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

18 comments:

Infoalchemist said...

I'm not sure why you would spend so much time and thought on these issues unless it's to relieve your own frustration. You can't possibly know everyone who lives on Bainbridge, so your remarks about the snobs are by nature unfair. Let's concede all your points--that housing on Bainbridge is expensive, that people who paid too much two years ago can't sell for a profit today (they shouldn't be able to do so in any case), that some people who live in Bainbridge feel superior. So what? What would you have happen?

Eleua said...

Info,

Yes, this blog is a cathartic release of my frustrations of being surrounded by arrogant, liberal twits.

In 2005, I would ride the Seattle-BI ferry and try to catch some peace-and-quiet on the ride. It was ALWAYS interrupted by some party talking way above normal conversational levels about how rich they were all becoming by "investing" in Bainbridge real estate.

I couldn't escape it. I would move to another section of the boat, and another group would be crowing about their home equity. It got to the point that I would have to sit outside to avoid overhearing all the smug talk about Bainbridge real estate.

Whenever I would chat people up on the topic (not on the ferry), NOBODY, and I mean NOBODY, ever considered that the present (2005-07) market could ever change. Bainbridge was just too desirable and people would always bid up the price.

One would think that with the premium that Bainbridge residents put on education that someone would have clued-in to the bubble conditions that were OBVIOUS. Someone would have thought this through and realized that you can't have property appreciate at 10-20%/year while incomes only appreciate 2%, without a rollback in real estate prices.

With all the financial eggheads that live on the island, someone would have figured out that the banking system would come under stress at all the zany lending, and that would eventually jeopardize the entire real estate cost structure.

Nope.

Give me my "Bainbridge Island Dream Home," my white wine, my Subaru Outback AWD, LaCrosse, my therapist, and canvas shopping bags and STFU about any economic reality. Borrowing money from home equity to buy another house to rent out at a huge cash-flow loss for a tiny cap-rate is a perfectly sustainable way to build wealth.

What did I know? I'm just a bitter, blue-collar renter that missed out on the being part of the "ownership society."

Debt is the antithesis of wealth.

Anonymous said...

Thanks for reminding me about the burning man.

Thurston Howell IV

Wisdom-Seeker said...

Keep raising awareness! We have to get people to the point where they're willing to stop piling debt onto our country. And we have to do it before the country goes broke.

Eleua said...

Wisdom-seeker,

It's too late. The country is broke, and the primary "growth" industry of the past quarter centruy has been engineering debt.

For all the college educations that have been passed out in this country, I find it truly amazing that we still think of debt as wealth.

Anonymous said...

oh dear !

Anonymous said...

Clearcut, when's the bottom? Prices seem rather high. I've heard the term "deep pockets" when it comes to BI homeowners...they are unwilling to lower their prices and can simply weather the downturn by staying high or leasing their property. Seems this tension has to give at some point...considering flat wages in a shrinking job market, higher inflation, flat 401ks and shrinking, and tighter lending standards. Next year should be interesting as many of the same houses sit and the rentals return to the MLS...lotsa inventory.

Eleua said...

When is the bottom? Unknown.

It might be better to ask, "What will the bottom look like?"

People won't be talking about how it is a bottom.
People won't be "in it for the long haul."
People will not equate home ownership as "the American Dream."

Rent will likely be at a slight premium to the house payment.

Interest rates will be high.

Price/income will be below 3.0.

Rental homes will cash-flow positive with an EBIT a few hundred basis points higher than 10year US Treasury debt.

The number of Bainbridge RE agents will be 1/3 of the current number.

Real estate agents will quit using the term "Bainbridge Island Dream Home."

Also, you won't see a rapid recovery. You will see a long, hard bottom that does not take off like it did in the mid-90s.

Deep pockets can't drive anything but a few homes in the upper end. The $600-900K range is getting killed right now, as those prices (median +/- $150K) were popular with the wanna-be Bainbridge, exotic financers.

I hope this helps. You know it's a bottom when nobody is talking about it being a bottom.

Anonymous said...

Your calculation is apples to oranges again. Families with median incomes don't buy median-valued homes. There are renters (22% of homes on BI) and condos. I would guess that on average median SFH sales on BI go to families with incomes more than 150% of median, say $115K. Supports a much higher home value, not median price but this also ignores that most BI buyers are trading up and thus have more than 20% down.

Eleua said...

Anon,

Do you have anything other than a "guess" to back up what you are saying?

People are only trading up if their equity allows it. Over the past 12 months, 15% of the price has come off homes, which represents the bulk of equity in the traditional purchase.

Anonymous said...

I don't have any data on what income level purchases the median-priced SFH on BI but it's obvous that it's going to be significantly higher than the median household income, given renters and condo-owners.

As far as most BI buyers trading up - one data point is the median age of 43. Another is the high home prices!

Eleua said...

Your presumption is that renters make significantly less than owners. I'll grant that renters may make slightly less, but not significantly less.

Anonymous said...

Uh, "slightly less"? - try *half*. Renter household income in King County is 63% of median income of all households - so it's got to be much lower as a % of homeowner income.

http://www.metrokc.gov/budget/benchmrk/bench06/AffHsg/AffHsg_06pg15-16.pdf

http://www.ci.bainbridge-isl.wa.us/documents/HousingNeedsAssessment%5Bp28-38%5DIncome%5B9-17-03%5D.pdf suggests that renter avg income on BI might be even lower (e.g. 37% of renter households in need of rental assistance).

The alarmist line "the median-income household can't afford the median-priced home - houses are overpriced" is simply a canard. Renters make a LOT less and always have. Which means the median-priced home is ALWAYS selling to buyers with incomes well above the median.

Anonymous said...

I have been looking to buy a home on Bainbridge for sometime and with a max price of 425K...there still is no inventory

Eleua said...

"Which means the median-priced home is ALWAYS selling to buyers with incomes well above the median."

Think about that for a while.

Eleua said...

No inventory at $425K...

Be patient. We just peaked the largest credit bubble in world history. These things take time.

Eleua said...

@anon 8/24 18:16

Think about this. Let's say there were no renters on Bainbridge Isl...

Would the typical median income family pay in rent what they are paying in PITI?

No way. The difference is the speculative premium, which will come out of the price as the deflationary spiral accelerates.

Thanks for playing.

QUALITY STOCKS UNDER 4 DOLLARS said...

Theirs always bargains somewhere if your willing to look that is.