Below is a San Diego housing update my financial planning
firm sent to our clients and friends. (If you'd like to sign up for
our quarterly updates, you can do so here
). Stick around
for some bonus pigg-only graphs at the end.
We all know that buying a home in San Diego costs a lot more than
in most cities. But that's always been the case, and probably
always will be, because San Diego is such a desirable place to
live. More interesting is the question of how expensive San Diego
is compared to its own history. This can tell us whether prices
are out of whack even after adjusting for the desirability factor.
A good way to measure housing expensiveness is to compare home
prices to local rents and incomes. Rents tell us how much it costs
to live in San Diego as a non-owner, while incomes show how much
money San Diegans have to spend on housing. By comparing home prices to
rents and incomes, we can get an idea of their cheapness or
expensiveness relative to the economic factors that typically
drive them. (This is also known as their "valuation").
Here's a chart of San Diego housing valuation since the late
The main takeaway is that, while there have been significant
forays into expensiveness and cheapness, there has been a strong
tendency to revert to normal, reasonable (for San Diego)
valuations. This makes sense: if prices become unhinged from rents
and incomes, we should expect them to move back into line
Valuations can be a big help in evaluating the housing market's
potential risk and reward. And they are showing that today's San
Diego housing market is quite expensive -- not nearly at
bubble-peak levels, but more so than at any time outside the
Can low interest rates (or something else) keep the game going?
Such high home prices are certainly a cause for caution. And yet,
there is an interesting twist this time around: interest rates are
unusually low, which has kept monthly payments reasonable despite
Here's a chart that compares the typical San Diego monthly
payment to local rents and incomes. It paints a very different
picture than the chart above, which only considers home prices.
Thanks to low interest rates, monthly payments are actually more
affordable (compared to rents and incomes) than they typically
have been over the past several decades. Put another way: the
expensiveness of buying a home is more than offset by the
cheapness of the borrowed money.
Can low rates keep home valuations propped up at their currently
high levels? It's possible, but there are a couple reasons to be
skeptical. The biggest one is that the idea depends on rates
staying unusually low. There is great debate as to whether that
will happen, and no one knows for sure. But in general, we think
that while unusual situations can persist, it's not prudent to
depend on that happening.
Even if rates do remain this low, it's questionable whether they
can keep home prices high forever. It turns out that, while low
rates may well play a part in today's elevated valuations, they
have had very little influence on home prices in the past. (To
keep this letter from getting too long, we'll leave it at that --
but if you'd like to read some evidence and theorizing about why
this is, please see this Voice of San Diego article Rich
a while back.) Again, it's possible this has changed, but we
are wary of depending on it.
Other factors could influence valuations as well. For instance,
San Diego is an unusually housing-constrained city -- while this
should show up in rents too, it could push prices up compared to
incomes. Changes to the number of out-of-town investors, to the
character of our housing supply, or to income inequality could
also exert pressure on the ratio of home prices to both rents and
incomes. Given that San Diego housing is, compared to global stock
and bond markets, a very small, illiquid, and supply-constrained
market, there is a higher possibility that it actually is
"different this time."
It seems like such changes should be slow-moving and relatively
subtle, though. And in any case, they are speculative. The odds
have not historically favored the bet that it's different this
time. The best approach is probably to allow for
the possibility that valuations have permanently shifted to some
degree, but not to depend on it.
Does it make sense to buy a home right now?
Summing it up so far:
- While San Diego housing
valuations have historically been all over the map, they've had
a strong tendency to eventually return towards the middle range
of their historical levels.
- Currently, San Diego
housing is quite expensive compared to history (though well
short of bubble peak levels).
- But unusually low rates
are keeping monthly payments at reasonable levels, and should
those low rates persist, it's possible they could
prop up valuations indefinitely.
- It's also possible that
to unique economic factors, valuations could settle at a
different equilibrium level than they have historically. But
this would likely be subtle and somewhat risky to bank on.
So where does that leave a potential buyer? It depends on the
situation, and whether one is more concerned with future changes
in monthly payments or prices.
If one is buying a home to keep for the long haul, and financing
the purchase with a fixed mortgage, then the main priority is
probably to lock in a reasonable long-term monthly payment. In
this case, it may well make sense to buy. As the second chart
above shows, monthly payments are lower than the historical
average even despite high purchase prices.
If on the other hand a buyer isn't planning to keep the property
for long, then it makes sense to be more concerned with what
prices will be when the time comes to sell. The first chart shows
the risks in that scenario. While it's possible that valuations
could remain elevated, current price levels suggest more downside
than upside. However, this will become less of an issue as time
marches on and incomes and rents have a chance to catch up with
prices. (To put some very rough numbers on it: 5 years feels
risky; 10 years a lot less so).
Every situation is different, but the rough rule of thumb is:
- If monthly payments are
the primary concern, it may make sense to buy.
- If future price changes
are the primary concern, it may be best to hold off until
valuations are a bit more reasonable.
The good news here is that there isn't a lot of pressure to do
either one. There have been times where it was crazy to buy in San
Diego, and times where it was crazy not to. This is neither of
those times. Either choice is reasonable, depending on
circumstances, so you can do what best fits your own
circumstances and lifestyle.
The same applies to real estate owners. Given the context of low
rates, valuations aren't high enough that anyone should feel
compelled to sell on that basis alone. But for owners who are
considering selling for other reasons (cash needs,
downsizing, moving out of state, selling a rental property, etc.),
they can sell now and take comfort that they are doing so at a
time of unusually high valuations.
1 - For more on the relationship between incomes, rents, and
home prices, see Rich's Voice of San Diego article on measuring housing valuations. As discussed in
that article, the price/income and price/rent ratios have been
very similar throughout history, so we've combined them here for
A few more graphs: