Are we in a Bubble?
Robert Shiller, Noble Prize Lecturer, offers the following definition of a speculative bubble:
A situation in which news of price increases spurs investor enthusiasm which spreads by psychological contagion from person to person, in the process amplifying stories that might justify the price increase and bringing in a larger and larger class of investors, who, despite doubt about the real value of the investment, are drawn to it partly through the envy of others’ successes and partly through a gambler’s excitement.
In 2006 I met a couple who had purchased a home in Kirkland, Washington. They referred to their purchase as the “5 Year Plan”. They put 5% down and had an adjustable rate mortgage with a low interest rate in the first five years followed by a very high rate in the subsequent years. They knew that they would be unable to pay their mortgage at the future rate, but they were banking on their home increasing in value within those five years so that they could either sell or refinance at an affordable rate. They were gambling on this investment.
There are many who hypothesize that the current King County real estate market is experiencing a bubble. As an analyst, my approach is to find evidence (data) that will either substantiate or invalidate the claim. I’ve gathered data from the NWMLS along with census data to explore the possibility that we are in a bubble.
Why Does this Feel Like a Bubble?
Let’s begin with the assumption that we are in a bubble. Since we are not in a situation where subprime loans, high usage rates of adjustable-rate mortgages (ARMs), low-doc loans, and low-down payment requirements are the norm, then why would some speculate that we are repeating the events that led to the real estate collapse in 2008?
Why does this feel like a bubble? Primarily due to the accelerating costs of single family homes. In some King County neighborhoods home prices have nearly doubled since 2012, while other areas of the United States are still facing home values below the high-water mark set in 2007.
For those who have lived in the Seattle over the past five years the increase in home values seems almost astronomical. With some areas experiencing a near 100% increase in home prices over that time.
Mortgages for sold homes are greater than existing mortgages.
Those who have an existing mortgage may find it difficult to justify moving, although their current home values have increased in kind. In the last five years the estimated average monthly costs for sold homes has risen to nearly 2007 levels. When comparing the estimated mortgage of sold homes against existing mortgages it can certainly feel and look like a bubble, at least from the measurement of home costs. Those who have experienced increased appreciation in their existing home may be hesitate to sell, in fear that home prices will continue to accelerate between the sale one home and purchase of the next.
There is certainly a rapid acceleration in home values in King County, Washington. However, appreciation in prices, which may be a condition of a speculative bubble, does not alone define a bubble.
Average monthly costs for home sales may be approaching 2007 levels, home inventory levels dropped below 2007 levels in 2016, and the available inventory continues to decline.
Residents of King County do not have to reach far back in their memories for the “I remember when …” stories of life in the region. The population in the area has increased as rapidly as housing prices. Between 2005 and 2016 the population of King County increased over 20%, while the number of households increased 15%.
Along with population increase, the average household income has increased nearly 50% since 2005. Since 2007 King County has added over 80,000 households (with reported earnings). Income for these households in 2016 was $29,000 higher in 2016 than 2007. The total household income in 2016, considering the increase in number of households and average income, represents 28 billion dollars over 2007 totals for King County, for a single year. Simply stated, there is more money available for home purchases.
increased income lends to affordability, for those who qualify
In 2006-2007 a combination of subprime lending, adjustable rate mortgages, and low documentation allowed owners to qualify for loans that they could not afford. In 2009 over 42% of King County home owners were spending more than 30% of their household income on housing. In 2016 that number was just 29%, the lowest level in thirteen years. Current mortgage requirements ensure that more home purchasers can afford their mortgage. This presents a challenge for renters that are seeking to enter the market, but we will leave that topic for another day.
The chart below shows the percentage residents that are spending more than 30% of household income on home costs, by owner status. Those who are purchasing homes can afford to do so.
The geographical restrictions of the region combined with population increase results in increased population density, down to the household level. Homes are more crowded now than in the past 13 years.
The American Community Survey tracks the percentage of households with an occupancy of 1.01 or greater per room. This number doubled for King County between 2005 and 2016.
So, is this a bubble?
To answer this, we really need a better understanding of who the current home buyers are. Do current home sales represent investor enthusiasm of a larger and larger class of investors drawn to the market by the envy of others’ successes and gambler’s excitement? Or are do the price increases simply represent a supply and demand equation where an increase in quality buyers, seeking real value of the investment (primary residence), are escalating the prices of home in a market where inventory is scarce?
I would speculate that it is the later but would welcome additional research to uncover the motivation of current buyers. Are they seeking real value or merely means to a quick return on investment?