Thursday, June 23, 2005 | This is part one in a two-part series. This story contains five charts in PDF format. If you do not have Adobe Reader and cannot view the files, a free version is available for download.
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.
Population and housing
However, before quitting your job to become a condo flipper, consider the magnitude of the change in the population-housing ratio as compared to the change in housing prices themselves. View chart.
I guess I’m just not seeing the big crisis. From 1999 to 2004, the ratio of population per housing unit increased in total by 2.7 percent. This means that if just three out of every 100 people got a roommate or moved in with the folks, there would actually be more housing availability now than there was in 1999. I do not deny that the trend in population versus housing should have caused home prices to rise somewhat – but did it justify a doubling of homes prices? No way.
The timing of home price increases sheds further doubt on housing supply as a defense of home price appreciation. View chart.
If a housing shortage caused the first period of increase (a claim which is itself dubious, as explained above), why did prices increase 42 percent from 2002 to 2004, when the ratio was absolutely flat? Why did prices increase 24 percent from 2004 alone, even as housing supply grew faster than population during that same year? Clearly, price growth during this latter period had little to do with housing supply.
Despite all this, everyone seems convinced that home prices are perfectly reasonable in light of San Diego’s severe and intractable housing shortage. I believe that’s because there is (or at least was, up until recently) a severe shortage – but it is a shortage of for-sale inventory due to the fact that everyone in San Diego is so hell-bent on owning a home, and in many cases, several homes. People have confused tightness of inventory for an actual demography-driven housing crisis, and in so doing they have made the incorrect assumption that prices are being driven by fundamentals rather than by investor sentiment.
The diverse economy
As of this writing, San Diego’s C.A.R. Affordability Index indicates that the median-priced San Diego home can be afforded by only the top 10 percent of San Diego earners. People are only able to keep buying homes at these prices due to “creative financing” and the equity from prior home sales. If either of those props were removed, San Diego incomes would not likely support prices at these levels.
“Everyone wants to live here”
First, although it’s indeed true that San Diego has a great climate and is a desirable place to live, this is not a situation that suddenly came into being in the late 1990s. San Diego has always had good weather – so how could weather explain the meteoric rise in home prices over the last five years? In other words, although San Diego’s weather might explain why people pay more to live here than to live in North Dakota, it does not explain why people are paying more to live in San Diego now than they did in the past.
But they are paying more – a lot more. Over time, the median San Diego home price has on average cost eight times the San Diego per capita income. As this graph shows, the comparative expense of San Diego housing is at an all-time high.
The second flaw with the “everyone wants to live here” argument is that whether people want to live here is not the issue. Although desire to live in San Diego may be a theoretically unlimited quantity, the means to do so is not. There is an upper limit to how much housing can sustainably cost in relation to income, and it’s got nothing to do with the temperature outside.
Still looking for those fundamentals
Tomorrow, part two will compare home sale prices with rents, examine the effect of interest rates, and get to the bottom of what’s really driving the real estate market.
Rich Toscano is an independent real estate analyst living in University Heights. He monitors San Diego’s housing market at The Econo-Almanac for the Landed Poor.