WHY DID SEATTLE REAL ESTATE PRICES GO UP SO FAST ?

WHY DID REAL ESTATE PRICES GO UP SO FAST ?

(Sorry this is so long, but nothing seems appropriate to edit out.)

I just retrieved the following information in a desert from a burning bush written on REAL, STONE tablets !

Just kidding.........the bush wasn’t on fire. Anyway, those of us interested in real estate have heard-seen stories about the “Real Estate Bubble” or just been plain amazed at how fast and far real estate prices have risen in the past few years. Most of what I know about the topic is gleaned from the Seattle Metro area experiences, but occasionally I’ll throw in hearsay and read-say about other metro areas.

As background, the past few years have NOT been the years with the fastest rate of price increase since I’ve been in real estate. That distinction goes to the boom of 1988-April 1990. After April 1990, the market slowed down dramatically, but prices fell only slightly during the rest of 1990, then rose slowly but steadily through most of the 1990’s.

Curiously, no talk of a real estate “Bubble” then.

Do we hear “Bubble” talk now because prices are so much higher now than in 1990, or because most of us have recently experienced the tech stock bubble of the late 1990’s, putting the fear of “popping” the bubble into all of us? Or, as many believe, are there sound economic reasons why the bubble “popping” is truly right around the corner? Who the hell knows, but it’s entertaining to speculate, and speculation should involve honest thinking and analysis, and that’s always good.

“Prices are too high........I’ll buy when prices get more real”.......the mantra of Bubble-believers. I first heard the statement, though, in 1988, my second year in real estate. The first person who professed that belief to me passed on buying a 3 BR 1 BTH rambler for $67,000. He bought a 2 BR 1BTH rambler years later for $105,000. It’s now worth $250,000. I’ve heard people say the same thing about prices several times since..........I guess one day it actually WILL be true, but when?

I think there are THREE main factors in why prices have risen so much lately. One reason is described fabulously here: http://www.demographia.com/dhi-ix2005q3.pdf. I found this site from a posted message in the Seattle Bubble blog: when I retrieve poster’s name, I will give due thanks and gratitude for his efforts and research.

REASON #2 WHY PRICES WENT UP:

Years ago, buyers need actual CASH to buy houses: 20% for Conventional type loans, 6% for FHA (although veterans could possibly buy without cash using VA loans.) Over time, house prices rose faster than inflation and it became more difficult (or impossible) for buyers to accumulate even the 6% required by FHA. Lenders began softening on buyer cash requirements, allowing sellers to pay for some buyer’s costs, BUT THIS WAS STRICTLY REGULATED AND LIMITED.

Eventually, prices were just too much, and lenders allowed sellers to pay virtually ALL of the buyer’s cost to buy. While this helped buyers, this action had the unintended side effect of bringing to the market A LOT MORE BUYERS. In real estate markets that were already selling at a healthy rate, now we dump in even MORE demand. More demand, limited supply......prices rose even further and faster! Not so good for first-time buyers.

In a final attempt to help buyers face increasing prices, lenders allowed buyers to, in effect, borrow their down payment. NEVER, NEVER allowed “in the old days.” Buyers, in effect, borrowed their down payments when they got FIRST MORTGAGES, generally 80% of sales price, attached to SECOND MORTGAGES, which were 10-20% of the sales price. So now lenders have created a market “to help buyers” by (1) allowing sellers to pay ALL buyer costs and (2) allowing buyers to “borrow” their down payments. Unfortunately, again, this had the unintended side effect of bringing to the market EVEN MORE BUYERS. So many new buyers, again limited supply..........is it any wonder prices rocketed ?

Because of these new loan products, and in spite of a growing population, the number of 'tenant' (vs. owner-occupied) households decreased drastically after 2000, and the number of tenant households still had not reached 2000 levels as of 2005 (last year I have statistics for.)

In 1987, a buyer needed $20,000 to buy a $100,000 house (a pretty nice house then;) in 2004, a buyer needed exactly $0 to buy a $300,000 house (still pretty nice.)

With these new loan products, the market became “artificially” saturated with buyers who would not otherwise have bought at this time. Did this process “use up” several years’ worth of buyers? Again, who the hell knows, but I believe so.

In amongst these new lending products are those referred to as “predatory.” I will not use that term to describe the loans, as it is pejorative. Firstly, the buyers I worked with who got those new 'riskier' loans would not have been able to buy a house otherwise. Are they riskier loans? Duh! Is it worth taking the risk to buy real estate? Well, that’s an individual financial soul-search not described well by the term “predatory.” To be sure, thousands of renter households became homeowners. It has been government policy for several decades to help this transformation take place. Homeownership rates in the U.S. have never been higher. Is this bad ?

Finger-waggers complain that many borrowers obtaining riskier loans will default and lose their homes. Did they ALL lose their homes ? Did the riskier loans increase homeownership rates?
Let's be careful not to throw the baby out with the bath water.

REASON #3 WHY PRICES WENT UP

I have not heard this reason mentioned in anyone else's Bubble screeds yet, but I'm stunned that I haven't read about it anywhere.

When I started in real estate, appraisers looked at the listing and the real estate purchase and sale agreement during the course of their appraising. Buyers often asked for sellers to contribute money for allowable buyer closing costs. Sometimes sellers agreed, sometimes not. The immediated suggestion that comes to mind is for the seller to raise the sales price OVER the listing price to cover the cost of money contributed to buyer loan fees. I tried this once and my broker threatened to rip out my fingernails. Raising sales prices to cover seller-paid fees was NEVER done then. Appraisers looked at list price, then sales price, and would never allow a property to appraise for over original list price.

Over time, prices escalated. Buyer costs to obtain loans increase with sales prices. REASON #2 above reviews how lenders relieved buyers of the need to save down payments, thereby increasing the number of buyers in the market, but this still leaves buyers owing loan closing costs. If these are, say, 2%, then buyer still needs $6000 to pay closing costs for a $300,000 house. In a nation where we have a negative savings rate, buyer saving up $6000 doesn't seem very likely, does it.

To the rescue.........the new, improved appraisal process ! Buyer asks seller to pay $6000 closing costs. Seller says sure, if I can raise sales price $6000. Appraiser no longer cares (or is directed NOT to care by lender eager to make loan) about list price. Buyer has good credit.......POOF ! buyer gets loan for $6000 ABOVE list price and closes sale.

What's the problem, say you ? After all, increases homeowneship rates right? Yes it does. BUT, on the public tax records of house sales, sales price is indicated as $306,000, not $300,000 ! There is no way to tag the sale on county records with the Barry Bonds asterisk (*) indicating that seller paid $6000 for buyer costs, and that the REAL agreed-upon price was $300,000.

Still no big deal...........yet. Real estate agents and appraisers rely on the accuracy of these sales records to arrive at list prices for sellers wanting to sell several months in the future. Market analyses and appraisals use these sales prices to determine the value of the next house going up for sale 3 months down the road. Now, three months in the future, seller of a very similar house in the neighborhood believes his house is worth $306,000, not $300,000. Still no big deal..................yet.............that is, until this process is repeated, and repeated, and repeated. So 2 years down the road, the house that should be listed for $300,000 is now listed for $340,000, like all the other houses in the neighborhood, with the great bulk of this inflation due to sellers paying buyer costs.

If this process happened rarely and occasionally, the effect might be minimal, but over the past several years, THIS WAS THE RULE, NOT THE EXCEPTION !

Seems like an artificially-created vicious cycle: prices too high, reduce buyer loan down payment requirements-->leads to more buyers looking for houses-->prices go even higher-->reduce buyer closing costs requirements-->more buyers in the market-->prices go even higher.........
at some point there is a limit, and obviously we are closer to the limit now than we were 3 years ago.

But where is the end point? the limit ? And does reaching the limit equal a "popping" real estate bubble, or just a quiet ride off into the real estate sunset?

........the rest of the writing on the stone tablets is kinda fuzzy.

The website mentioned at the beginning of this post lists another large reason for housing price increases, but I’ll address that issue in a later diatribe, er, uh post.

herb