UG’s Primer, Part 1: UGB, restricted growth, and the effect of supply on real estate prices
Posted on March 27, 2008
Filed Under Mortgage, bubbles, Portland, Statistics, Real Estate, Builders, General |
My last year at Nordstrom was 1979. I was the divisional men’s shoe merchandiser for the six Oregon stores, and the national economy was that of Jimmy Carter: High inflation (12%), high interest rates (prime 12.25%); malaise. Not in spite of that, but because of that we had a record year: 27% increase in sales, 37% increase in gross profit, an obscene 48% gross margin. It wasn’t difficult: it required buying more of what the customers wanted, less of what they didn’t. Then add these dynamics:
- Availability of capital: With people making fewer high end purchases - cars or homes - there was more disposable income for $50 shoes.
- Market inertia: The psychology of buying. With inflation on the front page every day, and with the prices of shoes going up accordingly, it became a frenzy: buy now or pay more later.
- The pulling effect of pricing and supply: While we held to a strict maximum markup and were hyper-competitive on price, if an initial 100 pair run bought @ $10 sold twenty pair, and when we went to reorder the wholesale price had risen to $11, all inventory was repriced accordingly. That’s how, counter intuitively, the supply can go up and the price rise simultaneously. New inventory pulls up the price of all inventory.
===
Dealing with the latter first:
The housing supply has three sources: Resales, new construction and foreclosures (REOs).
- Resales: The time it takes a seller to decide to list and to get a home on the market can be anywhere from two to six weeks. Any time in that period - and anytime after the marketing starts prior to a sales agreement - the seller can decide to pull the listing, for whatever reason. After a surge in listings last year - sellers hoping to sell before the market dropped - and a YoY bump in January and February this year, listings are down in March (4000 MTD compared to 5400 LY). Only those with no other option are staying on the market.
- New construction: Builders don’t share the same luxuries. The pipeline is at least a year, often longer depending on the necessary site prep. And once on the market, it stays on the market until sold (rentals in Bend the exception). Note building costs determine the price, not market comps; but once they hit the market that price pulls up the price of resales. As long as there’s available capital and frenzied (I’d better buy now!!) demand, untempered new construction can drive prices through the roof, as it did in Las Vegas (over 50% one quarter) and Phoenix (40%).
- Foreclosures: Bank owned properties have the exact opposite effect of new construction. Banks have no emotional attachment, and just want to unload…quickly. Prices come down and - as in California - if REOs are a significant percentage of new supply, will pull the rest of the market down as well.
What that has meant - and means - to Portland
Because of restrictions on growth, Portland has not had the flood of new construction - condos excepted - seen in other parts of the country. Price spikes, then, were kept comparatively low. We can look to our own micro-market - Happy Valley - as an example: Building was so uncontrollably rampant that we needed to add a new zip code in mid 2006; at one point prices jumped over 35%; now 42% of the active listings are new construction, and there’s an 11.1 month supply. Prices plummeted 21% (YoY) in February.
Compare that to N, NE and SE Portland, where building was limited: increases peaked at 15.9%, 22% of active listings are new; deduct condos and it’s 11%. There’s a 5.8 month supply, and prices increased 1% YoY in February.
In part because of the restriction of supply, Portland didn’t have the same pressure to fund peaks with novelty loans. At one point of the frenzy over 60% of new mortgages in California were interest only ARMs, devastating in a depreciating market. California has over 57,000 distressed properties; Oregon somewhat over 1400. We will see adjustment, just not to the degree; I think in the 5% to 10% range.
All said, let me repeat: Median price, in and of itself, is a poor predictor of a market’s health. It gauges mix, so when the subprime crisis hit and the lower end was priced out of the market, the higher end sold and median stayed artificially high. Now that foreclosures are hitting and selling (and bringing back investors), the decreases are artificially low. [I’d love to see a 10% correction and an uptick in sales.] Case/Shiller, though better, has its own limitations: because it calculates homes that have sold twice, it eliminates new construction completely.
Next, availability of capital and market inertia…
Comments
9 Responses to “UG’s Primer, Part 1: UGB, restricted growth, and the effect of supply on real estate prices”
Leave a Reply
Nice writing style. Looking forward to reading more from you.
Chris Moran
[…] Jeff Kempe released a breaking post on UGâ […]
[…] Credit Score Guide wrote an interesting post today onHere’s a quick excerpt My last year at Nordstrom was 1979. I was the divisional men’s shoe merchandiser for the six Oregon stores, and the national economy was that of Jimmy Carter: High inflation (12%), high interest rates (prime 12.25%); malaise. Not in spite of that, but because of that we had a record year: 27% increase in sales, 37% increase in gross profit, an obscene 48% gross margin. It wasn’t difficult: it required buying more of what the customers wanted, less of what they didn’t. Then add these dynami […]
[…] Jeff Kempe released a post on UGâ […]
Portland’s growth is not restricted by the UGB, the suburbs surrounding Portland restrict growth. Wouldn’t it be a better comparison to use Aloha, Canby, or any suburb on the outer edge of the UGB in comparison with Happy Valley? Portland just seems naturally restricted by the suburbs.
Suzan, the suburbs are within the UGB - including Happy Valley - so I think you’re missing the larger point:
The assumption is that where there is limited growth (thus limited new supply) the prices should be higher than where supply expands to (theoretically) meet demand. That may be true in the long term - Manhattan isn’t exactly cheap - but in the short term uncontrolled building creates inordinate spikes in both an up market and in a down.
The premise that started all this was that we’re mirroring California one year out. We’re not.
With Happy Valley did all the new construction not materially change the mix of houses sold out there thus driving the prices up? This would also explain the more rapid decline as builders with inventory sitting will reduce to sell as it sitting costs them serious cash.
So you think it’s possible that’s what was primarily responsible for the increases and decreases in HV ?
With the shoes example surely more people buying was an increase in demand - we need to figure out the ratio of those buying to inventory to really see what the story was?
Thanks for taking the time to write this up - it’s definitely interesting stuff.
A story in the Oregonian a while back said 46% of loans made in recent years were of the “novelty” type.
Great pseudo-analysis but I still can’t figure out how any of it points to Portland escaping the downturn affecting every other place in the country. And the part about how we didn’t over-build- tell that to the condos coming online as apartments.
I see these anlyses getting more and more complicated and intricate as time wears on and Portland prices drop. The anlysis here rivals the method used to price the CDOs that Wall Street was valuing using an abacus, a slide rule and chicken guts.
“If we take the distance to the moon and divide by the number of condos in Belmont thus creating an algorithm that sequentially parses the hypotenuse of the value of a brick from Alberta Arts, we can plainly see that Portland will not only appreciate at a rate exceeding the number of milkmaids in Holland but at a rate approaching 20%.”
[…] [Part 1, supply, here.] […]