Despite the fact that home prices have weathered a significant decline, San Diego homes remain quite expensive in comparison to their historical relationship with rents and incomes.

The following chart shows the ratio of a typical San Diego single family home price (as measured by the Case-Shiller Home Price Index and rebased to the December 2008 median price) in comparison to per capita San Diego income:

The first notable thing about this chart is that, up until the recent bubble, the price-to-income ratio had stayed within a relatively compact range.

The second notable thing is that the ratio got so out of whack during the most recent bubble that, even now, it is still well above its historical range.

A similar pattern can be seen with the ratio of home prices to average monthly rents:

The price-to-income ratio would have to fall 13% from here just to get down to the level of the 1990 bubble peak. The price-to-rent ratio would have to fall 20% from current levels to get to the 1990 peak.

To get to the levels seen during the post-bubble 1996 trough, the price-to-income ratio would have to fall another 40% from here and the price-to-rent ratio another 36%.

People often argue that today’s lower interest rates justify higher price-to-income and price-to-rent ratios. But the next charts (the same as above but with 30-year fixed mortgage rates overlaid) show that up until the recent bubble, the ratios have generally tended to peak and trough at very similar levels despite substantially different interest rate climates over time:

The fact that interest rate levels didn’t seem to exert a big effect on home valuations in prior cycles suggests that something else was responsible for blowing these ratios out of the water during the last bubble. The prime suspect, in my opinion, is not a low interest rate but a multi-year period of incredibly reckless mortgage underwriting enabled by the great securitization boom.

Now that EZ-credit is no longer with us, home valuations may eventually return to normalcy after all. But we certainly aren’t there yet.


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