You are viewing the printer-friendly version of Home Price Analysis for Seattle-Tacoma-Bellevue

Home Price Analysis for Seattle-Tacoma-Bellevue

With home prices rising strongly in most parts of the country, there has been widespread media coverage on the possibility of a housing market bust. A thorough analysis of the Seattle-Tacoma-Bellevue metro market, as detailed below, reveals that there is little danger of this. In fact, the local housing market is in excellent shape with a potential for significant housing equity gains, particularly for homebuyers who plan to remain in their house for the long run.

Because prices have risen faster than income, the ratio of price-to-income is currently above the historical norm. This measure is frequently cited to imply that there is a housing market bubble. But this ratio is a misleading measure in assessing bubble prospects. A more relevant measure is the mortgage servicing cost relative to income. This ratio is at a very manageable level. It implies no widespread financial overstretching to purchase a home in the region. Furthermore, the nationwide supply of homes on the market relative to home sales is very lean, suggesting similarly tight market conditions in the local area.

Price Activity

The current price of $310,300 is one-and-a-half times the national average.

The median home price rose 15% in 2004 and 36% in the past three years.

Home price growth has been weak throughout the 1990s. So part of the recent increase is attributable to the "catch-up" effect.

Affordability

Because the prices have risen faster than income in recent years, the ratio of price-to-income has been rising strongly. This measure is frequently cited to imply that there is a housing market bubble.

Mortgage rates declining to 45-year lows have been a major force in boosting home prices in recent years. Lower rates allow homebuyers obtain a larger loan without necessarily increasing monthly mortgage payments.

A more relevant measure for assessing the risk of a home price bubble is the median mortgage servicing cost relative to the median income. This ratio is currently right at the local historical average. It implies limited financial overstretching to purchase a home in the region.

Local Fundamentals

The job market has steadily improved. There have been 49,200 payroll job additions in the past 12 months to July. Many new job holders seek their own housing units.

The region added in the past five years an estimated 120,000 new housing units of which 80,000 were single-family units.

The ratio of five-year job gains to five-year new home construction shows the "hangover" impact of the housing shortage, or housing surplus. In our case, the local market is mildly oversupplied as the ratio is slightly under zero. With recent job gains and the expected continued economic expansion, the jobs-to-new home ratio will steadily increase.

Other Factors

ARMS accounted for over 47% in 2004 in many pricey California cities, and similar conditions are likely to be present in this local region. Furthermore, the interest-only loans accounted for about a third of all loans in 2004. Therefore, some homeowners will feel the pinch of higher rates over time.

However, a very small fraction of the loans (12%) have loan-to-value ratios above 90%, so the foreclosure risk is rather minimal. (That is, prices would have to decline by more than 10% to have a measurable impact on foreclosure rates.)

The baby boomers in their peak earning years and have been active in purchasing second homes, which many consider their future retirement homes. The baby boomer impact could continue for another decade.

The region is a highly sought after region with mild weather and being near the Pacific Ocean and the mountains. The local market will benefit from second-home purchases by U.S. baby boomers as well by wealthy foreigners.

Stress Test

Price declines in the local market are unlikely according to our stress test.

The local housing market will experience a price decline of 5% only under extreme unlikely scenarios. For example, mortgage rates rising to 10.5% in combination with 3,000 job losses could lead to a price decline.

Over scenarios that could lead to a price decline of 5% are shown below.

Such scenarios are highly unlikely. Most credible forecasts predict the region will create 60,000 to 100,000 jobs over the next 24 months and mortgage rates will hover around 7% by the end of 2006, which bodes well for future price gains.

Even in the unlikely event of prices declining by 5%, most homeowners will maintain sizable equity build-up in their homes. The table below shows the home equity gains if prices were to fall by 5% by homebuyers at various years of purchase.

Housing equity will most likely continue to accumulate to local homeowners. The equity gains under three price growth scenarios are presented below. One scenario assumes a historical conservative price appreciation of 1.5% above consumer price index inflation. With most credible inflation forecasts pegged at 2.5%, home prices can expect to rise by 4% per year under normal circumstances. The two other scenarios assume slightly below (1.5%) and slightly above (6.5%) the normal rate of appreciation.

The local market is more likely to appreciate at an above-normal rate because of the strong job growth and from being a relatively affordable west coast market.
Additional Discussion Points

Home price declines are very rare. In fact, the national median home price has not declined since the Great Depression of the 1930s. Stock market collapses, the OPEC oil crunch, economic recessions, and even wars have not negatively impacted national home prices since the 1930s.

There have been few times when local prices declined. In nearly all these cases, the price declines were accompanied by sharp prolonged job losses. It is difficult to foresee a price decline in a job creating economy.

Homes trade far less frequently than financial assets (about one home sale every 7 to 10 years for most homeowners). There are also larger transaction costs associated with selling a home due to the lengthy careful examination demanded by home buyers and sellers. Therefore, home prices are not prone to fluctuations as in the stock market. There are neither panic sells nor margin calls associated with homes.

Many non-quantifiable factors could be important for this metro market in determining home prices. Access to cultural life, the quality of museums, nearby local and national parks, water views, exclusive neighborhoods, weather, the international airport, city vibrancy, restaurants, and a host of other non-quantifiable factors could have an important influence on the overall pricing.

There are immense tax benefits to owning a home. These tax considerations were not considered in the analysis. For example, the 1998 law permitting primary owner occupants to trade down without having tax consequences. Also most home sales results in no capital gains tax. In addition, long-term capital gains tax rates were reduced in 2003, thereby providing higher return for home investors. These positive benefits, if accounted for in the analysis, would have shown an even stronger case for housing fundamentals in supporting home prices.

aa