Rational Prices

[admin]

The median price for a resale home in San Diego in July '06, per DataQuick, was $560K. Per http://sandiego.rentslicer.com/, the rental price for a four bedroom property is $2,559 per month.  Given a typical price-to-annual rental ratio of 10, the 'rational' price for a San Diego home is $307K.  Thus, per this analysis, San Diego homes must fall 45% to bring them down from $560K to a rational level of $307K.  This seems reasonable, from a gut sense.

My wife wants to buy in La Jolla, ultimately.  Per RentSlicer, the average rental price for a four bedroom property in La Jolla is $4,102, a 60% premium to the overall San Diego price.  Thus, the rational price for a La Jolla home is $492K.  This price seems reasonable/defensible for an ordinary neighborhood, such as Birdrock or Upper Hermosa.

What do you think?

[PerryChase]

Very reasonable to me. Those are the prices I’m holding out for.

That’s what happened in the 1990s and my prediction is that we’ll see that happen again.

Did you read the NY Times story? The seller listed for 1.1 Million then sold at auction for 530k. If that’s already happening in some parts of the country, I don’t see why it can’t become the norm in SD when the rough gets going.

[(former)FormerSanDiegan]

Your approach is perfectly reasonable and along the lines of how I (and many people on this board) would value property. With a few minor issues.

Issue #1. A “typical” price-to-rent ratio of 10.
This means that if you purchased the house for cash, the rent would come in at gross yield of 10% annually.

If, like today, other investments are paying 5-6% risk free, 8-10% moderately risky, and > 10% speculative, than this ratio is too low.

If (like in late 80’s), risk-free investments pay > 10% than this ratio is probably too high and you’d have to get down to a number like perhaps 8.

Here’s an historical example for what it’s worth:
A 3 bed/ 1bath in Clairemont sold for ~160 K in April 1996 (near the last bottom). Rent would have to have been 1333 per month to meet your ratio of 10. Rents in the area were about $1100 per month at the time, giving a ratio of ~ 12, 20% above your number. This is an equivalent gross yield of about yield of about 8.3%. Guess what the interest rate on a 30-year mortgage was in 1996 ? (Ans: ~8-8.25%).

Issue #2. Prices must fall 45%.
Actually using your analysis the price-to-rent ratio needs to fall 45%. Not just the price (unless the change were instantaneous) Since there are two factors 1) price and 2) rent, there are many ways for this to happen:
One extreme: 10% reduction in price and 35% rent increases over the next 7 years (<5% annual increases).
Sensible guess: 25% reduction in price and ~4% average rent increases over 5-6 years.
Another extreme: 50% price reduction and 5% decrease in rents over some time period.

[(former)FormerSanDiegan]

I would actually consider Birdrock more of a premium neighborhood than ordinary. I think you need to go across the I-5 to Bay Ho or Caliremont to get to “ordinary”.

[Daniel]

Nice website, that rentslicer.com. But do you know if those prices are asking prices, or transaction prices? It seems to me that either those prices are a bit high, or I’m getting a whale of a deal on my house (which I rent for about 10% less than asking).

[Anonymous]

Birdrock is a part of La Jolla, and is only okay: small homes, small lots, lots of cute, older homes next to new, ugly monstrosities. For “real” La Jolla (i.e., excluding UTC), it’s the most modest neighborhood.

[Anonymous]

Daniel, those are asking prices for current rental listings.

[(former)FormerSanDiegan]

rentslicer is a collection of advertised pricing. So it is biased to the high side for 2 reasons:
1. places with recent vacancies are higher than places where you’ve had a steady tenant
2. It’s not necessarily the final agreed-upon rent. Savvy renters ask for about 5-10% of the asking price.

[Daniel]

Aha, now it makes sense. Thanks for clearing this up, folks.

[(former)FormerSanDiegan]

Sure compared to higher altitude and coastal portions of La Jolla, Bird Rock is ordinary (or even downright guetto, if you ask the Jacobs). But they have the schools and the coastal breezes/climate. That makes it a premium in my book. Maybe I’m too blue collar?

[Anonymous]

And, you pay 60% more in rent for the privelege of better schools, cool breezes, and peeks of the ocean. Not unreasonable.

If we agree that prices will come down to capitalized rental value, the open items are (1) multiple and (2) rent. There are lots of ways to arrive at multiple, and your range of 8-12 is emininently defensible. My prognosis on rents is that they make go up short-term, but given how far prices must fall to ‘make sense,’ we’re going to see a bloodbath in San Diego. Thus, the exodus of native-born folks (40K left the county over 7/04-6/05) is only going to accelerate, as retail, research, and manufacturing continue to slow and move out of state. In a few years, I don’t see upward pressure on rents; I see downward pressure on them.

The traffic on 5 seems lighter this summer; I can’t wait to see the latest U.S. Census figures for San Diego county; I bet the outward migration of native-born folks is continuing, and even accelerating.

[rankandfile]

I second what Perry said. Prices seem reasonable and we are also holding out for that level…or we’re going to move.

[(former)FormerSanDiegan]

OK, I think we generally agree on the valuation method.

However, the multiple you pay will be higher for “better” areas because the Premiums for rent in “better” areas are much smaller than the Premiums to buy. I learned this in the 90’s when trying to find investment property.

And, you pay 60% more in rent for the privelege of better schools, cool breezes, and peeks of the ocean.

According to rent slicer the avg rent for a house in La Jolla is $2242, for Clairemont it’s $1783, a 25% premium.
OK so the numbers may not be accurate but they are probably within 10-20%.

The purchase premium for La Jolla versus Clairemont is about 150% based on median price. To be fair, if you compare similar properties it’s more like a tad over 100% to purchase (3/2 1500 sf CLMT house for 500K versus starter homes in LJ for 1M+).

So, the premium you pay to rent in a nice area is considerably less than the premium you pay to purchase there. This was true in 1995 and will likely be true in 2009.

As for outmigration and where rents go, that’s another matter. Last year there were 40K who moved out of SD compared to those who moved in form other areas within the US and what happened to rent ? Did it go up or down ?

WHEN prices fall enough, you may even see a lot of former outmigrators (like me) moving back. Some of us miss it there.

[Anonymous]

Absolutely right. The premium to rent in La Jolla is much less than the premium to buy. You can rent a nice 2 bedroom condo in central La Jolla easily for $2200, where a similar size place in UTC or PB may be $1700-1800 so maybe at most a 15-20% premium. The cost to buy equivalent house may be closer to double.

[Anonymous]

40K of folks who can afford to pay the rent, without having 20 stuffed in the home and garage, leaving was just the beginning. It’s just like slowing sales and home prices; just give it time, and the cumulative reduced demand from the folks-who-can-pay leaving for AZ, TX, and ID will result in reduced prices.

The rental prices you cite for Clairemont and La Jolla include 1BR and 2BR apartments and condos. There are few 4BR apartments, so I use the 4BR rate ($2,184 for Clairemont, yielding an 88% premium for La Jolla), as it reflects rental prices for homes, not apartments.

San Diego is a great place, but at these prices, it makes no economic sense for a business. If all one needed to attract and keep great researchers was ocean views and cool breezes, Nice, FR and Naples, IT wouldn’t be the economically depressed places that they are. General prices are too high here, and must fall, or else only retirees and their Mexican housekeepers and gardeners will remain, ’cause rational businessmen like me will leave.

[Author]

Posts