Tuesday, July 29, 2008

Is Bainbridge A Bargain? No, But It Will Be.

You know it's bad when the "Open House" signs outnumber the "Obama '08" signs by 2:1.

This is Bainbridge Island, Washington - the "Martha's Vineyard of the West" (yes, they really say that, and it is embarassing)- a place where smug, liberal dreamers come and bask in everlasting home appreciation.

One problem...homes are not appreciating. It turns out that Bainbridge Island is in the same credit pool as the rest of the nation. Believe it or not, Bainbridge Island has to borrow money from the same places that troglodytes in Nevada, Florida, Indiana, Texas, and Kentucky borrow money. For some odd reason, there isn't a boutique lending facility with special rates and conditions for the anointed in 98110 (or 98061 if you are really hip-n-trendy).

Could it be that people on Bainbridge are being confronted with the economic reality that there is a finite amount of money suitable to be set against a 30 year old, drafty home? I guess the idea that we are "special" isn't moving homes as it once did. Perhaps we were never "special," but just a convenient place for Californians to sell out of mediocrity and go slumming up north with all their hard-won home equity. Now that Californians are likely to be facing foreclosure, they don't have all those Bongo-bucks to throw around anymore.

My sources tell me that an abrupt change happened in October '07, with regard to the X-Cal market. It confirmed my hunch and the most recent numbers certainly solidify that assumption.

If the median house on Bainbridge Island is somewhere between $625-$850K (let's call it $750K for good measure), and the median household income is a hair over $75K, that might have quite a bit to do with the rollback in prices.

$75K/yr = $6250/mo. That's the income without all the zany home appreciation money that people were sucking out of WaMu refis and HELOCs by the boatload. In other words, if we don't count new debt as income, the median household on Bainbridge has to get by on less than $6500/mo.

Subtract $700 in federal taxes (it is likely higher)
Food - $500
Gasoline - $150 (assuming a Prius with an "OBAMA '08" sticker)
Insurance - $100
Utilities - $300
MC/Visa - $1000
Health - $500
Prop tax - $300
Prop insurance - $75
Auto debt - $400
Ferry - $150
Home maintenance - $200

That's a pretty spartan Bainbridge lifestyle. That presumes no annual trips to the Himalayas, Botox/Viagra, private schools, college debt, professional fees, B&B trips to Napa, Burning Man, visits to the shrink, bail money for "Paint Night," dinner parties with the Hip and Trendys, orthodontia, Eurail passes for the kiddies, 401(k) contributions, life insurance, pet day spa, and trimming down to the NYT Sunday Edition.

Assuming this is the median Bainbridge lifestyle and income, that leaves $1875/mo for the house payment. At 6.5%, 30 years, and 20% down, that's a $370,471 house. This presumes that every last dime went to the house and the median person has $75K in liquid cash to throw at the mortgage. At 7%, the house price drops to $352K, and at 8% the median Bainbridge household can afford $319,200.

Although it is fair to note that by using canvas shopping bags, you can save a nickel at Central Market for every plastic bag you don't use. While that $1.50 can get you a cheap cup of coffee once per month, the smugness of knowing that you single-handedly saved the planet can not be measured in dollars. Drive up in your Toyota Pious, complete with "OBAMA '08" bumpersticker, and you have just exercised the "nuclear option" of eco-smugness.

Let's look at it from a debt to income perspective. With a house payment of $1875 + $75 + $300, that makes the home DTI of 36%, which is too high by normal underwriting standards. Given the unrealistic budget outlined above, the high ratio makes sense. The price still has to come down.

Before the lending madness of the past decade, it was considered to be prudent to establish a 28% cap on home costs (not including maintenance) versus gross income.

$6250 x 28% = $1750, which makes us $125 overbudget. Take out that $125, and your home prices at 6.5%, 7%, and 8% drop to $345,700, $328,500, and $297,900 respectfully.

We won't consider further debt encumbrances like college loans, payments on the snazzy new Prius, or any lingering damage on the plastic.

Keep in mind that the person in the above scenario needed to save somewhere between $60K and $75K to drop 20% for the down payment. The budget does not have any savings of any kind.
If I recall correctly, the median price for Bainbridge Island during the years prior to the housing bubble was right in the mid-$300K range. Coincidence?

Studies of the value of a home, as measured by EBIT, cash flow, and rental substitution also peg the median value in the low to mid $300K range. Assuming that we don't get a rollback in income and that we don't overshoot in the correction (both wildly optimistic assumptions), we are looking at a substantial correction in Bainbridge Island real estate of 2/3 off the peak price. Supply has shifted dramatically upward, and when the speculative premium becomes a discount, 75-80% off the peak valuation will certainly be common.

When I ride on the ferry, I never hear anyone bragging about how expensive their homes are. Back in 2005, that's all I would hear. I don't see as many California license plates as I once did.

The tide is going out.

Ernst Stavro Bloviator,
Senior Fellow - Institute For Economic Reality