BOMA Seattle King County Real Estate in Greater Seattle: An Olympia Perspective Washington Center for Real Estate Research University of Washington realestate.washington.edu January 28th 2019

RISK: The likelihood that an expected future outcome will not happen

Presentation Brief Housing markets, and commercial markets interact in unique ways Housing determines many retail spending patterns Commercial working patterns influence where people want to live and… How they want to live! Taxation policies and other policies aimed at one part of the market have influences on other real estate sectors

Real Estate Market Issues in Olympia Condominium Liability Specific supply side issue Buildable Lands / GMA Issues General supply constraint Changes to REET Major issue affecting all real estate Capital Gains Tax (9%) Not residential? Changes to B&O Tax Rates on Service Businesses Increase tax rate from 1.5% to 2.5%

Ability to trade up or down Basics of urban housing markets Housing Ladder Ownership Price Insensitive Ownership - Trade-up Ability to trade up or down Ownership - First-time buyers Rental Tenure Idea of Social Equity You should also see movement between different housing types and tenures

Basics of urban housing markets Housing Ladder SF Houses close to the city Higher-end townhouses close to the city Highrise urban condominium - upper floors Ownership - Trade-up SF Houses inner suburbs TH close to the city Highrise urban condominium – lower floors SF Houses in suburbs TH in inner suburbs Ownership - First-time buyers Mid-rise higher density condominiums near city Townhouses in inner suburbs Quality Rent/Price Mid-rise Lower density condominiums closer suburbs Small SF Houses / Townhouses in outer suburbs Mid-rise higher density condominiums in outer suburbs High quality MF Suburban Housing Medium Quality MF Housing closer to the urban core Rental Tenure High quality MFH in the suburbs Medium quality MFH closer to the urban core Rental tenure most vulnerable Millennials largest demographic grouping – Average Age is 26 Average age first time buyers – 31.5 and rising Average age to trade up – 39 Older apartments and hotels - ADUs Rental properties far away from the urban core Each rung on the ladder represents a particular submarket

Median House Prices by type As rates go up, payments go up for the same amount – usually means that people cannot bid up prices and housing becomes relatively more affordable. Statewide Overall Median = $373,800 Condo Median = $323,200 Source: Zillow, NWMLS, WCRER.

Housing Affordability Index - Washington Note that values above 100 represents a median household income in the county and a median house price with a 20% down payment given prevailing interest rates. Sometimes lending criteria are more loose than others – we use consistent measures as 25% of gross income dedicated to mortgage repayments. Current overall is 106.1 indicating that a typical median household could afford to pay 6.1% more than the WA median house price First time buyers index is calculated using 70% of median house price, a 5% down payment, and an income at 80% of median – 61.7…. Source: Washington State Housing Market Report: WCRER

Building Permits by Type Clear that developers are responding with multifamily housing, as expected. But it is all rental… Source: US Census Bureau, WCRER

Building Permits by Type Total Permits 1786 1609 1785 1353 1634 1839 1978 3596 3460 SFH Permits 809 939 740 963 1299 1014 1340 1661 1608 MFH 977 670 1045 390 335 825 638 1935 1852 TH/SFR 36 41 44 30 72 31 71 94 65 Condominium 0 0 0 0 0 0 6 0 12 1745 Apartment Permits Source: US Census Bureau, WCRER

Building Activity by Type – Select Markets Spokane has no condominium units being built. Across the border, there are over 50 units under construction (excluding those targeted to vacation homes) Vancouver only has one 40 unit development underway (luxury) and several ‘planned but on hold’ Portland has few developments except for high end (Hoyt Street 150 units – many over $1m). No suburban developments. Initial figures show there are no new 20+ condo developments taking place in Snohomish, Kitsap, King, or Thurston Counties. In Pierce County, most of the condominium development is represented by the Ruston Point development. Source: US Census Bureau, Sightline, WCRER

Building Activity by Type – Select Markets Spokane has no condominium units being built. Across the border, there are over 50 units under construction (excluding those targeted to vacation homes) Vancouver only has one 40 unit development underway (luxury) and several ‘planned but on hold’ Portland has few developments except for high end (Hoyt Street 150 units – many over $1m). No suburban developments. Initial figures show there are no new 20+ condo developments taking place in Snohomish, Kitsap, King, or Thurston Counties. In Pierce County, most of the condominium development is represented by the Ruston Point development. Source: WCRER

Condominium Liability Under the current regime, there is a 100% chance that a condominium developer is going to get sued Anecdotal evidence suggests that insurance premiums average about $35k per unit developed Developers will build is the deal pencils out! But the actual risk and potential for unlimited liability means that they will only pencil out when the marginal unit price reaches a point where they can take that risk on HOA Members must sue the developer

Current Supply Dynamics Housing Ladder SF Houses close to the city Higher-end townhouses close to the city High-rise urban condominium - upper floors Ownership - Trade-up SF Houses inner suburbs TH close to the city High-rise urban condominium – lower floors SF Houses in suburbs TH in inner suburbs MISSING HIGHER DENSITY HOUSING OPTION Ownership - First-time buyers Townhouses in mid-suburbs Quality Rent/Price MISSING HIGHER DENSITY HOUSING OPTION Townhouses in outer suburbs MISSING RUNG OF THE LADDER ON SUPPLY High quality MF Suburban Housing Medium Quality MF Housing closer to the urban core Rental Tenure High quality MFH in the suburbs Medium quality MFH closer to the urban core All of the missing options are typical for first time home buyers!! Older apartments and hotels - ADUs Rental properties far away from the urban core Vacuum between rental tenures and first time buyers This is called the MISSING MIDDLE

Commercial Market Problem Owners and Renters have different spending patterns Owners have equity to generate wealth That can be spent AND invested elsewhere Rental housing is on the lower edge of affordability No middle ownership market, rents go up Dynamics of the urban environment change What does downtown look like if only rental housing is available? What if demand for office space declines? The ‘donut’ concept

Capital Gains Tax Exemption Problem Likely to influence holding periods? Increased tax liability at reversion Exemption Problem For residential real estate investment, you will see higher demand into a housing market already short on supply If only primary residence is excluded… Risk and… Owners will need to increase rents in order to meet the expected return or owners will need to find increased operating efficiencies Many smaller landlords will sell their properties rather than face increasing regulatory uncertainty – especially in Seattle

REET and B&O Taxes REET Similar to Capital Gains Taxes B&O Taxes? But this will hit everyone Will decrease overall housing turnover Owner occupiers have returns expectations B&O Taxes? Service employment represents approximately 66% of all private sector employment in Washington Tax on Gross Receipts not Net Income Effect on small to medium sized businesses Effect on demand for retail space Requirement for retail ground floor in multifamily developments in parts of Seattle

Summary Proposed Condominium Liability Changes Buildable Lands / GMA Will lower the risk of condominium development Positive impact for some types of commercial property Buildable Lands / GMA Currently there are provisions that contradict each other Makes the development process more risky Either go with more flexibility or less flexibility – currently a source of uncertainty Capital Gains Tax Research shows that a change in tax policy also changes investment behavior This particularly true in real estate markets where reversion value is a major component of total return in investment modeling and expectations Has the potential to make housing less affordable Dependent upon which real estate sectors are exempt

Summary REET Changes Increasing B&O Rates on Service Businesses Will be similar to changes in Capital Gains Tax More comprehensive and likely to have a negative impact on housing turnover Increasing B&O Rates on Service Businesses Restricts employment opportunities in the largest proportion of the WA economy Ironically, might be good for affordable housing because demand for housing might decline (fewer jobs) Risk of starting a business increased because it is a gross income tax Other Items Rent Control Janitorial Services - Is this different taxes on service businesses? Sales taxes on leases and rents See above on expected returns…

Conclusion Residential markets influence commercial real estate demand and vice versa While framed as taxes on business rather than homeowners or renters, the proposed tax changes have the potential to negatively impact housing markets Other measures proposed on the fringes act to increase the regulatory risk associated with real estate investment across all sectors Does making the anticipated future outcome less certain increase or decrease risk?

Will proposed legislative change my risk profile? Final Questions Will proposed legislative change my risk profile? How will these changes influence other sectors of the real estate market?

BOMA Seattle King County Thank You Washington Center for Real Estate Research University of Washington realestate.washington.edu January 28th 2019