Sunday, May 29, 2005

Consider this your Memorial Day/May Bank Holiday post, one day early.

There are many bits of evidence one can muster to identify housing bubbles. The Sunday New York Times trotted out a lot of data on purchase-to-rental price ratios to further bolster the argument that in California, Florida and parts of the Northeast, it's bubblemania.

The logic of the indicator is, of course, that if purchase and rental prices both increase at roughly the same pace, there are some actual economic fundamentals driving the inflation: population growth, job growth, income growth, whatever. Of course, the ratio can increase somewhat if the quality of the purchased housing stock rises more than the quality of the rental housing stock, but there shouldn't be a complete disconnect between the two.

Read the entire article to get a flavor for the data, but check out this chart for something to chew on. What stands out most remarkably to me is that in 2000:I, before the US asset-based economy switched from stocks to housing, the purchase price to rental price ratio across all major US housing markets (data for 54 of them are reported) was virtually the same. The national average stood at 11.6, with San Jose at the high end (14.1) and Pittsburgh at the low end (10.5). Note that this gap was not wide: San Jose was 122% of the national average and Pittsburgh was 91%.

It's quite a different story five years later. In 2005:I, the ratio for the national average is up to 17.1, with the top and bottom at an amazing distance from one another. The peak is now San Francisco at a stunning 34.1 (San Jose is a close second at 34.0); the trough is Albuquerque at 11.8 -- still above the national average from five years ago, I might add. Thus the high is now 199% of average; the low, just 69%.

Not only is the gap tremendously larger with the peaks in the stratosphere. The opposite motions of purchased versus rental home properties in a few markets has to be a harbinger of danger. Over the past five years, rental prices have actually decreased in frothy San Jose, San Francisco and Oakland, and have barely budged in New York, all while purchase prices have vaulted skyward. No wonder the affordability index of homes in the Western US has plummeted over the last year.

Current purchase-price-to-median-family-income ratios show just how wild the markets are in the most bubbly California regions:
San Diego: 9.3
San Francisco Bay area: ~8.0
Los Angeles: 8.0
And nobody relies on adjustable rate mortgages like folks in the Golden State. Even now, 50-70% (depending on the market) of all California homes are purchased with ARMs. In the Northeast it's only around one-third.

In California, the state's real estate industry may have begun sheeding jobs. The non-seasonally adjusted peak was August 2004 when 200,500 Californians worked in the sector. At last count (April 2005) that figure stood at 199,500. Y-o-y the industry is still 1.6% larger, but that is thanks to the last big burst of job growth in California real estate in the first half of 2004. The sector has been stagnant to slowly shrinking since last summer, and no wonder with the number of houses for sale actually falling.

In 2004, 8.60% of all non-farm jobs in California were in either real estate or construction, up from 7.45% in 2000. Compare that to the national figures of 6.37% and 6.15% respectively. Not only is bubblicious California more reliant on the real estate sector than is the country as a whole, but it has become much more so over the last four years than has the country as a whole. Thus any popping bubble in California won't simply cut into general consumption; it will take jobs in its wake.

The writing is on the wall. Time to study up on the 1990 California real estate crash.

UPDATE: Brad DeLong kindly links to this post and one of his commentators directed me to an old but similar story at CNN/Money which has some more juicy data. In particular, this story offers comparisons for the monthly cost of owning vs. renting in several markets. In places like Atlanta and Dallas it is actually cheaper to own than to rent. But in the frothy West it can be 51% (Los Angeles) to 69% (Bay Area) more expensive to own. With all those interest-only loans and ARMs in the West, these figures can only grow larger.

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