Seattle Bubble

Here’s an email I got from someone named Andy:

I am in the process of relocating to the Seattle area from the Midwest and have been monitoring your blog in an attempt to get some insight into the local real estate scene.

First, thank you for your highly interesting and informative blog. Knowledge is power and you certainly are providing some interesting information for the consumer.

Here are my questions for you. What is with the psyche of local home buyers and sellers in the Seattle market that they are willing to overpay for housing (at least that is my impression)? Am I crazy to pay what people are asking for a home?

Let me elaborate. I have been scouring every information source I can for real estate information in order to become the most informed consumer I can. Here is what I have learned in a nut shell. Nationwide housing is in a slump (to put it lightly). For example the recent announcement that U.S. median sales price of a new home fell 13 percent in October, compared with a year ago. There are some markets however (Seattle, Salt Lake City, San Jose) whose home prices actually rose YOY. I get that Seattle is somewhat special in terms of real estate markets.

An additional piece of information is that I’m one of those people that wants to be a home owner. I appreciate that home ownership may not be the smartest financial move when compared to renting (especially at this time) but I put a great deal of value on the intangibles. I have two small children and the concept of “home” is very important to me so I accept the potential financial downside of home ownership.

BUT as you have stated on your blog, Seattle prices rose 4.69% YOY as of September. So here is my conundrum. I have been monitoring housing prices on the internet using various real estate tools. I have been specifically monitoring a few houses to see if their asking prices are dropping, how long they stay on the market and what the actually sell for. I have noticed a disturbing trend that I simply can’t figure out and would like your insight. I have monitored a couple of houses (in Issaquah and Bellevue for example) that were purchased in September of 2006 for around $600,000. They were put on the market in the fall (September-ish) and the asking prices were about $720,000. My calculations show that these people were expecting a 20% increase in the value of their property in one year. Is that realistic for Seattle regardless of the market – prior to 2007 were people really getting 20% annual growth. The interesting thing is that I have seen the asking price for these properties now drop to about $695,000. This is still a 16% increase. If the numbers show that Seattle prices rose 4.69% YOY as of September, why would anyone pay more than $628,140 for a house that was previously purchased in 2006 for $600,000? Furthermore, I’m thinking for that house that was purchased in 2006 for $600,000 I would pay about $610,000 right now because even though it gained 4.69% in 2007 it will probably lose value in 2008. Are Seattle home purchasers crazy enough to pay $700,000 for a house that was just purchased a year ago for only $600,000?

Andy seems to have three basic questions: Do you have to be crazy to pay today’s home prices in Seattle? Is an asking price 20% over last year’s purchase price realistic? And lastly, how does the median home price relate to specific houses?

To address the last two questions, I will point out the statistics only tell part of the story. We primarily focus on the median single-family home price in King County when discussing prices here, but that number is useful only in gaining an overall picture of market direction, and is fairly useless when trying to determine a reasonable price for a specific home. There are a few reasons for this. First, as has been discussed here a couple of times before, the median price can easily be (and has been) skewed by a change in the demographic mix of homes sold.

Secondly, while the market in general tends to build momentum and move together in the same general direction, every neighborhood has its own unique considerations that will result in larger or smaller changes in price. For example, looking at the county-wide statistics (or even the more local NWMLS areas within a county) won’t tell you that a particular neighborhood just had a big box store approved to build two blocks from a home you’re looking at, causing its value to drop like a rock. When you are seriously interested in a particular home or neighborhood, you really need to look at all the factors that affect that particular location.

That being said, if the county-wide median is flat year-over-year (which it is), it’s a pretty safe bet that someone asking 20% over last year’s price has got their head in the clouds (to put it politely). Maybe that neighborhood has had some significant improvements in the last year, making them more desirable relative to other choices in the Seattle area, and a 5% would be realistic. You can’t tell just by looking at median prices though. Statistics are useful for gaining a high-level view, but to know whether a particular house should be appreciating and by how much, you have to look at that particular house.

As far as the more general question about the sanity of those that would shell out $600,000 for a run-of-the-mill house in Seattle, my personal opinion is that most people paying these prices have been caught up in the “bubble mentality.” It’s the little voice that says:

Look how fast prices are going up! Don’t you want to get in on that action? You know, if you don’t take advantage of it and buy now, you’re going to be priced out forever! You don’t want to be the only one of your peer group that doesn’t get a ride on the equity train, do you? Buy now before it’s too late!

For a great example of this mentality in action, check out this article I highlighted in 2006. It’s that mentality coupled with the easy, standards-free lending we saw 2004-2006 that pushed prices up to their present ridiculous highs.

However, as I’ve said many times before, if you have the finances, place a high value on the “intangibles,” and can tolerate the downside risk of buying now, more power to you. I’d at least hope that you will take your time home shopping and not pay full asking price for whatever place you end up selecting.