San Diego Housing Market News and Analysis
Shambling Towards Affordability: San Diego Housing Overpriced (But is it a Bubble?)
Submitted by Rich Toscano on February 2, 2014 - 10:54am
I must admit, I considered dispensing with the "Shambling Towards Affordability" title for these valuation updates, but in the end I decided that tradition must be maintained. Anyway, other than the fact that the housing market is neither "shambling" nor moving "towards affordability," it's a perfect fit.
One thing I did change was to combine my two previous valuation indicators, home-prices-to-incomes and home-prices-to-rents, into a single metric. I thought this would make it simpler to get a single big-picture view on home valuations, and it makes the chart maintenance a little easier on me as well. The indicator is constructed simply by dividing the Case-Shiller San Diego home price index by an equally weighted average of San Diego rents and per capita incomes, and normalizing the whole deal so that January 2000 equals a value of 100 (just like the CS index).
OK, enough background... let's have a look:
Despite the recent runup, San Diego housing valuations are still dramatically lower they were during the bubble. However, homes are far from cheap -- at 12% above the historical median valuation (down from a recent high of 13%), housing has become nearly as expensive as it got during the 1979 and 1990 peaks.
This isn't a very big sample set, but for what it's worth, here's what happened each of the last three times housing valuations rose to this level:
Despite last year's move up -- a result of both rising prices and a jump in mortgage rates -- this chart shows that monthly payments are still very much on the low side of history. For as long as that continues to be the case, it could allow valuations to "float" up above normal levels. When it changes, though, that will remove a major tailwind for housing valuations. (And, that really does seem to be a "when," not an "if," because rates are only as low as they are due to central bank intervention that must end at some point... as to when, that's anybody's guess.).
Interesting side note: last year's move up in the monthly payment index appears pretty minor on the scale of this chart, but it was gigantic in relative terms, increasing by 34% in just fourteen months! That is a major (relative) hit to affordability, but it's not readily apparent on the chart because we started at such low levels.
Anyway, you can see why I think there are many reasons that it's tough to know with any certainty what will happen with home prices and valuations. But we do know this: homes are more expensive than their typical historical level, and valuations are at levels that, when previously reached during our admittedly limited data set, always eventually returned to (and through) the median valuation.
Shorter version: San Diego homes appear to be overpriced. Proceed with caution.
Bonus Nerd-Out: Is Housing In a Bubble?
This is a question or proposition I've heard a lot... in fact, there is an active forum thread addressing this topic right now.
For what it's worth, I don't actually think it's all that meaningful to contemplate. The important thing to understand is whether something is overpriced, and by how much. The question of whether it is a "bubble" is mostly a matter of semantics, and is based on one's own definition of a "bubble," which can obviously vary from person to person.
But just for fun, let's try to figure it out.
I'll start with the definition. To me, the defining feature of a bubble is extreme overvaluation. Investor enthusiasm and rapid price changes can certainly figure into it, but if something's not really overpriced compared to the fundamentals, it's not a bubble.
So how overpriced is overpriced enough? For this, I will defer to the really smart folks at GMO, an investment management firm that has done a ton of research on historical investment bubbles. They have a purely quantitative definition of a bubble: when an asset's valuation reaches 2 standard deviations above its historical fair value trend. Such an occurrence should be, and has been, a very rare event. And very interestingly, almost all of the major bubbles they've studied (36, if memory serves) have eventually "popped," aka, come back down to their fair value. (The only ones that haven't popped are still ongoing, so the jury is still out on those. But the conclusion is still that bubble almost always -- or, maybe, always -- burst).
The red line in the graph below shows what the threshold would be for a bubble in San Diego housing:
While we reached, and handily surpassed, bubble status in the mid-2000s, clearly we are nowhere close just now.
Some might argue that the bubble itself distorted this definition: if we hadn't had the mid-2000s bubble, the standard deviation of the valuation series would be a lot lower, and the bubble threshold would accordingly be lower as well. Now, this is certainly an interesting point, but I don't feel that it's a good idea to start cherry-picking which data you use, as this kind of defeats the purpose of using a quantitative, unbiased definition. Nonetheless -- just for curiosity's sake -- here's what the bubble threshold would look like if we only based it on pre-2003 data (2003 having been picked somewhat arbitrarily as the year when SD housing really started to go nuts):
Even by this much less stringent definition (and again, one that I don't think is valid, for reasons described in the last paragraph), we do not meet the bubble criteria.
So, using GMO's quantitative 2-sigma definition -- which is as good a definition of any I am aware of -- this is not a housing bubble. For what that's worth. (But homes are still overpriced).
~Active forum topics~
~SD Home Price Snapshot~
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