San Diego Housing Market News and Analysis
Shambling Towards Affordability: November 2011
Submitted by Rich Toscano on December 11, 2011 - 6:37pm
Below you will find updated charts showing how San Diego home prices (and, further on down, monthly payments) stack up against local incomes and rents.
Longtime readers know that I consider the price ratios to be absolutely fundamental to determining whether housing is fairly valued. It makes intuitive sense that home prices would tend to track incomes and rents: incomes, because they determine how much money people have available to pay for housing; and rents, because rent prices reflect how much San Diegans are willing and able to pay to put roofs over their heads when there is no speculative or investment element involved. The historical record bears out this intuitive logic, as San Diego's home price-to-income and price-to-rent ratios have tended to be strongly mean-reverting over time.
Of course, there are other factors to take into account, such as employment trends, rates, and divergences between the various sub-markets that make up the aggregate numbers. But these ratios represent a good starting point in determining where the market stands from a valuation standpoint.
The first chart shows the ratio of the typical San Diego single family home to San Diego per capita income. (Median household income would be better but there's less data available -- however, having charted the data that is available, there is actually very little difference in the ratios whether they are based on household or per capita incomes). The price to income ratio is in blue, with historical mortgage rates charted in gray to provide context, and the historical median price to income ratio (what we might somewhat simplistically designate as "fair value") in red.
After the stimulus-driven bounce out of early 2009, the price to income ratio has declined to 7.3. This is a new post-bubble low, and is 10% below the historical median.
The next graph shows the ratio of the typical single family home price to average San Diego rent. The price to rent ratio sits at a more modest 4% below its historical median.
San Diego homes, then, are undervalued in aggregate based on these ratios. But not dramatically so. The following table lists the extremes in these price ratios in the three real estate cycles that have taken place since the 1970s:
We can see here that, despite the comparative vastness of the most recent boom, neither the price to income nor price to rent ratio has fallen as far below the median as they did in the two prior busts. Of course, there is no guarantee that they will do so, especially since the government is supporting housing to an unprecedented degree. But given the tendency for overshoot along with a raft of challenging economic considerations -- shadow inventory, weak employment, and a potential interest rate shock spring to mind -- I think the odds are fairly good that these price ratios will decline further still. (Whether that translates to significantly lower nominal home prices is up for debate, but that's another topic entirely).
Changes to the monthly payment-based ratios, which measure the monthly payment on the typical house against incomes or rents, have not been quite so subtle. Slightly below-average valuations have combined with absurdly low interest rates to produce payment ratios that are easily at all-time lows since the data started. The payment to income ratio and payment to rent ratios are, respectively, 45% and 40% below their historical median levels:
As I am always careful to point out, the price-based ratios are far more important than the payment-based ratios in determining whether homes are fairly valued. This is because the impact of rates is, unlike those of incomes and rents, ephemeral and undependable. However, in certain situations, individuals who are considering a home purchase may be more interested in the payment ratios. I discussed this distinction at length in a voiceofsandiego.org article early this year, so I won't rehash it here. Readers should note, however, that both price- and payment-based valuation ratios have improved since that piece was written, further moving the dial towards a home purchase making sense under certain conditions.
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