What About Price-to-Annualized Rent in La Jolla?

[admin]

Has the ratio ever been ‘normal’ in La Jolla?

Maybe not, per the data that I have.

Prices in La Jolla are, and have been, high:

[img_assist|nid=1844|title=
La Jolla Resale Home Median Price, ’88-’06|desc=|link=node|align=left|width=466|height=311]

Using the BLS owners’ equivalent rent index for San Diego, and applying the average rent for a 3BR and 4BR property in La Jolla from RentSlicer from August 31, 2006 ($3,105 and $4,088, respectively), I calculated the imputed annualized rent over ’88-’06:

[img_assist|nid=1848|title=
La Jolla Imputed Annualized Rent, ’88-’06|desc=|link=node|align=left|width=466|height=311]

Dividing price by annualized rent yields the following:

[img_assist|nid=1846|title=
La Jolla Price-to-Imputed Annualized Rent, ’88-’06|desc=|link=node|align=left|width=466|height=311]

The La Jolla P-to-AR ratio peaked at 46 in ’05, and troughed at 17 in ’95.

Please tell me that something is wrong with my assumptions or calculations: my wife is committed to living in La Jolla (with or without me, ha, ha), and as a rational guy, buying at 15-17X is really going to bug me.

Sincerely,
Puritanical Bible Beater

[powayseller]

It makes perfect sense that the price/rent ratio is higher in more desireable areas. If you want to get a house with a ratio of 4 or 5 (just a guess), move to Kansas. What does your wife like so much about La Jolla?

[Anonymous]

The draw to La Jolla is proximity to The Bishop’s School, where our daughter goes and where our son will go next year.

http://www.bishops.com/

If you want to see some impressive college placement stats, look at these:

http://www.bishops.com/academics/college_profile.htm

129 graduates in '06, 9 of whom are off to Princeton, 6 to Stanford, 4 to Harvard, and 3 to Yale; 17% of the graduating class.  It costs us an arm and a leg (and I'd prefer to save the money by sending our kids to Our Lady of Peace and Saint Augustine), but we don't have 'one adult, one vote' in our house on this topic.

[davelj]

Recent academic research has shown that a person’s lifetime income (a very rough measure of professional success) is more highly correlated with the best college that person COULD have gotten into than with the college s/he ACTUALLY attended. For example, two students with 1500 SATs and a 4.0 GPA who both got accepted at Harvard and San Diego State – with one choosing to go to one school and the other choosing the other – on average don’t show statistically different lifetime incomes. Again, this is on average. Kids from Harvard don’t do well because they go to Harvard; they do well because they’re the type of kids that can get into Harvard in the first place. That is, most of them are smart, disciplined and driven. The fact that they choose one college over the other doesn’t change these personal characteristics.

Personally, I wouldn’t spend money on Bishop’s or Harvard or any other highly tauted private school unless the amount I was spending was so small relative to my income as to be meaningless. But that’s just me.

[Anonymous]

Dave, I’m very familiar with that paper, published by Alan Krueger in ’99 out of the NBER. It makes perfect sense to me.

However: I value religion. I’d hate for my kids to have to ‘compete on clothes.’ I don’t want teachers forcing ‘alternative lifestyles’ as normal on my childern. Hence, I have no choice but to opt out of public schools.

Both of my kids are gifted. There are fine GATE programs in San Diego. But, the GATE programs have, for me, the negative public school overhang items that I list above.

Incidentally, I learned first-hand the value of hanging out with sharp folks. The folks I served with on my destroyer and submarine in my Navy days were awesome: smart (Berkeley, Cornell, Chicago, Harvard, MIT, Northwestern, Penn, UCLA, USNA), athletic, good guys. To do you well, I had stiff competition. So I upped my performance. That’s the value of being grouped with sharp folks. That’s what our kids will get at Bishop’s.

Lastly, we’ve got the money, and my wife is well prepared to spend it!

[Bugs]

The point you bring up about different areas having different multipliers is well worth pointing out. Among other things, an income multiplier is a (rough) measure of a number of factors in an investment. One of those factors is the risk involved with the property type, location, condition, etc. Another factor is the amount of competition at those prices in the sales market and the rental market, which don’t always move at the same pace or even in the same direction.

So yeah, you would expect GRM/GIM indicators (which are factors) to be higher in the more desirable locations and lower in the less desirable locations. You would expect them to be higher for the newer and better condition properties and a bit lower in the inferior condition properties because of maintenance and replacement costs as well as the lower rents. Bigger risks require bigger returns, which in turn reduce the rent multipliers.

Finally, it bears repeating (again) that rents are tied to local wages, not investment income; there are definite limits to how much people will spend on rents. People who retire from Phoenix don’t bring their nest egg to rent; they buy. Percentage-wise, the difference in rents between otherwise similar 2bd/2ba homes in La Jolla (93137) vs. Barrio Logan (92113) is nowhere near the difference in sale prices.

[powayseller]

Bugs, could you tell us more about the variability in price/rent in various areas, since you do that in every appraisal already. Also, can you tell us more about the last downturn? Someone told me there were foreclosures all around Poway High School, which is one of the best areas of Poway. Did you see any of that? Why do you think we reached the peak inventory of the last downturn in year 1 – is it because our population has grown? What are your observations in regard to people leaving San Diego, and the percentage of appraisals done for refi vs. purchase? Are refi appraisals more lenient? Thanks for all you’ve written so far; you are a wealth of information, and you explain it all so well. Oh, and do you believe as I do, that the new lending guidelines are going to bring sales to a screeching halt?

[no_such_reality]

PBB, the one potential flaw is the use of OE Rent. It seems that the number may be influenced by what the owner thinks it’ll rent for and not what they are actually rented for.

For La Jolla, it wouldn’t surprise me that 17x-20X is normal. SFRs, particularly larger SFRs with yards are on the high end of the ratio anyway. The typical 8-13X is more appropriate for small multi-unit dwellings duplex,triplex, fourplex. SFRs are strange beasts since they really aren’t a consistent rental market.

The higher rate is justified by the perceived quality of the cash flow and potential upside or reduced downside of capital preservation and expenses. iow, you’re not expecting your La Jolla rental family to kick holes in the wall, get covered in graffiti or turn in to a meth lab.

On the other hand, I think Condos compete nicely and directly against larger apartment complex units. Hence a rental comparison is more appropriate.

[Anonymous]

What Bugs and others say about residential vs. commercial makes sense to me.  If residential has lower risk, as evidenced by higher occupancy rates, it should be more valuable (i.e., have a higher multiple).

In 2005, residential rental properties in San Diego had a 95.8% occupancy rate:

http://factfinder.census.gov/servlet/ADPTable?_bm=y&-geo_id=31000US41740&-qr_name=ACS_2005_EST_G00_DP4&-context=adp&-ds_name=&-tree_id=305&-redoLog=false&-format=

In 2005, commercial properties in San Diego had an 84.7% occupancy rate:

http://www.signonsandiego.com/uniontrib/20060426/news_1b26office.html

If monthly rent was $1,000, the expected monthly rent for residential would be $1,000 x 95.8% = $958.  For commercial, it would be $1,000 x 84.7% = $847.

Thus, all other things being equal (expense ratio, expected appreciation, tax deductibility, etc.), residential rental properties should command a ($958-$847)/$847 = 14% premium to comparable commercial property.  Thus, if the reasonable commercial multiple is 8-10X, the reasonable residential rental multiple would be 9-11X.

Anything wrong with my analysis?  If not, what are other important factors (with data available), besides occupancy rate, to incorporate?

[Anonymous]

I’m still sorting through the difference in the San Diego and La Jolla multiples.

That a property in a less desirable neighborhood should have a lower multiple does not make sense to me. A less desirable neighborhood has lower rent, which would result in a lower price, using the appropriate multiple.

To me, only if the property in the less desirable neighborhood has higher risk — such as a lower occupancy rate, higher arson repair rate, higher property insurance rate — does it make sense that it would have a lower multiple.

[no_such_reality]

Think corporate bonds.

The multiple shifts for a variety of reasons, the main one being quality of cash flow.

The “quality” of the cash flow from highest quintile economic segment, dollar for dollar is perceived to be a higher quality (more likely to be paid, paid on time, with less unexpected expense) than the same dollar from the lowest quintile.

Basically, the same kind of thing as corporate bonds. Because of the kinds of tenants and the price range of La Jolla, a $1000 of rent get’s Aaa bond pricing (low return per $ of capital), the same $1000 of rents in say Rancho Bernardo maybe get Aa bond rating and a rough section of town gets B or Bb bond rating (higher face value of return per $ of capital).

[davelj]

I don’t think the “quality” of the cashflow is the main issue. True, you’re theoretically dealing with a better quality renter, but that actually may not be the case. The biggest issue is how much the cashflow is expected to grow over time. Rents in affluent, high growth areas are expected to grow more rapidly over time than less affluent, lower growth areas. Show me a high growth, less affluent area and I’ll show you higher price-to-rent multiples than low growth, more affluent areas. It’s like discounting the dividends of a stock. If V=CF/(D-G) where , V=Value, CF=Cashflow (rent less expenses), D=Discount Rate, and G=Growth, D may be a little lower for the higher quality properties (less risk), all else being equal, but the real differential in the denominator will be determined by G (growth). The higher the expected growth, the higher the value and thus the price-to-rent ratio.

[Bugs]

Now we’re getting into different property types that to a certain extent compete with each other.

I would characterize any use of rental factors to sale prices for SFRs to be an indirect indicator. It’s interesting as a point of analysis, but hardly anyone who’s buying or selling pay any attention to them when they make their decisions.

With the exception of short term flipping activity, the typical buyer for most homes is an owner-user. The economic proceeds are always a motivation but the fulfillment of emotional needs and the shelter aspect of SFRs will always be the main thing. Rental factors are useful to the extent that rental occupancy is an alternative to occupying it themself, but since that alternative is not often considered seriously it’s kind of a sideline.

Comparing SFR rental factors to those from other types of real property gets real tricky real quickly. For one thing, the rental terms vary a lot between these different types of property. For instance, because of what’s typically included with the rents for these different property types we could be looking at a rental market where expenses will eat up to 40%+ of the gross income (apartments and some types of office rentals), or it can be below 5% (for many of the retail leases).

Then there’s vacancy. Between owner-users and rental tenants, vacancy for SFRs normally runs very low. Flippers have apparently changed this vacancy rate in the last couple years, but prior to that homes just didn’t sit vacant for 6 months at a time. On the other hand, many of the office markets have vacancy rates that have been varying between 5% to as high as 30% depending on what and where. That’s a huge spread.

By the time you get to considering all these different variables, it’s easy to see why rent multipliers and capitalization rates vary by property type regardless of when in the cycle you’re looking at them. Heck, even among the same property types they tend to vary somewhat by size ranges because of the different motivations and criteria used by buyers at different pricing levels.

That’s why using gross income multipliers as a measure of value is sometimes like trying to use a spoon to make surgical incisions. They’re often used by lay people because they’re quick and easy, and to the extent they’re used on properties that are that quick and easy to compare they work okay. But many of the property types are not so simple, which is why the appraisers and investors use other tools and measure the income after taking out vacancy (Effective Gross Income Multipliers) or after all expenses (Net income Multipliers or Cap rates) or even after all debt service and tax liability is taken out of the income stream. As a general rule of thumb, the more of these variables we can reconcile out of the income stream, the easier it is to compare the apples to apples.

At this point we’re getting far away from how this discussion started, which was comparing GRMs for houses to their respective sale prices. I hereby declare this an official tangent. Discussing and comparing GRMs for SFRs is complicated enough without making it more so by dragging in disparate property types for comparison.

[desmoJ]

Both of my kids are gifted.

There is so much bs on this board, “both my kids are gifted” Puke. Does anybody think their kids are retarted? I think most post to impress, I just keep making money. lol

[Diego Mamani]

There is so much bs on this board, “both my kids are gifted” Puke.

Hey desmoJ, perhaps the kids are gifted, but not their parents (who don’t bother with modesty).

[Author]

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