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As we begin 2006, the housing market appears to have cooled to
some extent. But questions about the real estate bubble still
linger. My motive in dedicating this issue of My View to this
topic is to provide information and perspectives that readers
can actually use. I’ve asked an array of experts—realtors,
economists, mortgage bankers, real estate researchers, and
institutional real estate investors—whether they think there’s a
bubble in the first place and, if so, is it in danger of
popping. The answers I’ve received help to address the question:
For a potential homeowner here in the Northwest, right now, Is
this the best time to buy a home? Or, for a current homeowner,
Is this the best time to sell?
For those of us who are committed to helping make the dream of
homeownership a reality for more people, rapidly rising prices
continue to be bad news. That first step, getting into a house
of your own, has always been a daunting challenge. Now, in much
of the U.S., and certainly in the Pacific Northwest, it has
become even more difficult.
IS there a
Housing Bubble?
There is no simple answer to this question. A wide range of
factors impact home prices, and these include interest rates,
the availability of loan programs, the strength of the local
economy, employment growth and income levels, population growth,
and many others. Three economists were generous enough to share
their perspectives with me for this newsletter.
Paul Kasriel, Senior Vice President and Director of Economic
Research
Northern Trust Company
I’ll start with
Paul Kasriel,
Senior Vice President and Director of Economic Research at The
Northern Trust Company. Paul is direct and to the point.
“I think it’s a bubble,” he says. For Paul, it’s a
straightforward scenario: cheap credit has pushed housing prices
past their fundamental value; this has created speculation in
the housing market. If cheap credit causes a bubble, it follows
that when credit becomes too restricted, the bubble will burst.
“The question is what the Fed will do,” he says. Recent
consensus has been that the Fed would raise rates .25% at each
of their first two meetings in 2006—and possibly stop there. In
fact, the Fed did raise the Federal Funds rate by 25 basis
points on January 31; what will happen next remains to be seen.
State-Level House Price Appreciation Rates, Q1 2005
“Seattle is one of the higher-priced markets, relative to
incomes,” Paul points out. “And in general, across the country,
the market value of residential real estate is the highest ever
relative to household after-tax income.” As of the third quarter
of last year, that ratio nationally was about 210%, a post-WWII
record high.
“Right now, there are definite signs of some cooling off,” he
says. “I don’t see signs of panic yet, but there has been a
tremendous amount of speculation in housing in the last several
years, primarily in the condo market—but not just in the condo
market.” He thinks that a certain portion of those who bought
houses for investment purposes and are experiencing a negative
cash flow and seeing softening prices will be tempted to get
out. In other words, the air will be coming out of the balloon;
the question is how fast?
Next, I spoke with
John W. Mitchell, Economist, Western
Region for U.S. Bancorp. John’s answer to the bubble question is
“we’ll know that down the road.” One of the points he emphasizes
is that, in talking about real estate, we have to keep in mind
that “these are local markets.” If you look at statewide data,
for example, Oregon (up 16.92%), Washington (up 15.64%), and
Idaho (up 15.08%), were ranked 9th, 10th, and 12th nationally in
terms of one-year house price appreciation from 9/2004 to
9/2005. These are the most recent figures compiled by the Office
of Federal Housing Enterprise Oversight. Certainly this is
faster than the national average, but not the gusher growth seen
during the same period in Arizona (+30.33%) and Florida
(+25.18).
John stresses the difference between buying a house and buying
stocks as an investment. His view, in line with many of the
experts interviewed, is that if you’re buying a house to live in
it, the comparison simply doesn’t make sense. “From an
investment standpoint, buying a house is not as likely to be as
good an investment in the future.” He points to an FDIC study of
housing booms vs. busts. A boom was defined as a one-third
increase in real price in three years. A bust was a 15% drop in
nominal prices over five years. Only 17% of booms ended in a
bust. “Most of the time what happens is that you get slower
appreciation, a leveling out, even perhaps a slight decline—but
not a wholesale collapse in prices.”
I also spoke with
Michael Fratantoni, Senior Director,
Single-Family Research and Economics at the Mortgage Bankers
Association (MBA) in Washington, D.C. Michael is the primary
author of the in-depth and informative “Housing and Mortgage
Markets: An Analysis,” published by the MBA last September. From
his perspective, there’s no simple “yes or no” answer: his study
took 80 pages and 60 charts to understand the depth and
complexity of today’s real estate market.
“We track closely,” Michael emphasizes, “the inventories of
unsold homes. If you look at both new homes and existing homes,
those inventories have been increasing. That’s reinforcing our
belief that home price appreciation rates will slow.” Relative
to history, inventories are still fairly low. But inventories on
a national basis are generally above where they have been.
“These last few years have been unusual historically in the rate
of home appreciation that we’ve seen, and that’s likely not
sustainable,” Michael says. He adds that the MBA expects a
deceleration in 2006: “Getting back to more reasonable patterns
of price appreciation, more like 5 to 6%, rather than double
digits like we’ve seen.” Interestingly, this is the same growth
rate that experts predict for commercial real estate. [Please
see, “Strictly Commercial.”] Unfortunately, there
are always outliers. “The Seattle area, for example, may be an
exception,” he adds. “There are always going to be some hot
pockets.”
A Perfect Market for Real Estate?
If you’re looking for an area of the U.S. that offers a textbook
example of the factors that support home price appreciation, you
could hardly do better than the Puget Sound region. We’ve got
all the ingredients: low interest rates, a strong economy, a
growing population, positive job growth. Available new land for
development is at a premium. Traffic problems are growing, which
encourages those who can afford it to live near where they work.
We also have a low inventory of available homes, particularly in
the lower price ranges.
J. Lennox Scott, Chairman and CEO
John L. Scott Real Estate
J. Lennox Scott calls the four-county area that essentially
makes up Puget Sound “the perfect market for real estate.”
Lennox is Chairman and CEO of John L. Scott Real Estate, with
131 offices in Washington, Idaho and Oregon. He has been working
in real estate for 30 years. In terms of total home sales, Lennox reports, 2004 and 2005 were
record-breaking years for all three states. “This holds true for
the entire region,” he says. And he expects 2006 to be a
record-breaker as well, at least in terms of sales dollar
volume. He cites a prediction by the National Association of
Realtors: “2006 is projected to be the second best year on
record in terms of the number of home sales.”
Lennox’s comments on market demographics bear repeating: “The
real estate market is driven by first-time homebuyers, which
creates a chain reaction of sales up the price points.
Historically, nationwide, about 40% of sales come from
first-time homebuyers. This is what has created these all-time
record markets.” When interest rates came down, more and more
people were able to buy, which caused a chain reaction up these
price ranges. That prompted record sales not just in
lower-priced homes, but also in the mid and upper price ranges.
Lennox is seeing more compression between price ranges. In other
words, if you’re already in a home, your equity puts you in a
good position to “move up the pricing pyramid, because you’re
getting more of a price appreciation.” But if you’re not already
in a home? That’s the rub. Beginning around 2010, the so-called
“Echo Boom Generation”—grandkids of the Boomers—is slated to
reach homebuying aspirations in full force. This demand should
put a floor under prices for the current generation of sellers.
But what about the Echo Boomers? “Prices are only going to go
up,” says Lennox. “No one is speaking up for this generation.”
He sees a continuing, and very real, problem with housing
inventory in the affordable part of the spectrum.
The Challenge for
First-Time Homebuyers
A detailed statistical look at the challenge of affordable
housing comes from Glenn E. Crellin, who has been researching
Washington State real estate for the past 12 years as Director of the Washington Center for Real Estate Research
in Pullman.
Before that, he worked for the National Association of Realtors,
where he originally created the Housing Affordability Index.
Glenn E. Crellin, Director
Washington Center for Real Estate Research
In the 12 years he has been collecting data on Washington State,
affordability has declined to its lowest levels. The First Time
Affordability Index he compiles assumes that a first-time buyer
can afford to purchase property that’s listed at 85% of an
area’s median price, with this buyer earning 70% of the median
household income of that same area. The most recent data from
3rd Quarter 2005 show that, statewide, this buyer has only about
59% of the income required. “Their challenge is very great,”
Glenn affirms. “These buyers need to find something priced
significantly lower than entry level. Or to find a way to
increase their down payment. This is the worst picture—the
lowest affordability I’ve seen since I created that index in
1982.”
Demand impacts supply, which impacts price. Glenn quotes his
most recent (end of September 2005) inventory data for King
County: Homes priced under $80,000 are few and far between, and
are typically not in live-in condition. There were enough of
those homes to satisfy the market for four months. But in the
next price range, $80,000 to $160,000, there was only a 1.2
months’ supply. “Keep in mind that a six or eight months’ supply
is a balanced market,” Glenn asserts. The next rung was even
worse: in King County, in the $160,000 to $250,000 range, there
was only enough of a supply for .6 months. “Talk about pressure
on pricing,” he says. It gets a little better in the upper price
ranges, but “it’s still a very tight inventory across all price
ranges.”
The good news is that most other Washington counties, Glenn
reports, have inventories much closer to historical norms: short
in the $0-$80K range, balanced in the mid range of prices, and a
big supply of inventory in the upper range.
And for those who are thinking of selling, an aside:
particularly in the higher-price-range segments of the market,
it might not be a bad time to sell. The opportunity for
significant increases appears to be somewhat more limited.
Glenn’s prescription? “If we can achieve some greater price
stability, we still have an opportunity to bring lower and
middle income buyers into the market. But we have to be very
very diligent.” He cites both down payment assistance for
low-income buyers and the availability of lower-than-market
mortgage rates as important. The challenge is that currently,
housing development costs are very high. “As land costs
skyrocket, there’s a great deal of pressure on developers to put
elaborate homes on small lots, or else sacrifice profit.”
Bubble or no bubble, it’s essential, Glenn concludes, “to have
an active market at the bottom that can serve as the lowest
rung—to allow households to begin to develop.”
Mortgage Rates and
the Greenspan Conundrum
In addition to the slowing national trend of housing price
increases, there’s also some relief coming from interest rate
trends. There’s been a lot of talk in the media over the last
year and a half about the flattening trend of the slope of the
yield curve—just-retired Fed Chairman Alan Greenspan’s
“conundrum.” Long-term interest rates have been going down while
short-term rates have been rising, in slight increments, in
tandem with the Fed Funds rate.
James L. Kirschbaum, President
Action Mortgage
For current homebuyers, that’s good news. As Spokane-based
mortgage banker James L. Kirschbaum points out, this has, to
some extent, leveled the playing field for first-time
homebuyers. I know Jim well as he was the first Chair of the
Commission in 1983. Today he serves as President of Action
Mortgage Company, which does construction and permanent lending
in the five-state region of Idaho, Montana, Oregon, Utah, and
Washington. Currently, says Jim, “the traditional 30-year
mortgage is as cheap or cheaper than Adjustable Rate Mortgages (ARMs).
This is giving everyone more of a fair shake.”
Why? When short-term rates were exceptionally cheap, investors
and speculative buyers could leverage themselves to the hilt
with an interest-only ARM. Then, when a home’s appreciation hit
their target, they could resell, helping to drive up prices.
“This was happening a lot,” he explains. He points out, though,
that our region hasn’t seen the degree of “condo flipping”
that’s been happening elsewhere in the West, like Phoenix and
Las Vegas. This is the practice of buying and selling a condo
within a matter of months—sometimes weeks—to reap quick profits.
According to Jim, in the Pacific Northwest, the city of Portland
has seen the highest rates of this, and to a much lesser extent,
Seattle.
10-Year
Treasury at Constant Maturity, Quarterly through Q1 2005
Mortgage banker
Mike Olden is based in Bellevue as Operations
Manager of American Reporting Company. Mike makes the point that
no matter what the current interest rate environment, buying is
always a great opportunity “if the buyer can afford the
payments, and is comfortable with the situation.”
What it boils down to, says Mike, is “not so much the interest
rate, but can you afford the monthly payment?” From his
perspective, even if interest rates go up more than half a point
this year, you can still get a great rate on a 30-year fixed
mortgage.
“As consumers, we tend to look at interest rates, rather than
what we can afford each month,” he says. His company provides
credit reports, along with education, to develop better-prepared
borrowers. And he emphasizes the importance of the homebuyer
education provided by the Commission and other partners.
The Investment that
Keeps on Giving
Maybe I’m preaching to the choir here. But in answer to the
question, Is this a good time to buy a home?, all the experts
interviewed pointed to the absolute virtues of owning your own
home, whatever the current uncertainties, rather than trying to
time the market.
Here’s a sampling:
Jim Kirschbaum: “In the long run, everyone, with few exceptions,
would be better off to buy if they can afford to buy, whatever
the interest rates are. Down the road, you will get some
appreciation, some amortization possibly. You can build equity;
deduct interest from taxes; create something to bargain with;
build something.”
Paul Kasriel: “Housing has tax benefits, mortgage interest
deductions. For most people, realized capital gains are
tax-exempt. And unlike a NASDAQ investment, you live in it—it
pays a dividend.”
Mike Fratantoni: “It’s still true today: If you anticipate being
in a home for any reasonable period of time, four or five years
or more, it’s going to wind up being a decent investment for
you. And you’re also going to get to live in it.”
Expense of Owning vs. Renting
Managing the Risks of
Buying or Selling a Home
After weighing all this information, it’s probably time to state
some conclusions. After all, I did say at the outset that this
discussion is intended to be practical.
Let’s start with sellers, as that’s an easier discussion. For
most people, in most markets: Congratulations. The game’s over
and you won. I’m assuming you’ve lived in your house for a
while, built up equity and enjoyed the recent price run-up as
well. Should you sell today? I think the answer depends on
whether or not you really want to move to another home. If you
have a new destination in mind and can afford it, why would you
want to wait? Hoping for further price increases at this point
would be pure speculation.
The question for buyers is much more complicated. Basically, in
every price range except the highest ones, you will probably
encounter fewer choices than you’d like, and you will feel like
you’re not getting much house for the money. That’s normal in
any seller’s market. Historically, the best advice has been to
get a foothold in the market with monthly payments you can
afford; ignore any short-term price fluctuations; and ride the
long-term trend, which lets you build equity.
Does that advice still hold true today? In my view, the
consensus of the opinions reflects the fact that what we are now
experiencing in Washington State most closely resembles a “boom”
as defined by John Mitchell. That is, a one-third increase in
prices over a three-year period. That’s still a risky scenario,
as almost 20% of booms are followed by “busts,” which are 15%
declines lingering over a five-year period. It would be painful
indeed if you were forced to sell your home at a loss. But it is
still nothing like the chaos of a “bubble bursting,” which
carries connotations of fire sale prices.
According to the experts, there are several things you can do to
mitigate the risks of buying a home:
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Make sure you can afford the monthly payments. Here, the
type of mortgage instrument you choose is a key factor. Fixed
rates pose less risk to homebuyers, because they are
predictable. The downside is that they can be more expensive
over the life of the loan. If an ARM is your best route to
making the home affordable, make sure to calculate the “worst
case scenario” so you’ll know what to expect if rates go up.
-
Understand the difference between single-family homes and
condominiums. Condos are often more volatile in terms of
pricing. They are a popular vehicle for speculators, and the
supply/demand equation can change in a hurry when new
buildings are developed. They offer other uncertainties as
well, like the fees associated with ownership. But condos
can also be the best entry point for a first-time buyer—just
be aware that the risk level is usually greater than that of
a single-family home.
-
Get to know the neighborhood. Prospective buyers have
an array of resources at their disposal to help them gauge
the relative price stability of homes in a particular
neighborhood or region. In general, neighborhoods with
owner-occupied homes enjoy more price stability, compared to
neighborhoods with a high percentage of rentals. As
consumers, buyers need to educate themselves about the
neighborhood they’re targeting, including taxes,
transportation, safety issues, and schools.
-
Avoid using home equity to build consumer debt. Too
often, homeowners are tempted to take equity from their home
to finance other purchases. This places a burden on cash
flow, slows the growth of home equity and creates a major
financial risk. It’s OK to do in an emergency, but otherwise
it’s wise to avoid consumer debt as much as possible.
To update the old adage, there are three secrets to success in
real estate: Education. Education. Education. Get to know the
pluses and minuses of the different loan programs, and inquire
about the different forms of homebuyer assistance available from
federal, state, and local sources. Research every aspect of the
neighborhood you’re considering. And make sure you make a
realistic assessment of your earning capability. When in doubt,
err on the side of caution (buy a little less house than you
think you might be able to afford). Once you’re situated, try
not to pay too much attention to housing prices. Your home is
for living, not the other way around.
Strictly Commercial
Retail, office, industrial and apartment
properties are booming too
What about commercial real estate? Here at the Commission, our
scope is broader than single-family homes. We work with
developers and builders of multi-family apartment buildings and
facilities such as community centers, museums, and office space
for nonprofit organizations.
More importantly, experience shows that it’s essential to take a
holistic view. The housing market and the job market in a
community are inextricably connected. So we wanted to know how
commercial real estate fits into the mix. We spoke with Karl
Smith, Director of Real Estate, and Adam Babson, Associate
Research Analyst, at the globally recognized investment manager
and consultant, Russell Investment Group, which is headquartered
here in Tacoma.
Karl particularly wanted to convey the fact that “the real
estate market is not homogeneous.” For example, his group at
Russell manages $5 billion of investments in commercial
properties and real estate securities for institutions including
pension funds, university endowments, and nonprofit foundations.
These investments are diversified geographically and by property
type. The four major types—retail, office, industrial, and
apartments—tend to do well in different stages of the business
cycle.
Furthermore, it would be a rare exception if any of these
investors actually occupied a building or took a hand in
directly managing a property in their portfolio. Usually they’re
simply participating in an investment fund that happens to
invest in real estate rather than stocks or bonds. That’s a much
different scenario than a family buying a house as their primary
residence—or even as a retirement or vacation home.
That said, the market for commercial real estate investments as
measured by the NACREIF property index rose approximately 20% in
2005. As we have seen, this increase is comparable to those for
single-family houses in many areas of the country. And, like
residential real estate, factors such as the level of interest
rates or job growth help determine the commercial market’s
behavior.
Karl and Adam say that last year’s 20% return was one of the
highest ever recorded by the NACREIF index. “Currently,
valuations in each sector have begun to get rich relative to
historical valuations and relative to the broad market.” As a
result, they foresee returns this year in the range of 3-5%.
Clearly a slowdown compared to last year’s rapid growth, but
hardly a bursting bubble.
While they do not follow the single housing market
professionally, they were willing to offer an interesting
observation. They noted that journalists have been stoking our
fears that the situation with real estate might be comparable to
the recent tech bubble. But as Adam points out, “From 1990 to
2000, NASDAQ stocks went up 1100%. By comparison, from 1997 to
2005, Miami home prices are up 200% and the index for REITs
(real estate investment trusts) is up almost 100%. These figures
are pretty tame compared to the NASDAQ’s increase.”
NEWSLETTER ARCHIVE
About Us
The Washington State Housing Finance Commission is a self-supporting
agency that provides below-market financing to buy, build or
preserve affordable housing and nonprofit capital facilities. The
Commission builds partnerships with the private sector to raise
capital needed to further these social and economic objectives at no
cost to the taxpayers of Washington State. For more
information about the Commission and its work, visit
www.wshfc.org or call
206-464-7139 or 1-800-767-HOME (4663) toll free in Washington State. |
