Opinion: Why I'm Bullish on Real Estate in My Neighborhood

Here's a snapshot of recent occurrences in the real estate market where I live (Bellevue, WA):

* With the rebound of the local economy following the 2001-2002 dot-com doldrums, office vacancy rates in the urban core (Bellevue CBD) have fallen dramatically from above 25% in 2002 to 8.5% currently;
* An office tower (Civica) with Class A office space sold last week for a record $462 per sq. ft. This is the highest price per sq. ft. ever paid in the Seattle area for office space;
* A luxury 148-unit condo development (One Lincoln Tower) slated for completion in 2006 is almost entirely pre-sold. The lowest priced units sold for $540,000. Among the four units that remain, the "most affordable" is priced at $1.3 million for 1844 sq. ft. of living space, or $705 per sq. ft.(!);
* Year-on-year house price appreciation based on median resale prices (in King County) has been accelerating. It is currently about 15%, up from single-digit year-on-year price appreciation in 2001, 2002 and 2003;
* Anecdotal evidence suggests that residential real estate prices in my close-in neighborhood are rising at an annual clip of 20% or more, faster than the county average.
* This year's fundraising auction at my kids' elementary school brought in twice the "budgeted" amount from donors. Apparently, parents are feeling more generous this year, reflecting the improved local economy. Last Friday, for the first time, the PTSA hosted a fully catered evening carnival at the school, complete with free rides, inflatable play gyms for the kids, dinner for everyone and snacks--all paid for using "surplus" auction funds.

Despite the current strength of the local market, there is one exogenous negative factor: With interest rates rising (10-year Treas. is now 4.45% after touching a 3.98% low in early Feb.), mortgage rates are also up about 50 b.p. This rise in interest rates could put a damper on house price appreciation both nationwide and locally.

How will the list of positives fare against rising interest rates over the next year or two? With real estate all about location, a few important underlying considerations are:

* Proximity: My residential neighborhood, zoned for single-family detached homes and parks, is an easy ten-block walk from the urban core, with its Class A office towers, quality shopping mall (Bellevue Square), and growing number of restaurants and cultural amenities;
* Liveability: The city is encouraging development of a more liveable downtown, with more street retail and housing in comfortable, human-scale, "pocket" neighborhoods co-existing with CBD skyscrapers. The eventual outcome of this city planning effort is uncertain, but at least there is activity with good intention in the right direction;
* Schools: The local school system, which is arguably the best in the state based on academic measures, is a magnet for families who place education and a stable neighborhood environment high on their list of priorities;
* Housing Demand: With the office vacancy rate on the mend and more offices being planned, demand for housing will only increase as the number of local office jobs grows. Residential condos are also springing up in the CBD to meet some of this demand. However, no land is available close-in for building more detached homes;
* Density: Increasing density of development will continue to push land prices up at and near the urban core faster than further out in the fringes;
* Commute: As car and pedestrian traffic increases, so will demand for close-in housing, as many workers choose to live close-in rather than commuting through rush-hour traffic to get to work.

Although it is difficult to quantify the impact of all of these underlying factors on the price of local real estate, it is very clear that the neighborhood where I live has the "winds of growth" at its back. The house next door was built for $60,000 in the late 1970s and has seen a ten-fold price run-up in 25 years (9.5% per annum, compounded). (Disclosure: My wife and I are in escrow on this house.) With continued growth of the local economy and development of the CBD, I believe that similar price appreciation is likely over the next 25 years, even if rising interest rates temper market price appreciation in the short-term.

It may seem odd to predict that house prices will continue to appreciate at a multiple of the annual 3% or so increase in the average salaried worker's pay, when these workers are the ones who are driving much of the demand for local housing. What I believe is happening is that the "target class" of buyers of close-in homes is gradually ratcheting up to buyers in higher and higher income brackets. In other words, with the development of Class A office towers in the CBD, the neighborhoods adjacent to the CBD are being transformed into more upscale residential enclaves. Older homes built in the 1950s are, one-by-one, gradually being replaced by 3000 to 4000 sq. ft. new homes starting at $1 million, now aimed at executives and manager-level employees instead of rank-and-file workers.

With local job creation fueling demand for housing in an environment with a very limited supply of close-in detached homes, house prices will likely continue their ascent. From our perspective today, it seems almost ludicrous to imagine that the house next door could be valued at $6 million in 2030 (assuming the trend of ten-fold appreciation in 25 years continues unabated). Yet, the onward and upward build-out of the CBD, in conjunction with renewed interest in close-in urban living, makes continued above-average appreciation of local real estate a near certainty.

Today's absolute level of house prices in my neighborhood may feel bubble-like compared to where prices have been in years past. But, considering how consistent historical price appreciation has been during the work-in-progress, multi-decade transformation of Bellevue's urban core, I would characterize the city as being more in the middle of a prolonged build-out than in the middle of a price bubble.