The “valuation index” shown below compares San Diego home prices to
San Diego rents and per capita income. As of the beginning of 2020,
valuations had gone nowhere for 4 years. Then the pandemic hit, and
valuations popped 10% in a year. San Diego home prices (as compared
to rents and incomes) are easily the highest they’ve been outside
the bubble.

The next chart is similar to the first chart in that it compares to
local rents and incomes, but instead of measuring purchase prices,
it measures monthly payments (thus including the effect of mortgage
rates). This paints a very different picture than the first chart:
the rise in monthly payments has been more than offset
by the decline in rates! Monthly payment “valuation” is actually
lower than it was in early 2020, and was only lower at the depths of
the post-bubble housing crash.

Here’s a look at how home prices compare to incomes and rents
separately.

It should be noted that income growth was actually pretty robust in
2020, thanks largely to various economic stimuli that put money in
people’s pockets. Rents grew a lot more modestly, and actually
turned down near the end of the year. So, the price-to-income spike
looks smaller than the price-to-rent spike, but they are both in the
same neighborhood in the grand scheme of things.

Here’s a look at prices, incomes, and rents over the past 45 years:

Is this a bubble?

No. A bubble is more than just an expensive market… it is an
egregiously expensive market characterized by investors acting
totally nuts. Yes, purchase prices are expensive. But you can make
an argument that, because most home buyers finance the bulk of their
purchases, super-low mortgage rates are offsetting the higher prices
(see graph 2).

As for nutty behavior… I see some complacency, but not nuttiness.
(Unlike in growth stocks where we are now seeing a full-blown
speculative mania — see this
article we just put up for some fun examples of deranged
investor behavior).

Summary: yeah, it’s spendy, but kind of justified-ish by rates (if
they stay low), and investors are largely acting rationally. So, not
a bubble.

Are these valuations sustainable?

Also no, is my guess. The pandemic provided 3 boosts to housing
valuations, at least some of which are temporary.

1. Nobody wants to sell a house during a pandemic/lockdown. When
   the pandemic ends, more inventory will come to market. This one
   is temporary.
2. Tons of people started working from home, which likely
   increased the desirability of having a nice home (put another
   way, I’d say it increases the amount people are willing to spend
   on a home if they are there 24/7). Some people will keep working
   from home post-pandemic, but many will not. So this one is
   partway temporary.
3. I suspect that the plunge in rates was the biggest driver of
   price increases. Again, graph 2. If rates stay this
   indefinitely, then that supports higher home prices. But if
   not… well, I refer you to late 2018, where a very brief
   increase in rates was enough to start prices declining. Will
   they stay this low? I don’t know, but given that they only got
   so low because of a temporary pandemic, it seems sensible to at
   least allow for the possibility that they could go back up.

The first two are, respectively, temporary and half-temporary.
The third is maybe temporary but nobody knows for sure (and
unfortunately for our analysis, that’s the biggest driver). So
we’ll see, I guess… but them all together, I think the odds are
that some of this valuation pop is given back.

BUT. That doesn’t imply a crash or anything… I’m just talking
about this rapid 10% valuation increase we had (and maybe not even
all of it). Going back to the 2015-2019 range would be a fairly
minor adjustment.

There is a risk of a more serious decline in prices (obviously —
when valuations are unusually high, that’s always a risk). But I
suspect that would take a more substantial rise in interest rates,
vs simply a return to what we saw pre-pandemic.