The Return of Housing Affordability in Washington State

The Return of Housing Affordability in Washington State

Research compiled by Michael Luis & Associates, an independent public affairs and communications consultancy, and commissioned by Washington Realtors®.

While no one was looking, the storyline of housing affordability in Washington has changed dramatically. Beginning in the late 1990s in King County, and spreading to the entire state by 2005, the trend in home prices was steadily upward, and the trend in affordability was steadily downward. An entire generation of residents got used to the idea that home ownership was out of reach for those of moderate incomes and that “drive to qualify” was the only way to get into the housing market. These grim choices – very high prices or very long commutes – became part of the local culture.

Well, that has certainly changed. Although we are not back to affordability levels of the 1980s, housing markets in much of the state have moved back into a balance in which households with solid but not high incomes can again have the choice of ownership. The past few years have taught us that ownership may not be for everyone, but we can still expect about two thirds of households to want to own their home.

This paper is designed to provide information emphasizing the return of ownership opportunities through greatly improved affordability across the state. As we will see, change has not been uniform and not all areas of the state have recovered at the same pace. But compared to four years ago, all markets look better and, as the overall economy of the state gets rolling again, increasing numbers of Washington residents can get off the sidelines and pursue the home of their dreams.

The paper has two parts. The first part begins with a discussion of some important macro trends, then goes over the basic factors that determine affordability, and concludes with a look at possible future directions for markets. The second part provides statistical snapshots of major markets in Washington using a number of indicators to describe affordability trends in these areas.

Part I.  Market factors and trends in Washington.

1. Thinking about housing markets and affordability in Washington. Because so much of the “Great Recession” has been associated with housing in one way or another, significant national media attention has come to bear on housing. This has often been unhelpful as we try to sort things out in Washington. Some things to keep in mind:

A. There is no national housing market. Housing data is often presented at a national level, but there is no such thing as a national housing market. National housing production and sales can, once aggregated, be given a role in describing overall national economic trends, but that aggregation is meaningless from a market point of view.

The obvious point is that inventory cannot be moved to satisfy demand. An over-supply of cars or toasters can be shifted from areas of oversupply to areas of high demand, but an oversupply of houses cannot. Demand can shift a little, as footloose households search the country for affordable communities, but this is not a very large market force. Thus, overbuilding, as occurred in Florida, Nevada and California, can make a national total of unsold inventory look big, but that has nothing to do with the inventory in any one area and the relationship of local inventories to demand. So, unless one is in the national financial services business, it is best to ignore stories about the “national” supply and demand for housing.

B. Washington did not experience massive overbuilding. Like other attractive areas of the country, Washington did experience a flurry of home building in the 2000s and building has slowed dramatically. But compared to other fast-growing areas, Washington did not experience the massive levels of overbuilding that have resulted in a seemingly limitless inventory. One reason for this was the very high price of building lots which kept builders from being able to put up large numbers of spec homes. It also may be that the speculative activity that seems to have driven so much overbuilding was a Sunbelt phenomenon that anticipated the continued rush of the American population to warm climates. So while Washington does have new construction inventory problems in places, those problems are far smaller than other parts of the country.

C. The Great Recession has had less impact on Washington. With the exception of Vancouver, which is heavily influenced by the difficult Portland economy and parts of Southwest Washington that have been hit by the drop in demand for building materials, Washington has fared better than much of the rest of the nation. Figure 1 below shows unemployment rates in the state’s metropolitan areas which, together, account for about 90 percent of the state population.  Tri‐Cities and Wenatchee have some of the lowest unemployment rates in the country, and even Puget Sound is a point below the national average. And while the national unemployment rate has fallen little over the past year, unemployment rates across Washington have fallen up to a half point.

Many believe that recovery will happen faster in Washington than most other areas because of the state’s prominence in capital goods. In the past, capital spending has led the economy out of recessions. This bodes well for companies like Boeing, Microsoft and Paccar. Adding to an optimistic picture, harvests and prices have been good in the state’s agricultural sector in 2010. The State’s Office of the Economic and Revenue Forecast Council, the chief prognosticators of the state, are predicting a growth of 4.1 percent in personal income in Washington in 2010 versus 1.6 percent at the national level.

D.  Washington’s foreclosure rate is moderate. One of the fears among economists and homebuyers alike is the unknown “shadow inventory” of homes that are in foreclosure or heading that way and that will end up on the market. While Washington’s foreclosure rate is not rock-bottom, it is not nearly as high as other states with fast growing, dynamic economies where people bet too heavily on the future. As Figure 2 shows, Washington’s rate of foreclosure – both all current foreclosure and new foreclosure proceedings started in the first quarter of 2010 – is lower than all regions and other major Western states. According to RealtyTrac, in June of 2010 one house out of 556 in Washington received a foreclosure notice. This compares to one out of 411 nationally, and one in 423 in Oregon, one in 284 in Idaho and one in 193 in California.

As discussed above, houses are not portable, so the shadow inventory of California and Nevada is not going to turn up for sale in Washington. The factors discussed above do not point to a complete absence of risk for Washington home buyers, but they do suggest that potential buyers have some reasons to believe they can enter the market with confidence. More on future tends below.

1.2. Components of Affordability

Housing affordability is a function of three basic components: prices, interest rates and incomes. (Down payment requirements are a factor, but are usually treated as an assumption in affordability calculations.) Let’s look at each of these three and see how they have been trending.

A. Prices.




Figures 3 and 4 above show the trend in home prices for Western and Eastern

Washington markets covered by the Federal Office of Housing Finance (Vancouver is part of the Portland metro market and cannot be broken out). This price index is based on repeat sales data, which means that it tracks prices of the same house, and therefore controls for the gradually increasing size and quality of the housing stock. The well-known Case Shiller index uses a more refined version of this methodology, but covers only Puget Sound. Every market in the state, with the exception of the Tri-Cities, saw a sharp run‐up in prices in the 2003/2004 to 2007/2008 timeframe, and a sharp drop after 2008. Prices remain 40 to 90 percent above their 2000 level, or, accounting for inflation, about 15 to 40 percent above 2000 prices in real terms. These price drops will be discussed on a market-by-market basis in more detail below.

B. Interest rates. Interest rates have been at historic low levels for most of 2010.

This reflects federal policy to keep the cost of borrowing by financial institutions very low, as well as a low expectation of future inflation. Figure 5 below shows the trend in rates for 30 year conforming mortgages since 1978. The battle with inflation brought rates to nearly 17 percent in the early 1980s, and they did not get comfortably back into single digits until the 1990s. So although home prices were lower then, money was expensive.

To illustrate the impact of low interest rates, Figure 6 below shows the cost of financing $200,000 in mortgage debt under various interest rates, and shows when those rates would have been common. The savings are seen not only in monthly payments, but in the huge difference in total interest paid over the life of the loan.

So while the purchase price of homes in most of Washington has risen considerably in the past 20 years, the cost of borrowing the money to buy those homes has been cut in half over that period. This will figure prominently in the affordability discussions below.

C. Incomes. Compared to prices and interest rates, incomes move at a less dramatic pace. The question when considering incomes is what to measure. The broadest measure, “personal income,” includes investment income and transfer payments such as social security. But since most homebuyers live on what they earn in jobs, it seems reasonable to look at only those earnings.

The State tracks all wages and salaries paid to employees covered under the state’s worker’s compensation program, and these “covered wages” are the best source of data on earnings. Figure 7 shows the statewide trend in average covered wages since 1990 in both current and inflation-adjusted dollars. This shows steady growth in real wages during the 1990s helped buyers keep up with rising housing prices.

Average wages in the state have been flat in real terms for the past ten years, exacerbating affordability problems, as price increases far outpaced earnings. (Since wage levels vary widely across the state, these will be broken out by market area below.) The clear story on incomes is that improvements in affordability will need to come from the other two parts of the equation – prices and interest rates – and that we cannot expect to grow ourselves out of the problem of unaffordable housing.

1.3. Putting it all Together: Measures of Affordability

Researchers have combined the factors discussed above into indicators that show how they interact to create affordability. We will show the results for two of these: the Washington Center for Real Estate Research’s (WCRER) Affordability Index, and the National Association of Home Builders’ (NAHB) Housing Opportunity Index. Each shows similar results in a slightly different way.


A. WCRER Affordability Index. The WCRER, located at Washington State University, has created an index that shows affordability by county. The index assumes the buyer has an average income for that county, a 20 percent down payment, and will purchase the median‐priced home with a conventional conforming 30 year mortgage. (The WCRER also has an index for first-time buyers that assumes lower income, a 10 percent down payment, and a lower priced home.) Combining these assumptions and data, WCRER arrives at an index in which a score of 100 means that the median buyer can afford the median house. A score over 100 means that homes are more affordable and a score below 100 means they are less affordable.

Figure 8 above shows the WCRER all buyers index for Washington’s largest counties since 1994. All counties were comfortably above 100 until 2005, when, one-by-one the most populous counties, led by King County, began to drop below 100. At the height of the housing bubble, Clark, King, Kitsap, Pierce and Snohomish counties had all fallen below 100, meaning that the county’s average earnings were not sufficient to purchase the median‐priced house. But by the end of 2009, the last time the indices were calculated, all areas of the state had risen above 100, except for San Juan County and most areas were back to levels of affordability from the early 1990s. This shows the power of low interest rates to mitigate the impact of prices that, while lower, remain high relative to income growth. First-time buyers are still at a disadvantage in the more expensive parts of the state, so we can expect “drive to quality” to remain a reality for them.

B. NAHB Housing Opportunity Index (HOI). The NAHB uses the same basic price, interest rate and income data, but asks a different question: what percentage of homes sold were affordable to the household with the median income. NAHB also bases its research on metropolitan areas, which consist of single or multiple-county areas.

Figure 9 below shows the trend in HOI for the metro areas the NAHB covers in Washington (Clark County is considered part of the Portland metro area) beginning in 1998. The pattern shown here is similar to that in Figure 8, with an improvement in affordability in the early part of the decade, a dramatic decline in affordability in all markets around 2004-2006, and an equally dramatic improvement by the end of the decade. Like the WCRER index, the HOI shows that most areas of the state have recovered the affordability levels they enjoyed early in the 2000s.


Another way to view affordability is simply to look at the monthly mortgage payment required for the purchase of the median house. This payment is calculated as part of the WCRER index. Figure 10 below shows the monthly payment, in inflation-adjusted 2002 dollars, required to purchase the median-priced house in Washington’s largest counties from 2002 through 2009. In some areas notably the three large Central Puget Sound counties, the payments are at or below 2002 levels, indicating that the combination of falling prices and falling interest rates has wiped out the affordability problem that built over the past decade.

While some areas of the state are still not yet truly affordable for all families, these indices clearly show that the grim times of five years ago have largely gone away. Home ownership is once again within reach for creditworthy households with moderate income levels. But recent figures on sales levels shows that many potential buyers are still waiting for the right moment. So, we now turn to the very difficult question of what the future holds for those buyers still biding their time, and those ready to jump in.

1.4. Looking Ahead

No one wants to commit to a major purchase only to find out that waiting a bit longer would have resulted in a better deal. A large part of the slowness in housing market recovery can, no doubt, be attributed to caution and a belief that lower prices lie ahead. While no one can predict with any certainty exactly what lies ahead for the residential real estate market, we can point to data that give us some hints. The following three affordability factors can provide hints about future trends.

A. Prices. As seen in Figures 3 and 4, prices have trended down since 2007. The Office of Federal Housing Programs data only extends through March 2010, and more recent data from the Northwest Multiple Listing Service indicate that through July 2010 prices in most of the state are either flat or rising. (MLS data is based on sales transactions, so in smaller counties with a small number of sales, median prices can fluctuate month-to-month.) The Case Shiller housing price index for the Seattle and Portland metro areas shows prices bottoming out at the beginning of 2010 and rising slightly in both markets through May, 2010.

A recent forecast by Fiserv/Moody’s named Bremerton/Silverdale as the top U.S. metro area for projected home price appreciation by 2014. The forecast anticipates that Kitsap County home prices will appreciate by 45 percent in the next four years, and that prices in Tacoma will grow 33 percent and prices in Seattle will grow by 25 percent during that period.

Since Washington did not have a massive amount of overbuilding, and the foreclosure rate is not excessive, it is reasonable to believe that there is not a huge inventory that will take many years to soak up. And very little is coming online now: single family construction fell from a high of 52,000 units in the state in 2005 to only 17,000 in 2009, for a drop of 67 percent. At the metro area level, single family construction fell 71 percent in the Seattle-Tacoma market, 76 percent in the Portland-Vancouver market, 50 percent in Tri-Cities and 77 percent in Spokane. In other words, the supply of housing is growing at a very slow pace.

On the demand side, the population of the state continues to grow. In Washington, the 18-24 year old group that is now forming households outnumbers the over 75 year-old group by 122 percent, so natural turnover of the housing stock in the state will fall far short of what will be needed by new entrants into the market. Migration into the state continues, even in a slow economy. According to the Census Bureau, over 58,000 more people moved into Washington than moved out of the state in 2009. This net migration is down somewhat from the high of 75,000 in 2006, but is still an impressive figure in a down economy when businesses are not recruiting nationally as aggressively. In 2009 Washington had the fourth highest rate of net in-migration of the 50 states, and was also fourth highest in absolute numbers of net in-migrants.

The current natural rate of population growth is not that helpful to know, since babies do not need houses (although their parents might need a bit more space). The birth cohort of the previous generation, however, is the one to drive housing demand. Like the rest of the country, Washington experienced the “Baby Boom Echo” in the 1980s, as the Baby Boomers themselves had children. This cohort is now in its 20s and early 30s, and since a survey by the National Association of Home Builders pegged the average age of a first‐time home buyer at 33, the Echo generation will soon be at prime home buying age.

These supply and demand indicators would seem to point toward a strained supply in the years ahead and upward pressure on prices. Hence the bullish price forecast from Moody’s. But what about the near term? Might there still be downward pressure on home prices while inventory shakes out? One clue would be to look at the current supply and demand situation: an excess supply signals falling prices, a supply shortage signals rising prices, and a supply-demand balance indicates stable prices.

Conventional wisdom holds that a four-month to six month supply of housing on the market – listings are six times closed sales – is consistent with stable prices. In the market-by-market review below we will look at supply levels using MLS data.

B. Interest rates. The various factors that determine long term interest rates would seem to point toward a continuation of current historically low mortgage rates, but probably not much further lowering. The cost of money is near zero, and the Federal Reserve will likely keep it there. Inflation is also near zero, meaning that lenders do not have to build in a premium to account for the falling value of a loan. Stronger lending criteria and a return of a robust secondary market for conforming loans means little risk premium for solid borrowers.

C. Incomes. Even as the economy recovers, incomes will not likely grow anytime soon. Employment growth is likely to remain slow for some time to come, so there will be a large pool of unemployed workers keeping wage pressure down. Government employees, who have enjoyed more wage growth due to contract provisions, may see those provisions renegotiated.

Now, if the Great Recession has taught us anything it is the foolishness of trying to predict the behavior of complex markets, and it would not be responsible to attempt to provide ironclad guarantees that home buyers will not get a better deal by waiting. There is, however, ample data that seem to indicate that prices and interest rates are stabilizing, and basic demographic trends point to an increase in demand for housing in the state. Potential buyers will need to weigh these trends against the possibility that the economic recovery will stall and that the summer sales slowdown is a precursor to further price drops.

Conclusion

“There has never been a better time to buy a home than right now!”

That statement rolls off the tongue easily, but just how true is it? Well, with prices falling in all markets, and historically low interest rates on conforming loans, the cost of buying a house has come way down.

In parts of the state, the monthly payment on the average home is lower relative to average wages than at any time in recent memory. Figure 11 below shows two examples of this trend, with payments as a share of wages lower now in Pierce County than at any time since 1978, and payments in Spokane County almost back to historic lows of 2003. As the individual market summaries that follow will show, not all areas of the state are quite back to 2002 levels of affordability, but all are close.

So from the point of view of affordability, this is definitely a good time to buy. The harder question is whether it will get even better in the months or years ahead. No one can read the future, but the data indicate that most areas of the state prices are stabilizing. Significant month-to-month price drops have ended in most areas. The state continues to have a strong inflow of population, and most counties are growing at over one percent per year, while new construction is very low. As the economy strengthens, household formation will pick up along with demand for housing. If the supply is not growing, prices will eventually begin to rise. So while it is not a good time to try to turn a quick buck by flipping homes, it is reasonable to expect Washington’s major markets to experience relative stability.

The Great Recession has taken a toll on the central ingredient of homebuying: optimism. But if we step back and take a look at the long term prospects for Washington state, the future does look good. In measure after measure, the state stacks up very well against national and global competition as a place for forward looking businesses, and the state’s history of innovation bodes well for the future economy. It is a great time to invest in Washington.

Part II. Market Snapshots

Following are links with data snapshots for Washington’s major housing markets. The data come from different places and measure different things, so they are not always comparable. Please note the following:

Prices and monthly payments. These two lines will behave differently for different markets because they use two different prices measures. The “Price” line is based on the Federal Housing Finance Agency (formerly OFHEO) repeat sales index. This index is based on repeat sales of the same house, and so controls for different quality and age of the housing stock. For this report, the index is recalibrated to begin in 2002 at 100. The “Monthly payment” line is based on data from the Washington Center for Real Estate Research, which uses monthly transaction data to establish prices.

Housing Affordability Indexes. The differences between the WCRER and the NAHB indexes are explained in the text above.

Months of inventory. This is calculated based on a rolling five-month average of both current MLS listings and monthly MLS closed sales. Thus, for example, the figure for March would be the average of January through May. This averaging helps smooth out some of the month‐to‐month bumps in the data.

Housing units permitted. The U.S. Census Bureau collects data from all permitting jurisdictions on at least a yearly basis. The data presented here is only for single family detached housing.

Population. The population figures are taken from the Washington State Office of Financial Management’s population estimates program. There will likely be some revisions as the 2010 Census data is made available.

Clark County King County Kitsap County Pierce County Skagit County Snohomish County

Spokane County  Tri-Cities Thurston County Whatcom County Yakima County

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