I Just Bought A House In Portland…Was That A Smart Thing To Do?
I bought a house in Portland today. My family is thrilled to move there once my daughter finishes her school year in Bali. We are excited because of the greenery, great food, bike-friendliness, Portlanders’ open-mindedness, opportunity to run in Forest Park, and yes, even the cloud cover (my fair skin makes me susceptible to all sorts of bad stuff under the sun’s strong rays).
As happy as we are with the decision, I was more than a bit nervous when signing the purchase documents. You see, for the past couple of years, the three hottest U.S. real estate markets according to the Case Schiller Home Price Index, are Seattle, Portland, and Denver with year-over-year gains consistently above 10%.
Whenever I read a statistic about multi-year best performing markets/assets, my contrarian mind screams “Sell, Sell, Sell!” And that’s what I was hearing when I signed the docs.
To give you a bit of my personal real estate background, I started following the Case Schiller index in 2004 and it guided me well when making my other two house purchases.
Since I wasn’t familiar with the Portland real estate market, I dug up some numbers on single family home prices covering the last 40 years to analyze the data instead of just relying on my gut. Now, I realize there are many other important factors such as price-to-rent ratios, affordability indexes, interest rates, etc. but I chose to focus solely on past pricing trends to forecast future prices. This approach is akin to technical analysis of securities in the stock market.
To provide further context, I dug up the numbers for the other named hot markets plus three others on the West Coast- San Francisco, Los Angeles, and San Diego.
This graph alleviated some of my fears. Yes, Portland’s prices are about to surpass its previous high (2006) on an inflation-adjusted basis, but history shows that the new peak needs to be substantially higher before the market contracts. This would suggest there’s a lot more upside before things come crashing down.
Drilling down deeper into the Portland market, we can see that the month-on-month (seasonally- & inflation-adjusted) growth slowed from 1% per month in June 2016 to 0.8% per month in November 2016.
If the trend continues at the rate of 4 basis points per month, then price growth will continue slowing for 20 more months before going negative.
Next, I took a look at the boom and bust cycles for the six cities to estimate how much the market would drop once prices start to go down.
The Portland numbers are little misleading because the 159% statistic in the ‘.com & Housing Boom” was actually the cycle from 1988 through 2006, while all other cities were from the mid-1990’s to 2006.
Whenever any of the markets go bust, they decline for about 5 years and ultimately give up 25-50% of the previous boom cycle’s gain.
Portland’s single family home prices have increased 43% in this current cycle, and if it continues for 20 months at the rate I forecasted above, then the total gain will max out at 47% by June 2018. I’d then expect a 5 year drop of 12%-23% from that peak. This would mean that my $570,000 house would be worth $618,500 in June 2018 and then drop to anywhere between $502,850 and $552,250 by 2023. Again, all of these figures are inflation-adjusted.
As it turns out, that voice in my head might be right after all…at least for the medium-term.
So, why did I buy the house?
Well, one of the reasons was non-financial. We needed to secure a good school district for our 6-year old daughter. She’s already been to 3 different schools in 3 countries over 3 years. We didn’t want to risk moving her from school to school if we rented and then bought later somewhere else in the city.
Another reason was that my wife and I are fairly good at building equity through smart choices when upgrading a house. In particular, our new house comes with a sizable basement that we can fix up and rent out. At some point, we may even rent both the main floor and the basement, securing a cap rate of around 6%– not a bad rate of return while keeping the rents at market rate.
Finally, there’s one optimistic scenario I haven’t discussed yet.
It is widely believed that real estate market movements are all almost a purely local phenomenon. I believe; however, that this truism is becoming less-and-less true for several reasons.
First, there’s a strong trend towards telecommuting making it easy to work from almost anywhere. Second, there is a growing tendency for real estate investors to think more broadly, searching for better cap rates outside of their home markets. The combination of these two trends makes real estate less local as expensive market homeowners and investors look to relatively cheap markets for arbitrage opportunities.
Take a look at the graph below.
Single family homes are much more expensive in San Francisco, San Diego, and Los Angeles than they are in Portland. If any or all of those California markets start to tank, their residents/investors might choose to sell and flee to places like Portland. This influx could partially or completely offset the expected Rose City declines, propelling the Portland market to climb for several more years…much to the chagrin of life-long Portlanders. (Dear Portland, My apologies in advance. I promise to do my part in being a good, contributing member to the PDX community.)
So there you have it. We can’t wait to move to Portland after being in Tokyo and Bali the past few years. We’ll just try to be smart about home improvements and keep our fingers crossed that the market doesn’t turn to sharply against us.
Some additional graphs for those of you who love bar charts.