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Thursday, July 13, 2006

Wharton's Conclusion: Soft Landing

In case you haven't noticed, Gregory Wharton has posted the final chapter in his series on Seattle real estate prices. If you thought my response to his previous post was long, you're in for a shock. Find a comfy chair and make sure you have a good-sized block of time to tackle his 3,500-word thesis on what the future has in store for Seattle real estate.

Here are a few highlights from the beginning and the end:

First off, let's get this out of the way: if you're expecting the real estate market to continue with double-digit price gains at the mean while wages are stagnant and interest rates are rising, you're dreaming. It's not going to happen. We've seen some great gains in the market over the last five years, but they are historically atypical. It is also not true that "real estate prices always go up." Sometimes they go down, and anybody who tells you otherwise is ignorant of history.

However, if you're predicting a large decline in real estate prices while inflation is rising, regulation is propping up land values, and other markets remain volatile and risky, you're going to be disappointed. That's not going to happen either.
...
What I've been talking about here is probabilities and expected values. There is a probability that Seattle is experiencing a real estate bubble. I don't mean to suggest that it's zero. In fact, the probability is higher than it has been for a while, but is still quite low: low enough that the widespread angst about it overstates the danger significantly (in fact, the angst itself is an indicator of just how low the actual probability is). Bubbles are rare in all markets, but especially so in real estate due the unique characteristics of that market. I don't say this in an attempt to gloss the possibility, but to be realistic in the analysis. I do know what bubbles look like, and have even had some success trading them (It may have been dumb luck, but I predicted the stock market bubble years beforehand, and got out well before the decline started in March 2000).

The bulls should also be aware that the probability that the bull market we've been seeing is going to continue at anything like the recent pace is also comparatively low. For every unrealistic bear expectation, there is an unrealistic bull out there right now.

The probability that the market is going through and is near the end of one of its typical bull cycles is much, much higher. That bull cycle is showing some signs of exhausting itself, so the expected value of the probability of stagnation that might result must be factored into any investment decision.

The Seattle real estate market is historically cyclical. Seattle has experienced other periods of price appreciation similar to what we've seen in the last five years. They've all been followed by decade-long plateaus before the next cycle gets going. My parents bought a house in Bellevue near the peak of the last major upswing, in 1979. It was eight years before it began to appreciate in price, but its nominal value never actually fell. That is typical of this market when it goes soft.
In my (uneducated in real estate) opinion, his prediction that Seattle's real estate market is in for a soft landing seems to be based on four main factors:
  • his argument that the price run-up was based on "solid economic" foundations
  • Seattle's historical real estate pattern of boom-then-flatten
  • government and the banks won't allow real estate to go down (much)
  • when real estate softens, people just won't sell
Obviously I'm over-simplifying his argument here, as there is no way I could do it justice in a short summary like this. At the very least, those are among the major underpinnings of his forecast.

I'm still not convinced that the future will at all resemble the picture Mr. Wharton has painted, since I fundamentally disagree with at least 3 out of the 4 above-listed supporting arguments. I highly encourage you to go read it for yourself, and make up your own mind.

(Gregory Wharton, Seattle Real Estate Professionals, 07.12.2006)
Please read the rules before posting a comment.

20 comments:

Anonymous said...

The Tim,

You forgot to mention 0 down no doc loans and readjusing ARM's to your analysis.

Now throw in higher oil, falling dollar, interest rates rising, core inflation going up, etc, etc, etc.

WHo in the hell is going to have the money to buy these houses and afford to pay the PITI?

Van Housing Blogger said...

"Bubbles are rare in all markets, but especially so in real estate due the unique characteristics of that market."

I think this is 180 degrees wrong. In say, the stock market, you have billions of dollars waiting on the sidelines to arbitrage, short, shake up and loot any stock that looks stupidly over / under valued. The pockets of these market movers are deep enough to, well, move markets and get the prices closer to 'right'.

For housing market:

- marginal buyer is clueless.
- you can't short 'em.
- transactions costs are super high.
- market is illiquid.
- you can't ship it elsewhere.

This says to me that housing markets are a lot *more* likely to be out of whack with fundamentals than markets where you can arbitrage.

matt said...

Bubbles are rare in all markets, but especially so in real estate due the unique characteristics of that market.

I would ardently and adamantly disagree with this nonesense. Bubbles exist in Real Estate just as often as it does in any other market. Right off the top of my head, I can think of Japan circa late 80's, Florida circa late 20's, Texas circa late 70's. Localized Real Estate bubbles are numerous and exhaustive.

I would argue the nature of the Real Estate bubbles are diffferent than typical speculitve markets. They run on a different fuel but are maintained by the same speculative psycology. Therefore when they eventually crash, the result looks different, and the crash happens in slow-motion, hidden by the day-by-day flicker of the news cycle.

Mr. Wharton is basing his prediction on past events, which may be somewhat relevant under pre-exhisting conditions, but there's a whole new dynamic at work here, that he's completely underestimated. This is a psycologically driven bubble sparked from the Greenspan cheap money fire-sale of a few years ago. This is the fundemental driver in the speed and exhuberance of the current market, and we've never seen anything quite like it...

matt said...

van housing blogger, most agreed

dash_point said...

WHo in the hell is going to have the money to buy these houses and afford to pay the PITI?

Anon: Agreed. Short of any real economic downturn, credit tightening is effectively a pay cut, in terms of housing it will purchase. Then add inventory, builder oversupply/low cash-flow, curtailing short-term "investors", and I don't see a "soft landing" in the future for coastal metro markets--despite all the talk.

Tony G G G UNIT said...

van housing brings up a good point about most buyer being clueless.

The vast majority of people don't trade in the stock market because they see it as a universe of uncertainty where the possibility of losing your arse is great.

For those that know a bit about the markets it is still a risky place but you can minimize that risk with information and knowledge.

Now put these same people, who don't understand the markets, are willing to spend 100's of thousands buying real estate? An illiquid asset!!! I suppose the fact that RE is tangible property makes them feel better about it. I don't know. But then again RE NEVER GOES DOWN.

SeattleMoose said...

If you click on the link you can see Mr. Wharton is a "Architect/Developer".

Let me guess. During the biggest boom in RE in U.S. history he has probably been more developer than architect.

He has skin in the game and he and his fellow RE cronies get together to come out with some long winded "thesis" on why the RE market is not going to crater.

The fact that the "thesis" needed to be published at all (from a defensive position) is very telling...

Just more RE industry spin.

Anonymous said...

Good to hear somebody in the media say that Seattle is in for a "soft landing".

Til now it's been "continued appreciation".

Balanced said...

First time posting, though watched for months....
Here's what's happening in my neighborhood:

I live on Bainbridge in a low to mid-cost neighborhood for the island ($500-$600K). There are 4 houses for sale. 3 had offers and so far all three have pulled out after a few weeks or months because they were unable to find the financing.

I have never heard of such a high occurrence of this. As banks get stricter and appraisals more conservative (or one might say more realistic), I think even those who are willing to buy right now at these high prices (we bought our home for $350K 3 years ago), won't be able to follow through.

Call it what you will, bubble or no, soft landing or slow deflation, no one can deny the times they are a changin'.

SomethingOtherThanAnoymous said...

I hate to point this out and maybe you said it before, but, Tim, I think that's the first entry in which you’ve said "I highly encourage you to go read it for yourself, and make up your own mind." Maybe all this talk about "Agree with us or die" finally made you realize that the pursuit of truth should be the blogs goal (as opposed to getting people to all think the same thing), but I feel like this is the first post that included an article, your take on it, and an invitation to go decide for yourself. This is a good step. Kudos…

Anonymous said...

Mr. Wharton asserts that when the market is stressed and liquidity dries up that people just won't sell and prices will plateau rather than fall. That defies all logic - in financial markets reduced liquidity is what precipitates rapid price declines when people who are leveraged are forced to sell. In today's environment there are so many people who are too leveraged. It only takes a minority of people "on the margin" to move the market big time.

The Tim said...

SomethingOtherThanAnoymous,

It's certainly the first entry in which I've said those exact words, but my intent has never been to cram my viewpoint down other people's throats. Heck, there's a link on the right-side column to a blog that was established for the express purpose of refuting anything that is said on this one!

I thought that I had made it clear quite a few times that anything said here is just my (fairly uninformed) opinion, and nothing more. I even provide full access to the spreadsheet that I've populated with all manner of data. I guess I just assumed that "this blog is just one doofus' opinion, you should make up your own mind" kind of goes without saying.

My bad.

The Tim said...

BTW, since tone doesn't come across well over the Internet, I should clarify that the above comment should be read in a lighthearted manner, not an angry or defensive one.

Capitalistchristian said...

I would like to reference an article (quarterly report) dealing in past price corrections. This article is located at...

http://businessweek.com/the_thread/hotproperty/archives/2006/06/overvalued_mark.html

Just click on the link in the posting and go to the last page of the report which deals with past price corrections of the last 20 years in the United States. 66 of the most major corrections are listed. Here are the bottom line averages:

Average price overvaluation prior to correction: 34%
Average price decline: 17%
Average time it took for decline to occur: 3.5 years

On page 13 of the report it has Seattle listed as 34.1% overvalued and Tacoma as 31.9% overvalued. Therefore based on these past historic numbers if Seattle is "average" overpriced, we could possible expect a 17% decline over the next 3.5 years. So if the median price is now around $375,000, then in the beginning of 2010 it is possible that the median price will be at $311,250. In which time inflation and wages will have increased making homes more affordable. This seems like a reasonable course of action to me. I forsee this scenario, or perhaps more similar to what Mr. Wharton portends, then the "decline 40-50% crowd" over the next year or two. Just my thoughts, backed up with historical data is all.

Capitalistchristian said...

Okay I don't know what happened to my link, but here she is again...

http://businessweek.com/the_thread
/hotproperty/archives/2006/06/
overvalued_mark.html

meshugy said...

Wharton's analysis of the shrinking middle class is fascinating, and probably true. I think he said it all with this statment:

When we hear complaints about the unaffordability of housing as prices rise and real wages stagnate, we are hearing the lament of those who are slipping down the ladder, and there are many of them.

betamax said...

we are hearing the lament of those who are slipping down the ladder, and there are many of them.

Ah, meshugy, only you would trollishly exhume that old chestnut, the 'bitter renter' argument.

It's old, and there are too many people who have money and still rent, and there are too many examples now of people who sold at the top and laughed at the greater fool they sold to.

My wife's best friend is married to a natural gas multimillionaire. This is a guy who flew his family to Germany to watch the world cup. Owns a mansion in Barbados, but rents locally right now because he thinks it's a bubble and doesn't want to pay 3 million for a dump in the neighborhood he'd buy in. Get the picture? It's done.

richard said...

When we hear complaints about the unaffordability of housing as prices rise and real wages stagnate, we are hearing the lament of those who are slipping down the ladder, and there are many of them.


This is too simplistic - if these people "slipping down the ladder" have good credit scores, they're not priced out of all but the most expensive markets... As long as they're willing to get creative on the financing.

Anonymous said...

No offense betamax, but who cares what a guy with no relevant experience thinks in regards to the housing market?? The best part is you obviously bought into 100%. I'm not saying that the market is going up or down, but I wouldn't listen to some rich guy who made his money in natural gas, as a baker, a scuba dive instructor or any other equally unrelated industry.

betamax said...

The best part is you obviously bought into 100%. I'm not saying that the market is going up or down, but I wouldn't listen to some rich guy who made his money in natural gas, as a baker, a scuba dive instructor or any other equally unrelated industry.

You misunderstand me. I am not saying my conclusions are based on his (or any other individual's) opinion; I merely gave a single specific example to disprove the 'bitter renter' argument suggested by meshugy.

Next time read more carefully, in context, before jumping to false conclusions of your own.