Seller's Market

Prices are up, homes are selling quickly, and in some sought-after neighborhoods, bidding wars and escalation clauses are back. But with memories of the crash fresh and sequestration rippling through the local economy, people are worried about another bust. Here’s why experts say you shouldn’t be.

By: Luke Mullins

Emily White spotted the listing on a Friday night in January. A three-bedroom detached house in DC’s Brookland neighborhood—exactly what she was looking for.

She immediately contacted her agent, who arranged for White, a 29-year-old University of the District of Columbia employee, and her boyfriend to visit the property the next morning. When White arrived at 10:30 am, she was surprised to see another pair of potential buyers already inside. “It had only been on the market for 12 hours,” she says. By the end of the open house on Sunday, more than 100 people had visited the property and four offers had come in.

White and her boyfriend raced to put together an offer of their own. It included an escalation clause, which increased their bid to $105,000 above the asking price. But it wasn’t enough. They lost the house to an all-cash buyer who was willing to close on the property within a week.

If you’re not in the real-estate market yourself, you probably haven’t even noticed. But for would-be homebuyers, stories like White’s have become increasingly familiar. Last spring, a couple won a bidding war over a house in Gaithersburg by agreeing to adopt the seller’s dog. In December, a four-bedroom, four-bath fixer-upper along Northeast DC’s H Street corridor attracted 168 offers in two weeks. The following month, a penthouse in Chevy Chase sold for $8 million—the highest price ever paid for a Washington-area condominium.

While Washingtonians were distracted by the 2012 presidential campaign and Redskins quarterback Robert Griffin III’s knee injury, a funny thing happened: The local real-estate market snapped back to life.

After plummeting by a third during the housing bust, area real-estate values have increased by 14 percent since hitting bottom in 2009, according to the S&P/Case-Shiller Home Price Index. Only in five cities, including Phoenix and Detroit—which suffered steeper declines in the downturn—have prices rebounded more strongly. Sales volume is up, and properties are now selling faster—and for closer to their list prices—than at any time since 2005. And in certain neighborhoods, a pop of pent-up demand and a historic shortage of inventory have created market conditions—bidding wars, escalation clauses—that resemble the frantic days of the real-estate boom.

“This is real,” says developer Jim Abdo. “Buyers are suddenly finding themselves in a situation where they are having to compete for real estate again.”

But with memories of the housing crisis still fresh, the burst of activity has triggered concerns. How did competition for property get so intense so fast? Are current appreciation rates sustainable—or are we headed for another bubble?

We analyzed data and talked to dozens of economists, developers, builders, mortgage experts, and real-estate agents to determine where Washington housing prices are headed, what threats could derail the recovery, and which neighborhoods are best positioned for long-term growth.

One thing is clear: It’s not a buyer’s market anymore.

Faster and Faster. Across the region, homes are selling more quickly. In Northern Virginia, homes in all five counties spent an average of less than 60 days on the market in 2012. (click image to view at full size)

For Juliano Timm, buying a condo feels like the smart thing to do. The 48-year-old microbiologist recently received a cash gift from his family, and with interest rates low and the economy improving, real estate looks attractive again. In mid-January, he began searching for a two-bedroom for around $500,000 in DC’s Logan Circle, U Street, Dupont Circle, and Adams Morgan neighborhoods.

He never imagined it would be so frustrating.

Every property Timm has visited has been jammed with competing buyers. He began checking online listings several times a week, but even then, properties are getting snatched up before he has time to put an offer in—sometimes just days after they list. “I’ve been looking for a month, but it’s felt like a year,” Timm says. “I never thought it would be this bad.”

As the seat of the federal government, Washington enjoys special access to Uncle Sam’s generosity. Federal spending makes up nearly 40 percent of the region’s economy, a subsidy that was never more useful than during the Great Recession. While the national jobless rate reached 10 percent in the darkest days of the downturn, local unemployment never exceeded 7 percent. This resilient job market—and perhaps the excitement of President Obama’s arrival—has attracted a wave of young people to the nation’s capital. The local population of 25-to-34-year-olds jumped by more than 17 percent from 2006 to 2012. Many are well educated and work in high-paying jobs.

Over time, the stable economy and record-low interest rates have lured many young renters into buying. They prefer condos in fashionable urban corridors—such as DC’s Columbia Heights or Ballston in Arlington—where grocery stores, bars, and Metro are all within walking distance. Also fueling the demand are empty-nesters who want to trade their suburban home for a smaller place in a walkable “urban” community like downtown Bethesda.

But while demand for condos has remained firm over the last few years, the supply of new units has plummeted. When the real-estate market collapsed, many condominium projects in the pipeline were converted into apartments. Lenders, many of whom got pummeled during the bust, refused to finance new developments. The number of new condos hitting the local market fell by nearly 90 percent from 2007 to 2011. Says Abdo: “When nothing is being built—we are talking about the spigot being turned off—and you still have consumption taking place, eventually those inventories just evaporate.” By December, the area’s inventory of unsold homes reached its lowest level for that month in nearly a decade.

Meanwhile as prices have started to rise, investors have flooded the market again, making all-cash offers on properties they intend to rent out or flip. With more buyers chasing fewer properties, competition has grown fierce. In December, properties in three popular DC markets—Penn Quarter, Columbia Heights, and the U Street corridor—sold, on average, at or above their listing prices. By comparison, in 2005—the peak of the boom—homes in the District sold, on average, for 99 percent of their listing prices.

The result? Hot condo markets have driven real-estate values sharply higher in certain inside-the-Beltway neighborhoods. Median prices in Columbia Heights and Mount Pleasant surged by 32 percent over the past three years; values around U Street and in Shaw jumped by 27 percent. Prices increased by 11 percent in Ballston and 7 percent in downtown Bethesda over the past year alone.

Says agent Diana Hart: “I have not written an offer in the last month that did not contain an escalation clause.”

It’s not only condos that are scarce in today’s market. Leslie Friedson, a Long & Foster agent, spent two years helping a client hunt for a single-family home in an upscale neighborhood off 16th Street in upper Northwest DC. When letters, phone calls, and unannounced visits failed to unearth a seller, Friedson got creative. She drew up an offer of more than $1 million and dropped it on the doorstep of a house that wasn’t even on the market.

The ploy worked. Friedson is negotiating with the owner over a price. But her experience highlights the dynamic driving today’s market for single-family homes. “I have many more buyers right now than I have houses to put them in,” Friedson says.

On the Rise. After hitting bottom in 2009, home prices are climbing again. In the District, average sales prices have already breached their housing-bubble peaks. (click image to view at full size)

By the end of 2012, the area’s inventory of single-family homes was at its lowest since 2005. The shortage of listings can be traced back to the housing bust, says John Heithaus, chief marketing officer for the real-estate research firm MRIS. Area home values dropped by 34 percent from 2006 to 2009, leaving many owners today under water and unwilling to sell until they have enough equity in their homes to turn a profit. Others are waiting for values to improve further so their property will fetch a higher price. Low inventory also creates a vicious cycle: Many potential sellers simply can’t find a property right now that they’re interested in buying.

Just like in the condo market, this lack of inventory has created cutthroat competition in desirable neighborhoods. “I’m seeing multiple offers everywhere,” says Brian Block, managing broker at RE/MAX Allegiance in McLean. Buyers are making offers that aren’t contingent on home inspections or are tossing in perks, such as renting the home back to the seller for free while they prepare to move out. Many agents are working their broker contacts to find properties before they list and cut deals for them off-market.

The market is strongest in close-in neighborhoods with good schools and manageable commutes, especially in Northern Virginia. In the past three years, median home values have jumped by 19 percent in Fairfax County, 17 percent in Alexandria, 13 percent in Arlington, and 8 percent in Montgomery County.

The pent-up demand and historic inventory shortage means prices will continue to grow this year. But as rising home values allow more owners to list their properties and as new condo developments begin hitting the market in the next 18 to 24 months, prices will start to level off, says Alexander Paul, national research director for Delta Associates. Annual price growth will revert to its long-term average of 2.5 to 3.5 percent within the next five years, says James Bohnaker, an economist at Moody’s Analytics.

What may feel like a return of housing-boom chaos is actually a natural rebalancing of the market, he says: “The housing cycle is picking up again to get back to an equilibrium.”

Despite the positive momentum, the real-estate market still faces considerable headwinds. Record-low mortgage rates have juiced the housing recovery by making homebuying more affordable. The Federal Reserve’s bond-buying campaign, coupled with strong global demand for US Treasury securities, drove average 30-year fixed mortgage rates from 6.8 percent in October 2008 to 3.6 percent in January of this year. But Keith Gumbinger, a vice president at the mortgage company HSH Associates, says 30-year fixed mortgage rates could drift back up to 6 percent or higher as the economy improves in the next three to four years.

A more immediate threat is “sequestration”—the $1.2 trillion in federal spending cuts over the next ten years that Congress imposed to address the $16-trillion national debt. The cuts kicked in automatically on March 1. No agency will be hit harder than the Department of Defense, which would have $43 billion hacked off its budget for the next six months. Unless an alternative agreement is reached, the cuts will ripple through the local economy, forcing layoffs at the Pentagon and defense-contracting firms and possibly eroding demand for housing.

The sequester underscores a fundamental concern about Washington’s housing market. Federal spending has long been the backbone of the local economy, providing the job and income growth that drives home prices up. Nine cents out of every federal dollar spent remains in the region. And from 2000 to 2010, federal payroll and procurement spending increased by an average of 8 percent a year, according to Stephen Fuller, director of George Mason University’s Center for Regional Analysis.

But as massive deficits intensified pressure to shrink government, federal payroll and procurement spending fell from 2011 to 2012. “The federal government was certainly the [economic] driver for the last decade,” Fuller says. “It stopped being the driver in 2010.”

Even with a smaller boost from Uncle Sam, economists say Washington will have sufficient job and population growth to sustain a stable, healthy housing market in the long term. Over the next five years, the area will lose 22,000 federal jobs but gain 55,000 jobs in home construction and 39,000 in education and health care, Fuller says. Still, that won’t be enough for Washington’s economy to match its prior growth rates. “We used to do two points better than the US [economy],” Fuller says. “Now we are just going to do a fraction of a point better.”

Anyone who follows the news understands that home prices can rise and fall just like any other financial asset. But another broad housing bubble is unlikely to form in the area—at least in the near term, Bohnaker says. The lending practices that created the boom have largely vanished. Lenders—who once handed out exotic mortgages to anyone who walked through the door—are now required to assess that a borrower has the ability to repay the loan. The secondary market for mortgage-backed securities, which fueled the demand for subprime loans, is virtually nonexistent, says Guy Cecala, publisher of Inside Mortgage Finance. And a new federal agency, the Consumer Financial Protection Bureau, has been established to shield Americans from dangerous lending products.

Nevertheless, financiers are always inventing ways to extend credit, and the market’s appetite for risk will increase over time. It’s unlikely that risky mortgage products—or real-estate booms—are gone for good. If home prices in Washington are still increasing by double digits five years from now, your bubble radar should be flashing.

Just outside the Beltway on Leesburg Pike in McLean, workers haul building materials behind the glass facade of a six-story structure. When it’s completed, the development will include 400 apartments, a Walmart grocery store, and a 24-hour health club. About 300 hundred yards away, a pair of gray cement bridges glide into an unfinished Metro station. Late this year, the Silver Line will zip passengers from here to downtown DC in less than 15 minutes. A couple of blocks east, cranes deliver two-by-fours and metal beams to men in hardhats. In 2014, this 26-story luxury apartment building will have a rooftop pool and a communal walk-in refrigerator where residents can store their grocery deliveries.

It doesn’t look like much now, but the future of the local housing market is slowly emerging in Tysons Corner.

About six years ago, government and business leaders launched an initiative to transform Tysons from a car-dependent suburb into “the downtown of Fairfax County.” The master plan calls for four new Metro stops, condos, townhouses, apartments, shops, restaurants, athletic fields, bike paths, public art, and an elementary school.

The Washington area’s population is expected to increase by nearly a third, to 7 million, by 2040. Researchers predict growth will be strongest around places like Tysons—walkable clusters of businesses, restaurants, and housing tied to public transit. The movement toward these “town centers” is fueled by the region’s worst-in-the-nation traffic congestion and high housing costs. As such centers expand, their housing stock will become increasingly urban—think small townhouses and condos in densely populated neighborhoods—which will help keep prices under control.

The Metropolitan Washington Council of Governments, an association of local governments that addresses regional development issues, has designated 139 of these centers that are poised for growth, including DC’s H Street corridor, Columbia Pike Town Center in Arlington, and downtown Frederick. As town centers grow more popular, the Washington area will feel less like one large city feeding a network of suburbs and more like a series of smaller cities dispersed throughout the region. It’s in these town centers where demand for housing—and therefore home-price appreciation—is expected to be strongest.

The rise of activity centers will cut demand for what was once the symbol of success in America: the quiet suburban home with a two-car garage and a big back yard. “It doesn’t mean that there is nobody who wants a suburban cul-de-sac house,” says John McIlwain of the Urban Land Institute. “But those values are going to be much flatter than the values around these suburban town centers.”

Several corridors are ripe for particularly impressive housing demand over the coming decades. DC’s developing NoMa district, north of Capitol Hill, will see a 184-percent increase in employment by 2040—more than six times the region’s average. Silver Spring’s population will balloon by nearly three times the regional average over the same period. And don’t forget Tysons, which is projected to more than triple its population by 2050, to 66,000, and add nearly 90,000 jobs.

Says Jay Klug, a principal with JBG Rosenfeld Retail, which is spearheading a mixed-use development in Tysons Corner: “Tysons is making this transition from a very suburban, automotive-dependent place to a real urban area.”