage companies, real estate companies and most importantly consumers for our forecasts. Housing Predictor maintains more than an 85% accuracy rating with its forecasts.

Here is how they show Portland and Seattle in their forecast.

Given what I have seen in the performance of the Case-Shiller indices for the two cities – I found the prediction of a 12.6% spread in appreciation rates to be, well – interesting.

Prior to 2001, year over year appreciation rates in Seattle and Portland seemed to oscillate on different frequencies – but since then have tracked each other very closely. The spread in appreciation between Portland and Seattle has not been that great since 1991. I guess anything could happen – but I suspect the returns in at least one of these markets are going to challenge their claim of 85% accuracy. Perhaps it will be worthwhile to delve more deeply into similarities and differences between these two markets in a later post.

Edit:

Note that this piece has now been the subject of a cheap-shot post by our good friend Ardell over at Rain City Guide - who referenced it in her post entitled “Seattle Bubble Says Seattle Markets Going UP!“.

Most of you, I hope - caught the sarcastic references to the source - for those how didn’t (e.g., Ardell), you might want to read this article

Now that the real estate market in Seattle is finally showing undeniable signs of reversing direction (read: declining median prices), it’s interesting how the tone of some real estate professionals’ comments regarding this site (and others like it) are changing.

Seattle Bubble was started in August 2005, during a time when the “common knowledge” among those following Seattle-area real estate was that the Seattle market was hot (which it was), and that it would continue to be hot for a good long while, only possibly slowing down slightly sometime down the road. This blog began with a bias toward the notion that the market was in a bubble and a goal to collect as much information as possible to test that theory.

Throughout 2006 this and other housing bubble sites grew in popularity and the Seattle market (mostly) continued its hot streak. During this time, when local real estate agents commented or mentioned Seattle Bubble in their own blogs it was primarily with a tone of amusement. The general sentiment came across as something like: “Oh, that silly bubble blogger. He doesn’t know what he’s talking about. There is no real estate bubble in Seattle, and the market will only slow to 5-10% appreciation.”

These days though, the tone of the remarks is a little… different. Instead of “Seattle Bubble is wrong,” now it has turned to “Seattle Bubble is only right because they are like a stopped clock. If you keep saying the same thing all the time, eventually you’ll be right.” Here are a few recent examples:

With respect to the Seattle Bubble blog site my guess is that like a broken clock you can be right at least 2x a day.
- Reba

You have to chuckle though. Isn’t it like standing outside and saying it’s 42 degrees day in and day out for three years? One day you are bound to be more right than others. And for a few moments here and there you are bound to be spot on.
- Ardell

Keep in mind that Seattle Bubble (and most other bubble blogs out there) has only been in existence for a little over two years. Given the slow-moving nature of the real estate market, is it really that unreasonable that we should be making the same point–that the market is overheated and ripe for a correction–for two years?

Let’s also not misrepresent what Seattle Bubble and other bubble blogs have been saying during the past few years.

What we haven’t been saying:

The housing market is tanking right now! By the end of [insert current year here], prices will be down by 30 percent! Homeowners, get out now while you still can!

If we had been saying those sorts of things then yeah, the “broken clock” analogy would make some sense. However, that’s not what we’ve been saying at all.

What we have been saying:

The housing market is overheated. A slowdown is coming, and not just to 5% appreciation. Home prices will most likely drop, quite possibly by a significant amount. It might not happen tomorrow, but it will happen.

If we are right now, we were right two years ago. The only way broken clock type comments make any sense is if our perspective was unchanging and based on clichés and gut feelings. We’re not perma-bears here, we’re realists. When the market returns to sanity and healthy appreciation is on the horizon again, you’ll probably hear it here first. If anything is broken, it is the broken record of real estate agents that continue to claim the present market is not in trouble.