Shambing Away from Cheapness But Still Milling About In The General Locale of Affordability

Well, I thought the old “Shambling Toward Affordability” title for
this series of articles was a bit pithier but it just doesn’t
quite work now that home prices have been rising for the better part of
a year.  In any case, regardless of the what we want to call it,
it’s time to check
in on San Diego housing valuations as of year-end 2009.

The 2009 home price rally reversed the direction of the shamble, but
it didn’t really change the overall picture, which is that San Diego
home prices (in aggregate, of course) are still at middling levels of
valuation.

Here’s the price to per capita income ratio:

And the price to rent ratio:

Neither are close to “cheap” territory, but neither are they
expensive.  As a matter of fact, the price-to-income and
price-to-rent ratios are, respectively, just 1.5% and 1.6% above the
median ratios since the data series started in 1977.  Those
medians are admittedly skewed upward a bit by the recent protracted
boom period, but still, it shows that valuations are not too terribly
far out of whack.

Of course, these ratios don’t take heed of issues like shadow
inventory, the sustainability (or lack thereof) of the government
intervention that has played a big role in the recent rally, and so
forth.  But that’s not what they are about — they are about
comparing home prices to their historical relationship with rents and
incomes, and from that standpoint prices are still within reason. 

Mind you, that is the aggregate San Diego home price as measured by
the Case-Shiller index (or my proxy thereof, for the last couple
months).  As we all know, different areas of San Diego may exhibit
a very different valuation profile.  These countywide graphs
provide a starting point and a good 5000-foot view — they do not
substitute for area-specific due diligence.

As opposed to the middle-of-the-road valuations for home prices,
monthly payments on homes are pretty much as cheap as they’ve ever been:

Since home purchase valuations are not all
that cheap, the low payment ratios are obviously a result of
ridiculously low mortgage
rates (helped to their current levels by heavy-handed government
intervention).  As I’ve frequently pointed out, this is
nice if you are a buyer who is going to lock in at these low rates for
the very long term.  But as far as it relates to home valuations
it’s not all that relevant.  Low rates can provide a temporary
boost to the
market, but unless rates are going to remain low for a long time*, the
fact that they are low right now doesn’t affect the level of home
valuations that San Diego can sustain over the long term based on local
incomes and rents.

* –
They’re not.

I like to update the payment ratios
because they are interesting and they definitely have an impact on
current market conditions.  That impact is extremely favorable,
obviously — which is to say that however the housing market is doing,
it would be doing worse than that if rates weren’t so low.   But low rates should not be
used as an argument in favor of higher valuation ratios, as they often
are, because it’s
never worked that way (nor should we expect it to, for reasons
described in the previous paragraph).

For what it’s worth, I expect the
valuation ratios to go lower at some point in the years ahead. 
The main reason is that all the government stimulus borrows from future
demand, so when the time comes to “pay back” that demand, there will be
downward pressure on valuations.  The (potentially severe) rate
increase that I expect at some point would also put downward pressure
on valuations.  (That would be no more permanent an effect than
the current low rates’ impact on valuations, but it could push them
down for a while). 

This expected decline in valuations
doesn’t necessarily imply lower nominal prices, as currency debasement
could cause everything to rise in nominal terms.  It just implies
that when the government stops providing so much housing-specific
stimulus (if they stop
providing so much housing specific stimulus), home prices will likely
begin to fall in relation to rents and incomes.