by Aaron Fairchild:
You can’t go to a cocktail party these days without someone saying now would be a good time to invest in real estate. Of course, one question that always arises is, “When are we going to hit the bottom?” This is a question my father and I have been debating for the last several months. He owns and runs a local bank and my partners and I invest in real estate. He believes that the bottom is still out a fair bit, whereas I see clues that the bottom will be sooner than later. He is fond of telling me stories from the early to mid-seventies; these stories inform both of our opinions. To him, they indicate how bad it could get, and to me, they form a stunning contrast to today’s current market realities.
Let’s take a look at some of these historical clues that indicate the health of the Seattle market. The first set of clues to examine appeared during the period from the mid 1970’s through the first quarter of 1988. This period represented 13 difficult and depressed years in the region; the regional economic gorilla was Boeing, and they had just eliminated over 60% of their workforce, 64,000 people. According to my father, “during that time loan officers carried around quit claim deeds in their briefcases to take control of homes that laid-off Boeing engineers could no longer afford.” Furthermore, during that time he was typically lending to single-income households. There were fewer women in the workplace than today, and even if a woman wanted her income to count, FHA underwriting guidelines required a letter stating that she was using contraception. Loan officers called it the “pill letter.”
Another story from my father relates to local consumer confidence. At that time, he used to tell his loan officers that one of their jobs was to convince depressed real estate agents that they could actually find a client to help buy or sell a home. People were leaving Seattle in droves, and driving past the famous billboard that read, “The last person to leave Seattle, turn out the lights.” It is hard to imagine how low consumer confidence really was, when today Seattle has far more employers than it did back then, and attracts a steady and diversified flow of employees capable of home purchases. The last time Seattle saw more people leaving than coming was in 1982.
Now let’s look at further clues that arose after the “Boeing Bust” that show what a sustainable real estate market looks like. For the most part, my father and I agree that from 1988 until late 2000 was a period of stability in the market. Interest rates dropped into single-digit ranges, allowing homeowners cheaper and easier access to mortgages. Inflation was low, and the economy in general was moving along steadily. Most importantly, incomes were able to keep pace with increases in home values; as more households took on second incomes, there was more money in the household to buy or upgrade homes. Fortunately, while there was easier access to capital than in the 1970’s, underwriting guidelines remained conservative. To put less than 20% down on a property, you generally needed to purchase Mortgage Insurance and stringent debt-to-income underwriting ratios provided sustainability in an otherwise solid real estate market. During this time, the correlation between incomes and housing prices remained generally constant. This was a time of prosperity and sustainability where housing values increased at a rate of roughly 5% per year between 1990 and 2000.
The run up in property values between 2000 and 2007 provides a dramatic backdrop to where we find ourselves today. The incredible rise in property values came as a result of easy access to capital due to lax underwriting guidelines. These loans were unsustainably constructed by banks to sell into profit-thirsty debt markets.
The result in this chaos is, of course, the recent reckoning where mortgages defaulted, banks were forced to write off huge amounts of bad loans, and a glut of homes fell in foreclosure precipitating a concurrent drop in housing prices. Now we see our final clues to indicate the market has or will soon reach bottom: we observe a return to rational lending practices, an end to wanton speculation, and unprecedented government intervention in stopping the flow of home foreclosures and increasing consumer confidence. Finally, the real estate market is now showing signs of normalizing to more predictable, rational levels as they relate to income levels and affordability. The Seattle housing market has not been more affordable anytime during the last thirty years.
Although it is too early to tell who will win our debate, my father and I agree that the factors which drove down housing prices are finally correcting. Time will tell where the bottom of the market is, but the question still remains at the heart of our debate, “Could it get as bad as it was during the depressed time of the early-to-mid 70’s?” My father’s stories create the backdrop to my outlook on our local real estate market and provide valuable insight and lessons; however it is hard to imagine going back to a time where Seattle experienced negative population growth, 12% unemployment, with predominately single-income households, and only one major employer.
The clues of contrast examined through his stories and prior economic indicators provide us with lessons from our past and demonstrate just how far we have come over the last 35 years. We have certainly made mistakes and have been guilty of greed, and as a result we have paid the price in a substantial drop in property values and the vaporization of wealth borne from home equity. However, when contrasted with the clues from our past, returning to the market conditions that existed in the 1970’s seems unlikely. I believe we are likely near the bottom of a fundamentally sound Seattle real estate market.
by Aaron Fairchild: