San Diego Housing Market News and Analysis
Shambling Towards Affordability: Year-End 2010 Edition
Submitted by Rich Toscano on February 14, 2011 - 6:32pm
It's time for some valutions. The charts below show San Diego housing valuation ratios updated through year-end 2010.
Let's start with the price-to-income ratio. The decline in home prices since the summer brought this ratio back down to 7.6 -- right in the middle of fair value territory per these ratios. In fact, it's 5% below the median price-to-income ratio over this entire period (which incidentally is 8 on the nose).
The price-to-rent ratio came even closer to hitting its "fair value" at just 1% above its historical median. (I have theorized that the higher price-to-rent ratio reflects slightly depressed rents as a result of the bubble-era building frenzy).
So compared with incomes and rents, San Diego home prices in aggregate were more or less at fair value as of the end of 2010.
Middle of the road purchase prices combined with ultra-low mortgage rates to get us back near historical lows in the payment-based valuation ratios. The monthly-payment-to-income ratio was 39% below its historical median!
And the payment-to-rent ratio was 32% lower than its median value:
So what does this all mean? There are really two separate questions to grapple with:
If you buy now, and you get a big mortgage (high loan-to-value ratio), you are locking in a monthly payment that has effectively never been lower in comparison to regional incomes and rents. (I am of course referring to the county in aggregate, as some areas remain more expensive... so assume for this article that we are talking about the "typical" home as measured by the aggregate number charted above). To the heavily mortgaged buyer, San Diego housing has never been cheaper.
But that's not necessarily a reason to run out and buy, because to the extent you intend to sell the home in the future, you have to consider question #1. Low mortgage payments are of little consequence if you are just going to sell the house 5 years down the road. In that case, the primary driver of how well you do in the transaction will be what's happened with home prices when you sell.
But if you are hanging onto the home indefinitely, that's something different. In that case -- assuming that you intend to buy a house with money that is mostly borrowed -- the future path of prices is less important than the future path of payments. Put another way, who cares what happens to the home's market price if you are sitting tight and making generationally low monthly payments the entire time?
Of course it's possible that payment ratios could go even lower. But catching the exact bottom is a speculator's game. One could argue that monthly payment ratios 30-40% below the three-decade median should be "close enough."
This is why I believe it can be a very good deal to buy in some cases. But there are conditions:
Well, we are out of the danger zone of high aggregate valuations as far as the price-based ratios are concerned. But unlike with payments, home prices are not actually cheap. They are right square in the middle of their historical range. While this removes the dangers posed by overvaluation, it certainly doesn't rule out a move into undervaluation. It has happened in the past, and that was after housing booms that paled in comparison to the latest one, and at times that the economy didn't face the structural problems it is facing now.
My own suspicion, and this is purely a guess, is that valuation ratios will drift downward in the years ahead. Not plunge, but drift downward. This is based on headwinds to housing price growth I anticipate: a big foreclosure backlog, structurally high unemployment, higher rates, and the potential for a serious economic downturn (plus much higher rates) as a result of a US sovereign debt crisis. (I know I have said that rates don't impact valuations as much as many people think, but nothing happens in a vacuum -- a sufficiently large and sustained rise in rates could certainly exert some downward pressure on valuation ratios, at least for a time).
That said, unless (until?) rates really get out of control, I don't imagine that there will be big moves down in pricing. The scenario I envision is valuations grinding downward over a course of years, but doing so against an ongoing rise in wages and rents. As long as the process is slow enough, valuations could drop quite a lot without having too much of an impact on nominal home prices. (This is usually when people start arguing that nominal wages and rents will flatten or decline over the coming years... I hope that by now everyone has come to understand that the Fed isn't going to let this happen).
So, let's sum it up...
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