Time for a valuation update! These graphs should be familiar to regular
Piggs; for anyone who’d like some background please see these two Voice
of San Diego articles: how
to measure housing valutions and
how
mortgage rates impact prices.

Onto the graphs… here is San Diego home valuation index, measuring
how expensive homes are compared to local incomes and rents:

Friends, this thing is getting pricey. Valuations are still far short
of peak
levels, when they reached 72% above the historical median. But at the
current 28% above the median, we are well above the highest valuation
achieved outside last decade’s epic housing bubble.

But then there’s that mortgage rate thing… while rates are far off
the lows in
a relative sense, they are still very low historically. The monthly
payment index (which is just like
the valuation index, but measures monthly payments instead of home
prices) remains below its historical median:

So we’ve got increasingly expensive purchase prices, way higher than
outside the bubble and even approaching early-bubble levels. But rates
are still low enough that monthly payments are reasonable compared to
local rents and incomes. Which is is the same as it’s been for a while
now, just… more.

The relationship between rates and prices is more nuanced than
many people believe, as I discussed in the second article linked above.
But I think it’s reasonable to believe that the prolonged period of
low rates has played a big role in helping get valuations
up to these levels. If rates were to return to more normal-ish levels,
that could very well pressure valuations down towards more normal
levels as well.

It’s possibly worth zooming in on that recent rise in the monthly
payment ratio to see what this might look like. It doesn’t look like
much on the graph, but it was
pretty big relatively speaking. Just since September, mortgage rate
increases have driven monthly payments up by over 10%, even if you hold
everything else equal. You can see where that would start to bite, were it to keep
happening.

That’s the problem with citing low rates as an excuse for high
valuations (in real estate, and any other asset class): it only works for as long as rates stay
low.

Don’t call it a bubble… (yet)


I acknowledge that the purchase prices are getting
pretty extravagant, but there are two counters to the idea that it is a
full-on bubble:

First, the rate thing. I think that is a mitigating circumstance, as
described above — albeit one that could change.

Second, you have to distinguish between a market that’s “overpriced”
and “a bubble.” Markets get overpriced all the time; cycling between
expensive and cheap is the natural order of things. But a bubble is
really a special situation in which people are acting totally
irrationally and driving valuations to extremes, so that the only
plausible outcome is a price crash. I just don’t see that here. Not
yet, anyway!

Taking a quantitative pass at the question, the investment firm GMO
defines a bubble as an asset that’s risen 2 standard deviations above
its historical valuation — an arbitrary but reasonable criteria.
From here, valuations (not prices, but valuations) would have to rise a
further 13% to meet GMO’s bubble threshold:

So we aren’t there yet, especially if you factor rates into the
equation. But we aren’t far from it either!