6/29/99

Long-Term Housing Market Cycles

Dear Clients & Friends,

Having a sense of the larger perspective may help maximize your return or reduce the risk involved in real estate investments. In this letter, I'll discuss my perspective on long-term cycles in the Puget Sound housing market. Short-term cycles will be covered in a future letter. The graph below shows a simulation of the long term housing market cycles. Please look at the Strand™Index graphs for actual data from the Seattle market over the past 16 years.

All housing markets across the US are affected by swings in the national economy. International markets, too, are proving to have an increasing influence in our local markets. But, every major metropolitan area will experience cycles specific to its own location. These cycles can be affected by business activity in the dominant local industries or demographic shifts, changes in land use policies, etc..

Since at least the 1960's, and possibly before, the greater Seattle housing economy has demonstrated a pattern of long term cycles of about nine or ten years in length. This has been characterized by upward price volatility in the "8" and "9" years of each decade, followed by a radical drop in market activity and some correction in prices in, or near, the "0" year.

Between the "0" year and the "5" or "6" year of the decade, sale volumes tend to be fairly steady and prices in the housing market generally follow the same pace as the Consumer Price Index (CPI). At about the "6" or "7" year of the decade, the market begins to pick up momentum and builds to a peak again, in the "8" or "9" year. For those who are interested, much of this can be documented with 1) King County property records detailing peaks in residential construction activity, 2) employment statistics originating in the offices of the Washington State Department Of Employment Security, or 3) population changes in the Puget Sound region.

Although the patterns of market swings have remained fairly consistent, the causes have changed from decade to decade. In the late 1960's sale prices (appreciation) in the housing market showed noticeable peaks. However, by about 1970 the aerospace industry was laying off significant portions of their labor force, causing an exodus of some of the region's population and reducing demand. This was punctuated by the infamous billboard imploring … "the last person leaving Seattle to please turn out the light."

By the mid-1970's the Boeing Company began re-hiring, in-migration of the population resumed and the region's economy was diversifying. In the late 1970's sale activity was again brisk, and prices moved up quickly. This peak was brought to a close in 1979 and 1980 by dramatic increases in mortgage costs when interest rates climbed from 9% to 18% in a matter of weeks.

The market was flat from 1980 to 1985. But, by around December of '85 mortgage interest rates dropped below 12%, the point at which the critical mass of the home-buying public could qualify for conventional mortgages and listing and sale activity kicked into gear, again. Market pressure built to an unprecedented peak in late 1989 when potential purchasers were standing in line if a broker's sign were placed in the yard and some segments of the housing market experienced over 35% gain in prices over a 12 month period. This was the point at which the market experienced the long-term peak.

The market began to quickly unravel in January of 1990. By about March or April this was observed through agent's field experience (see Strand™ Index graphs for long term cycles). Although employment and mortgage interest rates were stable, the volume of available inventory expanded at a pace faster than the market could absorb.

Also, by mid-1990 the onset of the Gulf War cinched the deal on slowing the housing economy as banks were reluctant to issue loans to borrowers going into combat. Again, the market plodded along with prices remaining flat for the first half of this decade. By 1996, the market began to pick up steam, again, and has cooked along with prices rising steadily since then.

SUPPLY & DEMAND: These changes are all reflections of shifts in supply and demand trends. The market contractions in 1970 and 1980 were indicative of an erosion of demand. In 1970 people lost (or feared the loss) of their livelihood. As the population base declined, so did the demand for houses but the housing inventory was still growing due to the new construction already in the pipeline.

Demand components include the DESIRE and the CAPACITY to purchase. In 1980, although the regional population was increasing, rising interest rates eroded the "capacity" of buyers to complete a real estate transaction. Even though the desire was there to purchase, buyers who may have qualified for a mortgage loan at 9%, often could not qualify at the 15% to 18% rates that were available at the time.

In 1990 the market fell apart primarily because the rapid increase in SUPPLY overtook the demand at that time. Between January 1st and the late summer, available listings increased 500%, likely the result of "excess profit breeding ruinous competition." Also, demand was somewhat curtailed by the Gulf War when banks were reportedly reluctant to issue loans to active military and reserve personnel who were called up to serve during active warfare.

Between 1990 and 1996, again, sale prices remained fairly stable. From 1997 to the present time we've seen significant gains in prices, showing that the market is holding to its well-established pattern of long term cycles.

If we hold to the patterns of the past, we're likely to see a drop in the market strength sometime early next year. BUT, please remember that it's still a market and there are no guarantees. There are plenty of forces in motion that would suggest no let up is in sight. If the stock market continues its gains, the high tech labor market maintains its shortage, and the US and its allies are able to entice worldwide political and military adversaries to keep from doing anything rash, we could usher in the new millenium with unprecedented, worldwide economic growth.

Regards,

Robert E. Rothstein
© 1999