Speculation in San Diego

There's a great two-part article by Rich Toscano on the housing bubble in San Diego over at the Voice of San Diego website (Part 1, Part 2). In his article, Rich looks at the common misconceptions for why there has been such a rapid increase in housing prices here in San Diego. Many people attribute it to low interest rates, population outpacing housing growth, and San Diego just being such a nice place to live. From the article:

Conventional wisdom goes that San Diego is experiencing a severe housing crisis with no end in sight. The recent run-up in home prices is completely appropriate due to the supply and demand imbalance caused by a lack of developable land, years of under building, and a huge surge in population due to San Diego's desirability as a place to live. Adding fuel to the fire is the fact that San Diego's wealth has grown significantly due to its robust and diverse economy.

Sounds pretty convincing. The only problem is that it's entirely false. There is no housing crisis. There has been no population boom. Local incomes have not even kept pace with inflation. And while San Diego may be a nice place to live, it was also nice five years ago, when homes cost half as much as they do today.

Rich then shows how each of these claims is overexaggerated. For example, while it is true that since 1999 San Diego's population growth has outstripped available housing, the delta between the growth rates - 1.7% population grown annualized over the years 1999-2004 vs. 1.3% housing growth annualized over the same set of years - has far outpaced the growth in housing prices, which have more than doubled during the same period. Despite the rise in home prices, rents have risen much less over the same period, and are actually slowing in their annual increase. A friend of mine who works in the rental property management field recently told me that over the past one to two years rents have been pretty flat. (Of course during this same period home prices have continued their illogical climb.) One graph that was particularly alarming to myself was the graph plotting average home price against average salary over this time frame. This graph, shown below, illustrates the unsustainable situation we find ourselves in now:

In Part 2 of his article series, Rich pins the blame for the rise in house prices on investor speculation, dubbing the San Diego real estate market a "classic speculative bubble." These statistics, from the article, sure are sobering:

• 80 percent of mortgages were adjustable-rate, meaning that many borrowers were speculating that their salaries or home equity would increase faster than their mortgage interest payments.
• 47 percent of mortgages were interest-only, meaning that many borrowers were speculating that their salaries or home equity would increase faster than their mortgage interest payments and the eventual addition of mortgage principal payments.
• 27 percent of mortgages involved no down payment, meaning that many borrowers could (and did) use ultra-low rate interest only ARMs with no money down in order to afford far more house than their incomes would typically allow.
• 37 percent of condo conversion buyers were investors, meaning that, given the comparatively low rents discussed above, the only possibility of these people not losing money is for condo prices to rise enough to cover the current negative cash flow.

We only need to look back a few short years to the dot com collapse to see the end product of rampant speculation. While homes are less liquid than equities, and hence a sharp and immediate drop-off is less likely, I still think we're poised to see a rather painful drop in home prices and a scary increase in foreclosures over the coming years!