Shambling Towards Affordability (December 2008 Edition)

Submitted by Rich Toscano on March 24, 2009 - 4:43pm

Based on their historical relationships with rents and incomes, San Diego home prices are now reasonable.

There. I said it.

The long-term price-to-income and price-to-rent graphs tell the tale:

Neither ratio is at its all-time low, but both are firmly in the middle of the range that prevailed for two decades before this latest bubble blew the valuation metrics sky-high.

The price-to-income ratio would have to fall 15% from December's level to equal its all-time low hit in 1997. The price-to-rent ratio actually hit its low in the prior cycle, in 1986. It would have to fall 22% from here to hit that level. Of course, given the exaggerated bubble-time overshoot to the upside, it's reasonable to believe that valuations could overshoot to the downside and set new lows.

On the plus side, these charts use the December Case-Shiller release (the most recent), which as I've often discussed best reflects November 2008 pricing. Home prices in the real world have dropped a bit further -- and the ratios gotten a bit better -- since then.

Here are the same charts with conforming 30-year fixed mortgage rates overlaid:

These charts aren't supposed to serve as timing indicators or to give buy and sell signals. They do not take account of external factors such as unemployment or foreclosures. They don't account for potential changes to future rents and incomes. And they aggregate the whole county into a single number, ignoring important distinctions between different sub-markets.

What the charts do provide is a broad-stroke view of how expensive San Diego homes are, in aggregate and compared to history, when measured against the region's average rents and per capita incomes. And these indicators say that while San Diego real estate as a whole is not dirt cheap, it's perfectly reasonable.

That alone has been a long time coming. Just for some perspective, here is the price to income graph with a blue dot placed over the month that I launched the Econo-Almanac:

Another way to measure valuation is to compare rents and incomes not with home prices but with monthly payments. While this provides some good context, I do not favor this valuation technique. For one thing, mortgage rates are artificially low, with the Fed monetizing into a mortgage market that was already underpricing long-term inflation risk to begin with. But that is just a subset of the general problem with this approach: rates change, and if you are trying to determine long-term sustainable levels of affordability, you have to consider the path of rates over said long-term, not just during a given month.

On top of that, the data suggests that monthly payments haven't historically made for a good valuation metric. I wrote about this in the last update of these charts:

It is pretty clear that for most of the history displayed on the charts, the payment-to-income and payment-to-rent ratios hewed pretty closely to mortgage rates themselves. Typically, the monthly payment ratios would move up when rates were moving up and down when rates were moving down. It wasn't until the recent housing bubble, when the payment ratios shot up while rates dropped and then languished at generational lows, that this relationship broke down.

But the recent bubble is an aberration in which home prices rose not due to low rates but to an extended period of incredibly reckless mortgage lending. Looking back beyond this risky-lending-induced bubble, there just isn't much historical data to suggest that homes should necessarily be more expensive when mortgage rates are low and less expensive when rates are high.

The point can be further illustrated by comparing the recent bubble peak to the early 1980s, when double-digit mortgage rates prevailed. If monthly payments are a good valuation metric, then these charts suggest that the overvaluation of the recent bubble was not nearly as large as that seen in the early 1980s. This is ridiculous, of course. The recently burst bubble absolutely blew away prior booms in terms of magnitude, as a quick glance at the bubble aftermath depicted in this long-term foreclosure graph easily demonstrates.

All that said, monthly payment levels do have an impact. They feed into the rent-vs-buy decision, for instance, which in turn influences demand for housing. So they are worth looking at -- they just shouldn't be looked at in isolation.

And with that long pre-amble, here are the new all-time lows for the monthly payment-based metrics:

Here are the same charts with interest rates overlaid:

The payment-to-income ratio is 3% below and the payment-to-rent ratio 6% below their respective all-time lows, both hit in the 1990s downturn. So by this metric (for what it's worth, which per the above is questionable) San Diego homes are cheaper than they've been since this data began.

But even by the superior price-based indicators shown earlier in this article, San Diego home prices are now reasonable. So despite everything else, the San Diego housing market has that going for it. Finally.

(category: )

Submitted by SD Realtor on March 24, 2009 - 5:32pm.

You know we will have to label you as a heretic now... you know that don't you?

Submitted by drboom on March 24, 2009 - 6:13pm.

BEDEVERE: Tell me. What do you do with witches?
VILLAGER #2: Burn!
VILLAGER #1: Burn!
CROWD: Burn! Burn them up! Burn!...
BEDEVERE: And what do you burn apart from witches?
VILLAGER #1: More witches!

--------------

Heresy aside, my wife and I have actually found a couple of houses in decent areas that we can afford to buy at 30% DTI with our smack-on-the-median household income. More to the point, we couldn't afford to rent they very same houses.

So ... now what should good little piggies talk about?

Submitted by kewp on March 24, 2009 - 6:30pm.

Great, after I spent my savings getting my teeth fixed! This was supposed to take at least another 2-3 years to correct!

DANG IT!

Submitted by jpinpb on March 24, 2009 - 6:39pm.

I still can't buy the place I'm renting for it to make sense unless I put a really good chunk down, which in these times, I'm hesitant to do.

I've posted this in other threads, but this is really a perfect place for it and appropriate.

My rent is 1800 a month. There's a townhouse in my complex selling for 380k. If I were to go the FHA route and put 3% down and pay whatever upfront, closing costs, realtor fees, I'm looking at about 35k or so, more or less.

380k -3% using 5% interest rate. I know, it fluctuates. If I don't pay points, let's just go w/5% for now. I'm looking at 1979. But then there's property tax of 316 and HOAs of 255 and insurance - not sure. Let's say 50 bucks a month and PMI - 150-180? or so.

I came up w/a grand total of close to 2800 or so. That's not counting upgrading the unit or any special assessments, since the complex is about 20 years old and surely going to need some maintenance.

So shelling out the minimum, I'm looking at about 1k more for the privilege of "ownership." And even if I do deduct the interest on my taxes, factoring that in, it'll be about 300 to 400 less from that. I'm still paying about 600 to 700 more a month.

Also, KIM, there are 4 units w/NODs in my complex. One of the units is for sure an investment property b/c the notice went to their house in PB. So the complex has some potential future inventory putting downward pressure on pricing.

I wouldn't say that in my complex that rents = owning.

Maybe if I want to tie up more money it could pencil out. But the uncertainty of employment everywhere makes me reluctant. I'd much rather have cash on hand JIC. That and the probability that there could be further declines on the way in my complex, why put more money down the drain, so to speak.

Submitted by North15 on March 24, 2009 - 7:19pm.

Rich,

Thanks for making this specific point:

"And they aggregate the whole county into a single number, ignoring important distinctions between different sub-markets".

It has become obvious that the coastal areas are lagging in price correction, with over correction occurring in several inland markets. It will be interesting to now watch the equilibrium that will occur in these two extremes.

Submitted by ralphfurley on March 24, 2009 - 7:34pm.

I don't understand how they collect the median number. It is from sfr sale prices? Or sfr and condos lumped together? If more of the cheap stuff is selling, then the median would be brought way down, no?

So if the houses in the middle range haven't budged much since the peak (as compared to the crap shacks), then the majority of houses are not at historic lows (ratio-wise), are they? Just the low priced ones that are selling.

We would need to see more movement in all price ranges to get a true correction. Am I wrong?

Maybe I should have woken up for my statistics classs in college.

Submitted by ralphfurley on March 24, 2009 - 7:37pm.

North15 wrote:
Rich,

Thanks for making this specific point:

"And they aggregate the whole county into a single number, ignoring important distinctions between different sub-markets".

It has become obvious that the coastal areas are lagging in price correction, with over correction occurring in several inland markets. It will be interesting to now watch the equilibrium that will occur in these two extremes.


That's what I was thinking. We need to see more movement everywhere to get a true correction.

Submitted by peterb on March 24, 2009 - 7:38pm.

Now if we could just count on rents and incomes to not start adjusting downward....

Submitted by SDEngineer on March 24, 2009 - 7:41pm.

jpinpb wrote:
I still can't buy the place I'm renting for it to make sense unless I put a really good chunk down, which in these times, I'm hesitant to do.

I've posted this in other threads, but this is really a perfect place for it and appropriate.

My rent is 1800 a month. There's a townhouse in my complex selling for 380k. If I were to go the FHA route and put 3% down and pay whatever upfront, closing costs, realtor fees, I'm looking at about 35k or so, more or less.

380k -3% using 5% interest rate. I know, it fluctuates. If I don't pay points, let's just go w/5% for now. I'm looking at 1979. But then there's property tax of 316 and HOAs of 255 and insurance - not sure. Let's say 50 bucks a month and PMI - 150-180? or so.

I came up w/a grand total of close to 2800 or so. That's not counting upgrading the unit or any special assessments, since the complex is about 20 years old and surely going to need some maintenance.

So shelling out the minimum, I'm looking at about 1k more for the privilege of "ownership." And even if I do deduct the interest on my taxes, factoring that in, it'll be about 300 to 400 less from that. I'm still paying about 600 to 700 more a month.

Also, KIM, there are 4 units w/NODs in my complex. One of the units is for sure an investment property b/c the notice went to their house in PB. So the complex has some potential future inventory putting downward pressure on pricing.

I wouldn't say that in my complex that rents = owning.

Maybe if I want to tie up more money it could pencil out. But the uncertainty of employment everywhere makes me reluctant. I'd much rather have cash on hand JIC. That and the probability that there could be further declines on the way in my complex, why put more money down the drain, so to speak.

As Rich said, this is an overall look at San Diego. It doesn't take into account variations between submarkets.

You're looking at, or close to the coast - those areas, and high end areas further in like 4S, haven't seen nearly the depreciation of areas like most of North County (excluding coastal areas from Carlsbad on down), East County, and the southern cities.

It makes sense to wait if that's your desired area - I can pretty well guarantee those price drops are coming to your area. Theres only so much extra people will pay to be 5 miles closer to the beach - which is why the areas with price drops are selling lots of houses, while inventory in higher priced areas (like the coastal areas) is sitting frozen by and large.

Submitted by SDEngineer on March 24, 2009 - 7:52pm.

ralphfurley wrote:
I don't understand how they collect the median number. It is from sfr sale prices? Or sfr and condos lumped together? If more of the cheap stuff is selling, then the median would be brought way down, no?

So if the houses in the middle range haven't budged much since the peak (as compared to the crap shacks), then the majority of houses are not at historic lows (ratio-wise), are they? Just the low priced ones that are selling.

We would need to see more movement in all price ranges to get a true correction. Am I wrong?

Maybe I should have woken up for my statistics classs in college.

I believe the statistics on this and other sites posted by a number of folks show that both the low and the mid end (under 500Kish) have shown a lot of movement. Only the high end (esp. jumbo's) is stagnant. Certainly in the last 18 months of watching the market, I've seen those discounts moving higher up the food chain. Check out mid-market areas that aren't at the coast, and you'll find they've undergone some pretty drastic shifts over the past year (areas like Discovery Hills in San Marcos, western and newer areas of Mira Mesa, Santee, etc.). All areas where the crap dropped first, then the nicer middle market areas fairly nearby.

Submitted by ctr70 on March 24, 2009 - 8:20pm.

I know Rich mentions this post doesn't take in account submarkets, but that is a huge factor. All across the Coast of CA from SF to San Jose to LA to OC to SD...the only houses selling are the bank owneds at the very low end of the market. These are not in the good school districts or desireable locations.

So how can you possibly come up with a rent to price ratio when the medians are incredibly skewed right now in CA to the low end? I mean come on, the Bay Area median is now $300k. Because the only thing selling are the bank owneds in crap hole neighborhoods like Antioch and Vallejo. If you looked at the price to rent ratio for San Fran, Palo Alto, Etc... it would still suck. The same goes for Rancho P., Carmel Valley, Encinitas, Beach communites, etc, etc, etcc... the rent to price ratio still sucks.

Yeah I do agree it's good now in City Heights, Oceanside, Chula Vista, Escondido and East County. But that is very skewed and does not represent SD County.

Submitted by SDEngineer on March 24, 2009 - 8:40pm.

ctr70 wrote:
I know Rich mentions this post doesn't take in account submarkets, but that is a huge factor. All across the Coast of CA from SF to San Jose to LA to OC to SD...the only houses selling are the bank owneds at the very low end of the market. These are not in the good school districts or desireable locations.

So how can you possibly come up with a rent to price ratio when the medians are incredibly skewed right now in CA to the low end?

Rich isn't using the vanilla median (which is even lower). He's using the Case-Shiller numbers, which are representative as they measure same house comparable sales.

Not that some submarkets are still significantly overpriced (like the coastal and high end zones), but the majority of the market (not just the low end) is now pretty reasonable.

Submitted by patientrenter on March 24, 2009 - 8:48pm.

Congrats to San Diego Piggs!

Those of us eyeing property in other still-inflated areas will have to remain patient, as will those San Diegans who want to live near the coast. I'll hold onto my champagne for now.

Submitted by moneymaker on March 24, 2009 - 8:59pm.

Now if I just had a job! Just kidding,actually I bought (I'm now renting money) in February. I haven't gotten buyers remorse,probably because I got a really nice repo at 46% of the high. I suspect there will be a small rush to buy this spring to collect the $8000 tax credit.

Submitted by GoUSC on March 24, 2009 - 10:18pm.

Here's the real question. What has the affordability ratio been historically in the beach areas... I would bet to say it has never been as good a ratio as elsewhere and rightly so. Coastal areas cost more.

Any info on this Rich?

Submitted by SD Realtor on March 24, 2009 - 11:20pm.

Good points all around. There is no doubt that many areas in the county still have a alot of depreciation left in them. How long it will take for them to go is debateable but I think we have a few years to go. However there is also not a doubt in my mind that these places will always always always run much higher then the national dti numbers.

Submitted by CA renter on March 25, 2009 - 12:25am.

Gotta grab a hankie here, Rich. It's like the end of an era. You just said "that which cannot be said" on a bubble blog. ;)

We could see this trend coming just by the actions taken by fellow bubble-sitters over the past few months. It seems many have purchased their own homes after waiting for years to buy a house. They've been telling us that they are paying less to own than equivalent rent, and even the staunchest of the bears have to agree that this is one of the most important metrics when valuing home prices.

Kinda sucks, because it was fun being a housing bear when everyone else was delusional.

I admit that many areas are pretty clear for buying right now, and the downside is greatly minimized for today's buyers. Our old home which we sold for ~$400K in 2004 had a model-match sell the other month in the high $100K range (~$190K, IIRC), and if you consider those homes actually peaked at around $475K-$500K in 2005, that's a pretty steep haircut. We purchased it in early 1998 for just under $120K, so it doesn't look so crazy anymore.

We're still waiting for the higher-end areas to fall, but I sincerely wish all the recent purchasers the very best in their new homes.

At this point, even we have to weigh the amount of decline and length of time it will take to see the remaining decline in our area. We may end up paying more in rent than what we'd save by waiting. We've been actively looking, and if we find the exact right house at a price around 2001-2002 levels, we will probably buy, too.

Thank you so much, Rich, for keeping up this blog so we could trade ideas and thoughts with one another. It's been a life saver for so many people!

Cheers! :)

Submitted by scotttherealtor on March 25, 2009 - 5:47am.

Here is another classic example of this economy.

http://www.youtube.com/watch?v=UgoS61dKY68

Submitted by rubberducky on March 25, 2009 - 6:37am.

Because Chrome crashed and lost my open tabs, I can't find the link I'm looking for.

One of the other sites I frequent (or it was here and I just can't find it), indicated median housing sell prices are moving up. Yaay, we are saved, right? Unfortunately, they're moving up because the foreclosures are moving upmarket. Houses are not selling for more.

With many ARMs yet to fail, the Fed diluting our Dollar (they added $1 Trillion dollars lately, reducing the value of the Dollar for good or bad), and businesses continuing to fail, do we really think the bottom is coming in?

I don't, but I'm not smart about this stuff anyways (e.g. please feel free to contradict me constructively), I'm taking my own haircut right now.

Submitted by ibjames on March 25, 2009 - 8:53am.

I went to a finance seminar yesterday, and a stanford professor was speaking. He went into how the fed needed to put that money into the economy, and that the difference is that the money is put into the economy but the velocity of the money cycling through is slow, so that is why we haven't experienced any inflation.

He also said that the fed thinks that they will be able to see when there is too much money and cut off the tap before inflation gets out of hand. He said that many are skeptical.

With the job market the way it is, I'm really having doubts if this is a good time to buy. I think that housing in close to coastal areas still can go down, and that a few more unemployment announcements may change the buy mentality. It's easy to lose focus on how bad the economy is when the stock market has had a week or so of gains. The real problem is that layoffs are not over.

Submitted by peterb on March 25, 2009 - 9:20am.

Consider the multiplier effect of when a lender lends out money. 30:1 money creation takes place. That's inflationary and real velocity as it's money creation as well as velocity. Now consider when the Fed lets lenders pile-up money in their balance sheets? If it does not get lent out, there's no velocity and no 30:1 money creation. Herein lies the problem with assuming money in the banking system will lead to increases in prices. There's a high historical correlation of this, but correlation is not causation.

The money needs to get lent out to have the inflationary effect of raising prices. And what are the factors that cause money to get lent out??? This is a credit implosion we're experiencing right now. Not a standard recession.

And, what does it take to buy a house? Usually, the biggest utilization of credit in most people's lives. Unemployment usually has an effect on this.

Submitted by carlsbadworker on March 25, 2009 - 10:43am.

I'm so tempted to say: we told you so! We, the temecula buyers, have been arguing that price has returned to normal in our hoods for months. There is still downside as price may overshoot (It is a battle against the government bailout effort. I don't know which side might win). So if your goal is to maximize the investment return (such as buying a rental property), I would think it is still smart to wait. But if your goal is just a home, the current price looks alright at non-coastal area if you can find the right house. For Inland Empire as an example, the average monthly rent for an apartment is $1,157 and the average after-tax monthly mortgage payment on a median-priced single-family detached home is $971, so it is not a bad time to own a house.

On the topic of rental property, I still haven't figured out why the "investors" are rushing to buy houses. Yes, cashflow is positive if the rent could stop dropping. But at the same time, we have no hope of significant price appreciation due to the hidden inventory (therefore equity is dead money) and the cashflow is really tiny. If a major maintenance comes up or you encounter a tenant who doesn't pay his rent, here goes your cashflow.
Also, I always believe that most recent-purchased properties can cashflow because their owners are playing with the black-swan event. Many of those I know do not insure enough or delay maintenance, that's why they could cashflow. Did anyone read the story that sometime ago a landlord lost a lawsuit because he failed to replace his window screen therefore the unfortunate tenant was raped? That's right, the window screens are supposed to keep out flies, mosquitoes, moths and rapists. What's the rush to be a landlord when you could potentially face hugh liability whenever someone gets hurt within your property?

Submitted by ibjames on March 25, 2009 - 11:55am.

then you put the screen on, and there is a fire and they get burned, and they say the screen kept them in!

Submitted by pencilneck on March 25, 2009 - 12:10pm.

I don't believe the current estimated per capita income data is accurately capturing the changes to the economy of the past 6 months or so.

But what would this really mean? Only that the steep dive in the first chart (price to income ratio) may currently be plunging a little less rapidly than shown. Which could also mean that we're a little closer to the actual bottom.

Great info Rich. There is a lot to digest there.

Submitted by danthedart on March 25, 2009 - 12:38pm.

So in San Diego, historically the price to income ratio is 7-9? Nationally it's 3-4? Wow, what a discrepancy there.

Submitted by paranoid on March 25, 2009 - 12:45pm.

How does Case-shiller index account for the weighting factor of different areas? I know they use sales-pairs of the same houses. But still if there are 10 houses sales-pairs in oceanside with a price reduction of 50%, and 1 house sales-pairs in CV with a price reduction of 5%, I guess CSI will give a different value than the opposite case (where 10 sales-pairs in CV and 1 sales-pair in Oceanside).

Because most sales-pairs are from lower-end areas, even CSI gives a biased value, though better than plain median value.

If i'm correct, all the analysis in the post needs to be taken with a bowl of salt!

A better analysis would be to do same analysis on zip-code basis (or a group of them). esmith already has software to recreate CSI on a zip-code basis. If we can find income and rent info for each zip-code (or a group of them), then similiar graphes can be made which will give a much better picture of current housing market.

Submitted by SDEngineer on March 25, 2009 - 12:54pm.

danthedart wrote:
So in San Diego, historically the price to income ratio is 7-9? Nationally it's 3-4? Wow, what a discrepancy there.

As noted in a previous post, Rich is using per capita income in his post. The 3-4x national ratio is using median household income. There's a large difference between household and per capita income.

In San Diego, per capita income (2006 numbers) was about 39K. Household income for the same period was about 66K.

Using those numbers, San Diego's historical price to income ratio is normally in the 4x-5x median household income. More expensive than national, yes, but not quite as bad as you thought.

Submitted by Huckleberry on March 25, 2009 - 2:33pm.

paranoid wrote:

A better analysis would be to do same analysis on zip-code basis (or a group of them). esmith already has software to recreate CSI on a zip-code basis. If we can find income and rent info for each zip-code (or a group of them), then similiar graphes can be made which will give a much better picture of current housing market.

So, where can we view these charts/data that esmith produces?

Submitted by FormerSanDiegan on March 25, 2009 - 3:23pm.

Huckleberry wrote:
paranoid wrote:

A better analysis would be to do same analysis on zip-code basis (or a group of them). esmith already has software to recreate CSI on a zip-code basis. If we can find income and rent info for each zip-code (or a group of them), then similiar graphes can be made which will give a much better picture of current housing market.

So, where can we view these charts/data that esmith produces?

http://sdhpi.blogspot.com/

Submitted by CricketOnTheHearth on March 25, 2009 - 5:16pm.

Wow, Rich, I'm kind of scratching my head at this graph.

Contrary to my earlier prediction, the price to income ratio has just kept rocketing almost straight down for the past year. I see no sign of inflection (shallowing-out) in this graph yet. Will it pull up in 2010 and match the 1996 bottom or just keep heading to the earth's core? I dunno.

I can't bring myself to call us "near the bottom" yet because the fundamentals just don't seem to be there. In your immediately previous post you noted that the job market in San Diego is imploding... and Dr. Housing Bubble doesn't think that the California economy will turn around until 2011. Then there are all those Alt-As which have only begun to reset in earnest this year, and will be continuing to hit all this year and into next.

No, I'm not saying you said "we are near bottom", I understand you simply pointed out we have gotten into the "band of normalcy". I'm just wondering, based on the fundamentals and on peoples' mood, if the price/income ratio will even stay in the "band of normalcy" and bottom out somewhere in there, or will it challenge the previous lows, or will it blast on through and form a new bottom.

I guess time will tell. Meanwhile I continue saving my pennies for that down payment.

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