San Diego Metropolitan Magazine

Ah, “the bubble.” Does it exist? When will it burst? Will homeowners see their equity float away?

Don’t count on an implosion. But pricing already is flattening and the current 10-year cycle will inevitably end. Some of the key questions are when, how much and what will cause it?

Housing market pundits have hit the media hard lately to weigh in on the impending San Diego housing crash, including The New York Times, Wall Street Journal and Money magazine, to name a few. Mainly they predict the San Diego housing market is a bubble ready to burst. The Economist magazine is especially strident, predicting worldwide housing deflation.

Certainly the market is slowing. The number of residential property listings recently peaked at 11,782 (they were at one-half that level last year), meaning lots of inventory on the market. The average sales period has lengthened to 45 days in the first quarter of 2005, nearly double the 24 days of a year earlier.

Over the past several years the practice of “value listing” — listing a home at a range rather than fixed price — has achieved top-of-the-range offers, or even higher. That occurrence exemplifies the “frenzy” that had people talking. Today, real estate agents report most offers on value listing properties are coming in at the lower parts of that range.

Clearly, the frenzy is over. But has the market hit the wall? Let’s put it to some tests:

The Income-To-Housing Price Test: In San Diego, the median income is $58,280, while the median housing price is $488,000. That gap has dramatically widened from 1990, when the median income was $35,208 and the median housing price was $181,922. While this should convince employers to raise salaries and public policy makers to permit more housing, it is a meaningless statistic as a test of the overall market. Obviously, with more than 30,000 sales expected this year, plenty of people can afford a home, particularly if they already own one. No sign of a wall here.
The Population Test: A severe decline in population growth would smack the housing market. Yet, even though recent net migration numbers are down, the region continues to grow, mostly from more births than deaths. Our population has increased an average of 50,707 persons each of the last five years, but the portion attributable to net migration folks who move here has steadily declined from 56 percent to 39 percent. We are still growing and people need places to live. No wall here.
The Health Of The Economy Test: Forget recent figures that show our unemployment rate at 3.8 percent. It would take much more to demonstrate sagging prospects than a local economic index dropping on account of local stock price reductions, or fewer employment ads in the newspaper. Meaningful signs would be a simultaneous collapse of several local sectors, such as technology clusters, defense and tourism, and a corresponding drop in wages. Some consumers are buying homes at the very top of their ability to afford. If they lost their jobs, or were forced to take work at lower wages, the housing market would shudder. None of this is happening.
The Rent Ratio Test: This is based on the stock market’s price-to-earnings ratio which compares share price to annual profit. The higher the ratio, the more expensive a stock is relative to its underlying value. Here’s the math: Take the price of a typical house in an area, divide it by the amount that house would cost to rent for a year and the result is what might be called a rent ratio. San Diego measures about a 30, which is high. This means that at the median home price of $488,000, the monthly rent is $1,356 ($16,267 per year). Some other U.S. markets are one-half that ratio. The problem with this test is that simply because home values have risen more than rents does not mean there is a bubble waiting to burst. Rising home prices have come about for many reasons. It is a gamble to purposely rent on the theory that home prices will eventually come down. If they don’t, the inability of a resident to benefit from equity increases could hurt their ability to get back into the market. This test remains worth watching.

The Market Will Cycle Down

Why do we need to know if the bubble will burst? The truth is, unless you are a speculator — and studies do show that many more of us are speculating — it is not particularly important, especially if you have a long-range outlook. If a “home” is a place to raise a family, cook backyard patio barbecues and live out life, perhaps its value matters much less than some think.

What would cause the housing market to collapse?

A sudden and steep rise in long-term interest rates.
A breakdown in the local economy coupled with a sudden and severe decline in net migration.
A catastrophic event: environmental or natural disaster, terrorist hit, etc. Essentially, this would have to be something of biblical proportions to move the market.

The interest rate scenario is the most plausible. At the low rates to which we have become accustomed, it probably would not take much to dampen the housing purchase market. In 1991, long-term interest rates were 8.5 percent to 9.5 percent. Today jumbo rates are hovering at 5.6 percent. Obviously, consumers can purchase homes at much higher rates, but it has been a long time since they have faced the prospect. Fast-rising and higher rates would be a big psychological hit for consumers.

As time marches on, those who live in their homes will continue to see their equity fluctuate with the market. For these folks, the best advice is to stop worrying about the bursting bubble. The housing market has declined in value before and we survived to talk about the experience. In 1992 housing prices were at their peak averaging $187,510. The San Diego economy tanked (from 1991 to 1993 there was a net loss of 19,500 jobs) and median housing prices depreciated to $174,450 by 1996. Stated bluntly: the San Diego economy experienced a severe meltdown, yet housing prices only dropped 7 percent. They fully recovered the following year.

In a declining market, homeowners simply will not lock in their losses. It is more likely they will just lock their doors. In other words, they will wait out any period of decline before they sell their home. During those same recession years of the early 90s, that is exactly what occurred. The number of housing transactions declined precipitously.

Timing Does Matter For Speculators

Whether or not we are at the peak of the market cycle does not matter unless you are in a neighborhood with many speculators, such as Downtown San Diego, where we recently reported speculative sales in excess of 30 percent compared to an estimated 10 percent countywide. To stunt this trend Downtown and in most countywide projects, builders and their lenders have imposed anti-speculative rules.

This is not a good time to be speculating. In that game, timing does matter. The market is at or past its peak. The mortgage you assume today may be tomorrow’s negative cash flow when you attempt to re-rent the place.

It is best to strategically plan your life for at least the next five years. Decide if you are going to stay in the community, and what you can afford. Go shopping. Buy it. Do not wait for a market crash. There are better prices out there now, because the market is slowing.

If your timing is wrong, so what? Enjoy the barbecue. When you are ready to sell and “move up” your pricing will be at the same relative level as everyone else’s.

Gary H. London is president of The London Group Realty Advisors Inc., providing real estate consulting and economic analysis. Check him out on the Web at www.londongroup.com or e-mail him at glondon@sandiegometro.com.