Wednesday, February 08, 2006

With national real estate sales booming (in most markets), interest in what one's home is worth is correspondingly high. Here in the Seattle area, home values continue to skyrocket, even though actual sales are somewhat lagging, mostly due to our miserable winter weather. We're all curious about the house up the street that just went on the market with a ridiculous asking price, only to be in shock three days later when a "SOLD" sign appears.

What is driving the escalation in property values and when will it stop? It reminds me so much of the bubble of the late 90s (of which I was a victim) that it's scary. When inflation rates and wages are stable, why are home prices appreciating at such an "alarming" rate? Low interest rates and questionable mortgage schemes allow many to get into the market who probably wouldn't otherwise be qualified. It's a risky proposition, but as home equity increases so quickly, it seems to be working. So far.

When I bought my first house in 1985, the hard part wasn't the down payment, but the monthly payment. The absolute best rate for a 30-year fixed at the time was 13%--nobody was getting any lower. I got 13.5% as a first-time buyer. Can you imagine anybody paying that that kind of rate for a million dollar house in today's market?

Therefore, I'm wondering: Are current house prices directly related to mortgage interest rates or is there something more? Obviously, speculation is a huge factor in the supply and demand equation, but speculators wouldn't be out there without conducive interest rates and the belief that low interest rates will continue at least until they're able to "flip" their property.

Supply and demand as a general rule also dictates that some parts of the country will be more desirable than others, resulting in a few pockets of receding property values in where employment opportunities are lacking or a particular region is said to be undesirable for others reasons, such as weather, crime, recreational opportunities or cultural environment. But for the most part, the nation's real estate market is booming--commercial and residential.

So what happens when the bubble inevitably bursts? Are we in for a soft landing, where as interest rates slowly rise, property becomes less affordable, appreciation slowly levels off and values begin a gradual decline? That would be bad enough--the idea that one's home value might actually go down is anathema to most, no more so than to the tens of millions who bought or re-financed in the last several years.

Consider the other alternative: interest rates spike up, which could happen for any number of reasons (some perfectly organic/cyclical and some beyond our control). Massive terrorist attacks, expansion of war, sudden escalation of oil prices, domestic labor strife as major industries fail to compete in global market, natural disasters such as earthquakes or global warming or any number of other causes.

Speculators drop out of the market. Marginal buyers can no longer qualify for even the most back-loaded mortages as banks tighten credit. Unemployment rates rise as companies are forced to cut back due to lower demand. Suddenly, fewer people can afford to buy a house and many people with variable rate mortages are finding they can't afford their new monthly payments. A mild panic ensues as owners of multiple homes, speculators, and millions of retirees try to escape before the bottom falls out. The bubble has completely burst, all within a year of rapidly advancing interest rates.

What happens to inflation? Depending on the root cause of rising interest rates, inflation could easily double or even triple, adding to the country's woes. Worse yet might be deflation, where home values continue to decline rapidly, wages sink as unemployment skyrockets and the over-capacity of the nation's industrial base and a continuing flood of cheap import easily keep up with demand.

Conversely, if positive conditons prevail, things may continue much as they are. There will be up and down cycles, of course, as the economy evolves. If we're able to get out of the Iraq with some semblance of victory (moral or otherwise), that may help. If oil prices are contained, that will control inflation. Best of all would be a technologically-inspired rebound of heavy industry in the US, particuarly the auto business, which would help keep unemployment in check. All are factors in keeping interest rates low, which is key in maintaining the real estate market.

Six or seven years ago. stupendous wealth was destroyed in a matter of months when stock market speculation and rising financial markets finally hit a psyhological tipping point and crashed. Since then, real estate has been perceived as the safer investment, aided by easy access to capital, causing a steady rise in demand. A big difference between the dot-com boom and the current real estate boom is critical: today's boom is fueled largely by borrowed money. Should today's housing market go bust, it's not going to be fixed in a few years.

All this leads to, the new beta website which is promising to revolutionize how home values are calculated. Through their own proprietary algorithms and methodologies, actual market values are available to any homeowner, and it's all done on-line and with a fair degree of confidentiality. It is not a front for a real estate company, nor is it a lead generator for real estate agents. It is a new model for home appraisals and it's success is almost guaranteed in the current environment of intense interest in home values, especially in the country's hotter markets.

Testament to the pent-up demand for such a service is evident by the fact that less than a week after the beta website went live, it was totally shut down by overwhelming demand. How's it going to make money? The same way that Google does--advertising. After a year or two (depending on the site's success), there will be the inevitable initial public offering, making Rich Barton (founder of a little dot com company call xpedia) a little wealthier. The fusion of real estate and technology will be complete as millions of homeowners check in on their homes' values, virtually in real time, many of them trying to gauge the market so they can sell at the absolute apogee. Mark that date on your mental calendar--you might want to be somewhere else.


gpb said...

Interesting essay.

I think (know) that you've thought more deeply than I have about these things, and that you know a lot more. But the bubble-icious nature of the real estate market has always puzzled me. My own ill informed opinion worries about what's going to happen when the Japanese and Chinese and Europeans decide that it's not the best deal in the world to lend us money at the rates they're getting.

I find your original loan terms very interesting. I remember pretty well the high interest days of the early 80s. My memory of it is that you got a great deal at 13.5%.

SB said...

See what putting Zillow on your blog can do -

Not to mention NPR's story this morning on a 5 blade razor.
where the host shaved on-air (great radio, right?) and sort of declared the 5 blade razor the winner.

seattlefrank has its finger on the pulse of something or other.