Thursday, May 11, 2006 | It’s time to wrap up the series on real estate market misconceptions with a two-parter on the granddaddy of them all: the frequent claim that the San Diego housing market, its multi-year moonshot now drawing to a close, is straight on course for a soft landing.
“Soft landing.” The phrase is routinely invoked by just about every housing pundit in Southern California. But what does it mean?
Some analysts have used the term to describe a few years of stagnant – but not falling – home prices. Their more optimistic brethren have forecast an environment in which prices rise only at the rate of inflation, or, more optimistic still, at a “modest rate” of 5 percent annually.
Variations on the theme notwithstanding, the forecasters have one thing in common: They all assume that a soft landing is the most likely outcome for the San Diego housing market.
Predicting the future is, as I’ve discussed before, a dangerous business. Exogenous factors are certain to have an influence that simply cannot be predicted, making it a bad idea to insist that one outcome or another will necessarily come to pass.
But if one can’t predict anything with outright certainty, one can evaluate degrees of likelihood. And the facts in this case indicate that a soft landing is very far from the sure thing that it’s often promised to be.
The soft-landing thesis is primarily based on two historical realities. One is that home prices have rarely declined outright. When homes have gotten too expensive in the past, price appreciation has usually just flattened out for a while until incomes could catch up and even things out.
The second historical fact is that those few instances where prices actually did drop have taken place when large numbers of people were forced to sell their homes due to recession-induced loss of income. Given San Diego’s low rate of unemployment, housing commentators cite this precedent as proof that home prices will remain firm.
The analysis offered by soft-landing proponents seems reasonable on the surface, but in truth it fails to take something two crucial factors into account. The first, to be discussed in part two of this article, is the almost inevitable upturn in forced selling that is waiting in the wings. But the second, more important factor, is the enormous extent to which the current home-price runup has dwarfed the prior booms to which it is being likened, rendering such comparisons fairly useless.
For an idea of just how big a housing boom we’ve been through, have a look at the graph comparing home price growth during the 10 years leading up to the housing market peak in 1990 versus the 10 years leading up to 2005. In the first decade – a period during which San Diego experienced a housing bubble that eventually led to home price declines – prices rose by 85 percent.
For all of that late-1980s bubble’s notoriety, however, the decade leading up to 2005 saw prices rise at two-and-a-half times the clip, increasing by 239 percent.
What’s more impressive is that inflation was higher during the 1980s than during the 1990s, meaning that the difference in “real” home prices is even more extreme than the above graph indicates. This graph shows the growth in the ratio of home prices to median incomes during both periods. The home-price-to-income ratio increased by 10 percent in the decade leading up to 1990, versus an incredible 119 percent in the ten years leading up to 2005.
This graph shows that we are now at a point where homes are substantially more expensive than they have ever been in the past 30 years. Measured by the ratio of home prices to median incomes, homes are 73 percent more expensive than their three-decade average and 55 percent more expensive than at any prior bubble peak.
Even by housing bulls’ beloved comparison of monthly payments instead of overall prices – a tactic that, among other flaws, requires one to depend on endlessly low interest rates in order for prices to stay aloft – people are paying significantly more each month than they have since the bad old days of high-teen mortgage rates in the early 1980s.
The current expense of local housing, and the enormity of the bull market leading up to it, defies comparison to past situations. It simply does not make sense to assume that the aftermath of this history-making price explosion will be anything like that of those prior, comparatively pint-sized housing booms.
Next week we will look at just how long it would take for home prices to normalize under the various soft landing scenarios offered up above – along with some of the challenges that will face the market during that time.