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I will be out of town this week, so you all will be able to enjoy a few days without being assailed by charts and graphs. First, let’s wrap up the series on San Diego rents.
A couple months back, I wrote a blog entry maintaining that San Diego home prices in aggregate had finally become “reasonable” in comparison to local incomes and rents. Several readers replied by arguing that while the ratio of home prices to rents might be back in the middle of its historical range, rents themselves had become unsustainably high as a result of bubble-era economic distortions and were likely to fall substantially.
Now underway is the fourth in a series of blog entries in which I’ve tried to determine whether or not San Diego rents became unmoored from their fundamental underpinnings as the housing bubble took place. The first installment compared rent levels with local per capita income; the second measured rents against median household income. Both comparisons indicated that rents were pretty well in line with incomes after all. The third entry compared San Diego’s housing availability to its population and determined that, as of 2008 anyway, the rent to income ratio was quite reasonable considering the number of San Diegans vying for the region’s supply of homes.
The purpose of this exercise is to determine whether the housing bubble somehow caused rents to become unsustainably expensive. If we find that 2008 rents were in line with their fundamentals, that doesn’t mean that rent prices couldn’t drop in the future due to a recession-induced deterioration of those fundamentals. But this is a different question from whether rents were overpriced to begin with.
That latter question is the one I’ve been trying to answer, and so far, the answer has been that as of last year, rents appeared reasonable in comparison to San Diego incomes. The last topic I want to look at is to what extent incomes themselves might have been distorted by the housing bubble. We all know that huge money was made in the mortgage, real estate, and home building industries. The constant stream of cashed-out equity also provided raw material for quite a consumption binge, to the benefit of the retail industry.
The housing bubble clearly raised overall income to unsustainable levels within certain sectors. Then again, employment in those sectors has dropped hard since the bust began. The question is whether the housing bubble beneficiary industries have been sufficiently cut back to size at this point, or whether even more job losses are required to get those sectors back to historically sustainable shares of economic activity.
In an attempt to answer this, I’ve graphed the three primary housing bubble beneficiary sectors — construction, finance (which includes real estate), and retail — as a percentage of overall San Diego employment for as far back as the data goes. The idea is that the number of people employed in a sector is a decent proxy for how much money was being earned within that sector. On each graph I’ve included the one-year trailing average in black. Pay most attention to this line, because it smoothes out seasonal variation and because it’s the most appropriate measure considering that the rent-to-income and population-to-house ratios discussed in prior articles all used yearly averages. I’ve also included an average level starting at the beginning of the data series in 1990 (which was, coincidentally, the peak of the prior housing bubble).
For all the whackage it has undergone, the construction industry’s 2008 average was still above the average that prevailed since 1990. Construction also still accounted for a substantially higher proportion of San Diego employment than was seen at the trough of the prior real estate bust:
The finance and real estate sector, in comparison, was well below the post-1990 average and pretty close to its mid-1990s trough:
Retail employment throughout 2008 was the lowest since the data began:
All three sectors together were not quite the lowest proportion of San Diego employment that they’d ever been, but they were near the lows and were well below the post-1990 average.
All in all, employment in the sectors that benefited unduly from the housing boom appears to be back to levels that are below the averages that prevailed for nearly two decades and are, presumably, sustainable. Whatever distortions the housing bubble might have inflicted upon the “income” part of the “rent-to-income” ratio appears to have come and gone.
In short, I don’t see anything that invalidates the conclusions of the prior three articles on the topic: as of 2008, San Diego rents were reasonably priced based on the historical relationship with their fundamentals.
Which, again, isn’t to say that rents couldn’t fall as a result of the current economic carnage. Let’s actually take a look at what the post-1990 housing-driven recession tells us about that:
Rents did decline for a couple of years during the worst of the 1990s bout of San Diego unemployment. However, the declines didn’t amount to much. Between the 1992 annual high and 1994 low, rents fell by 1.1 percent. By 1996, rents were at new all-time highs.
Last month’s unemployment rate was a hefty 9.1 percent — higher than anything seen in the 1990s — so we are firmly in the territory in which economic weakness seems able to induce rent declines. And here we may remain for a while yet.
But if I have to guess, I don’t imagine that rents will fall by the precipitous amounts implied by some readers. This series of articles has shown that we entered the downturn with rents at fundamentally justifiable levels, meaning that there was not a bubble-era excess to work off as there had been with home prices. And while rents can decline during periods of high unemployment, the 1990s experience suggests that these rent drops will be fairly mild.
It’s true that today’s economic downturn is worse than that of the 1990s. On the other hand, back then we didn’t have a federal government that was engaging in previously unimaginable levels of effort to ensure that prices do not decline in any sustained manner. I’m going to say that makes for somewhat of a wash.
So San Diego rents are probably declining as I write this, and they may do so for a while yet. But when all is said and done, I venture to guess that they won’t fall by a whole lot.
— RICH TOSCANO