Seattle Bubble

I would like to highlight a post from over on the forum that I think should be read by more people. It was written by my friend Catherine (a.k.a. “Dove”), and posted to the thread How did you first learn of the National Housing Bubble? (Although it really speaks well to the Seattle market specifically.)

It was a long awakening, for me. I put “2004″ in the poll, but depending on how you call it, it could’ve been a year earlier or later.

The first sign of trouble came when we’d been married a couple years, living as poor grad students in an apartment, and I started dreaming about getting a house. Nothing fancy, really - like maybe one of those cute little cottages with a tiny yard that Need Lots Of Love. Surely an itsy bitsy house couldn’t be that much, right? Cue realtor.com telling me what a funny little girl I was. That sent my spidey sense tingling a bit - if tiny crappy houses are that much, who the heck can afford a house to raise a family in? Strike 1. That was 2003 or 2004 I think.

Strike 2 came when I first got a job as an engineer - and a good one - and my husband and I started making plans about where to live. My family had recently moved, and now both our families were in the midwest. We wanted to live close, so we eyeballed houses in Denver, just for planning purposes. And promptly realized that they were extremely affordable. That tiny crappy fix-er-up I’d wanted? Less than my annual salary. Big New House For Big Family? We could totally swing it. Heck, save aggressively for a couple years and we could almost buy it outright.

I quickly flipped the page back to Seattle to see if the same was true here, but no dice. Apparently a mansion in Denver is worth about the same as a mud hut in Seattle. We still couldn’t afford *anything*. We promptly resolved to rent, save aggressively for a couple years, and then move to Denver, which is where we’d rather live anyway. This was 2005.

I’d heard that big cities were supposed to be expensive, but this was rediculous. I mean, it’s not like Denver is that much different from Seattle in terms of size and opportunities. Saving and moving seemed obvious. In fact, why wasn’t everyone doing that? I suspected again that something was wrong. Strike 2.

Throughout that year I began actually watching the housing market - planning to buy in the eventual future, I figured I should get a better feel for how it worked. And as I thought about things, I began to put a lot of stuff together very quickly. (1) We can afford a pretty nice apartment, with tons of money to spare. Seems like we ought to be able to afford a crappy house. But we can’t. That seems . . . odd. There ought to be some sort of in between transitional product, right? They should be pretty comparable, right? (2) Actually, come to think of it, we’re pretty well off - I make more than a lot of friends and neighbors and relatives all of whom are homeowners, and I can’t afford a house. What gives? (2) And actually, come to think of it, who the heck is buying all of the houses? Where do all the normal people live???

More complaints confirm it isn’t me. My brother in law has trouble with his house and then more trouble with his house and then a little more trouble. My co-worker is crying about how she can’t afford the low-end condos. My *boss* is considering buying a townhome full of 70’s shag. And she’s not your run-of-the-mill manager, either–she’s gotta make twice what I do.

As soon as I saw a suggestion somewhere that there was a housing bubble, it all clicked. The market that had smelled so funny for years now made sense. That was maybe a year ago. If not immediately convinced, I definitely acknowledged that it was a strong possibility. Any desire I had to buy a house evaporated overnight.

The final straw actually came recently when someone on that blog pointed out that rent prices were out of whack with housing prices. For some reason, I’d never thought to check that - I’d just always assumed those markets would pace each other. A quick run by Craigslist confirmed it.

That cute little crappy house I’d wanted? Rents for about the same as my apartment. Perhaps a bit more, $200 or $300 more. Psshaw. Shopping around a bit more, I saw nice houses go by at decent rents. And it suddenly dawned on me that if I wanted to, I could live anywhere in Seattle. Fancy condos downtown? Check. I could make rent. 5 bedroom houses? No sweat. Fancy Vacation Homes On The Water With Stunning Views? Ahhh… I might not want to pay for it, but the mechanics says I could afford to live there full time. (Not that I’m going to - still sticking to plan A, but still . . .)

Quick check on the real estate market and . . . yup, I still can’t afford the mud huts.

That’s it, I decided. That market’s hosed.

I think Catherine hits the nail on the head. If the Bull Cadre gets their wish and home prices in Seattle continue to defy all logic and reason… at least I’ll already have some local friends when I move to Denver.

I am hoping someone here will be able to clear this one up for me.

One of the frequently-repeated arguments that real estate salesmen use to try to convince the renter-serfs to buy a home is that once you buy a home, your costs are fixed. While that’s not entirely true (taxes, insurance, and maintenance can all increase—and it’s not true at all unless you get a fixed-rate mortgage), the costs can certainly be more stable than renting, where your monthly rent is likely to increase with inflation.

However, the very same people that tout the “fixed-cost” of home ownership will turn around and offer another argument for buying: get on the equity escalator so after your home appreciates you can trade up to nicer digs. This is where I get confused. If your goal is to “trade up” for a nicer home in 5-10 years, aren’t you negating the entire “fixed costs” argument?

Let me throw a few numbers out here to try to explain what I’m talking about. Let’s say Milton S. and his wife are paying $1,200 per month to rent a little two-bedroom house. They decides to stop “throwing away their money” on rent, and rush out to purchase a home (before they get priced out forever), finding a two-bedroom 1,200 sqft house in Shoreline for $325,000. Assuming they get a 30-year fixed at 5.75% and have the $65,000 to make a 20% down payment (a fairly generous assumption), their monthly PITI payment is now just shy of $1,900. They do save over $2,000 that year on their taxes, so let’s shave off a slightly generous $200 per month, and round the monthly payment down to $1,700.

Right off the bat our example couple has willingly signed up for a 42% hike in their monthly expenses (not counting maintenance). That’s quite a premium to pay just so you can have “fixed costs.” With hikes of 3% per year, it would have taken 12 years for their rent to reach that level. But hey, at least their costs are fixed, right?

Well, what happens when 10 years down the road they want to “trade up”? Thanks to the “equity escalator” and annual 4% appreciation, their $325,000 house nets them a sweet payday of $227,500 (after fees & taxes). Unfortunately, the house they would like to trade up to—a four-bedroom, 1,900 sqft house in Ballard that cost $450,000 when they bought their first home—has been appreciating at 4% per year too, and now costs $666,110. Even after putting the entire amount down from the sale of their first home, their monthly PITI payment (minus tax savings) will jump 65% to $2,800. The situation is even more skewed if you assume greater appreciation (like say, 7%), with their $1,700 payment skyrocketing to $3,294.

After 10 years and just one trade up, jumping on the equity escalator has resulted in a 133% increase in monthly costs for our fictional couple (over the original $1,200 rent). If they had instead continued renting, their monthly rent after ten years would have increased “just” 34% to $1,613.

So I guess what I’m saying is that I can’t see how the “fixed costs” and the “trading up” arguments can both be true. The real issue here seems to be that the idea of trading up when an over-inflated market is your starting point just doesn’t make any sense. If Milton and spouse had bought that $450,000 home to begin with, still only putting down $65,000, the monthly PITI would have only been $2,521 (assuming PMI— it would drop to $2,350 in three years when the equity reached 20%).

Can anyone describe to me a situation in which “trading up” is a winning proposition?

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