Is San Diego's Housing Market Headed For Another Bubble?

CAVANAUGH: After years of talking about a depressed real estate market, now we're talking about another bubble? It may sound strange, but economist are warning that there are signs that housing prices are going up a little too high a little too fast. For instance, in May, San Diego home prices were up nearly 24% over last year. And California as a whole experienced the biggest year to year housing price jump in 33 years. Joining me to discuss what might be causing this big jump in prices, and if it's a bad thing, are my guests. Erik Bruvold is president of National University System Institute for Policy Research. Welcome back. BRUVOLD: Good to be back. CAVANAUGH: Alan Gin is here, author of USD's index of leading economic indicators. GIN: Thank you. CAVANAUGH: Let's put this boost in home prices in perspective where are housing prices in San Diego now as compared to the real estate bubble years of the mid-2000s? GIN: We have had a big run-up in prices recently, but that still leaves us pretty far behind where we were when we hit the peak. We hit the peak in early 2006, and we're probably about 20% below those heights. CAVANAUGH: So theoretically, San Diegans can still get more home for their money now than back in 2006? GIN: That's correct. Prices were a lot higher a few years ago. CAVANAUGH: Erik, what are the signs that housing prices may be getting out of whack? BRUVOLD: I think one good ratio to look at is the Raich yore between the median house price and then household income here in the region. If you hook through the '90s, we bumped around along 4-4.5 times that ratio. In the bubble, we were as high as 8 times. So people were needing to go into exotic mortgages. Right now, we're at about 5. I like the say the market's got fizz. It doesn't necessarily have a bubble, but we're drinking ginger ale right now. And the next six months are really going to be telling as to where this market is going to go. CAVANAUGH: What is the perfect ratio? BRUVOLD: San Diego always runs high. People are willing to spend more for the housing they get here in San Diego because some of the other costs of living that we have are relatively lower than other parts of the country. But I would say somewhere between 4-5 is a ratio which seems sustainable in San Diego as reasonable levels of mortgage interest rates. CAVANAUGH: Recent reports have cited anecdotal evidence of bidding wars. Buyers in San Francisco are waiting for contingency clauses for inspections just to see that deal go through. Did we see this in 2005, 2006? BRUVOLD: Absolutely. Now, it's not clear necessarily where the buyers were motivated by the same factors. But we clearly saw in 2005, 2006, people camping out for a week before new phases of new home developments that would be on the market. Turnarounds, homes listed for a day before they were getting cleared. But the difference between then and now is one of the things going on now is that the inventory of homes that are on the market right now are still at very, very low levels. And there are probably some short-term and also some long-term reasons why the supply that's being put into the marketplace is depressed. CAVANAUGH: There also seem to be reports of housing prices jump and bidding wars taking place in Washington DC, Seattle. And the real estate victim areas of Las Vegas and Florida, what kind of an impact does that kind of activity nationwide or in areas across the nation have on San Diego? GIN: Well, I think one thing is that this activity is symptomatic of an improving economy. We have had, not great job growth, but itself job growth. The unemployment rate is coming down. And interest rates are still relatively low. So that has just caused a lot of this activity. And activity in other place don't necessarily affect San Diego in terms of reducing the differential in terms of prices. Our prices are not as far out of whack as they might be. CAVANAUGH: The S&P Case-Shiller index says homes in Orange County and in a couple areas in California are now overvalued. Do they mean overvalued in the present market or overvalued just in general? How do they make that determination? BRUVOLD: Well, I'm not an expert on why they reached that conclusion. We would say again that housing prices are not out of alignment with their historic relationship in San Diego County between household incomes and the median price being paid for homes. Are they at the upper reaches of that boundary? Sure. But we have to balance that by realizing that interest rates have hit historic lows. I would again -- I think Alan is absolutely right. This is good news. This is an improving job market. And most San Diegans have the majority of their household wealth in their home. And with stabilizing prices, that's a good thing. But housing prices jumping 24% year over year this last May, that's startling, isn't it? GIN: It's a huge surge. And it's a cause for potential worry. You do worry that we might have a repeat of the situation that we had in the middle of the last decade. But things are different right now. The economy is on the ascendancy. And a key thing is that the lenders are much more cautious in terms of their activity. So not getting a lot of these subprime loans. Lenders are requiring more down payment, things like that. So that means there's a little bit more caution in the market. And that may keep things from getting too far out of hand. BRUVOLD: I think that's a great point. And it's possibly one of those things on the horizon you got to watch out for. Right now, the politicians, the regulators and the lenders are being quite conservative. They sort of remember the pain. To the extent to which as prices continue to increase and affordability declines and people are priced out, the worry is that the politicians, the regulators and the bankers will lower those standards and get into the kinds of situations we are. Right now, people can remember the pain and things are going well. But if you start to see a lot of exotic mortgages being advertised, if you see the regulators pull back, and especially if you see the missions complaining about affordability, people being priced out, communities not being able to participate in the American dream, that's the time to worry. That's at the point where the lenders start to go we got to reduce standards. CAVANAUGH: What causes a jump in housing prices that's not aligned with income? Is it just limited inventory? BRUVOLD: It's that age-old factor which matters in economics, pure unadulterated greed. So people start to look at increases in prices, they start to say as an asset class, that's one that's going to return good value. And they try and get in, buy low and sell high. So we saw in that period of the run-up, people taking out loans, leveraging to try and catch that upswing in the asset bubble. And that's great if you're the kind of guy who can get out while the musical chairs are still going. The music stopped, there was no chair for them to sit, and they're stuck with a loan which is going to reset at a high interest rate in a year. GIN: In addition to the lower unemployment and low interest rates, the supply does have some sort of impact. Construction virtually dried up during this downturn. We had the worst years on record in terms of construction activity. But also now a lot of the foreclosures and distressed properties that were flooding the market are now off of the market. And we're seeing a lot less in that area in terms of supply. And as prices go up, what that means is that fewer people are underwater. And if you're underwater, you see that prices are rising, so maybe you'll catch up. BRUVOLD: And that's why inventory is so low. And San Diego's construction industry was devastated by the downturn. And it's also moving into a period where the vast majority of our new homes will be condominiums, the kind of properties that require a lot of things to regulate, to permit, to build. We see the next few years being real slow in returning new supply to the marketplace. CAVANAUGH: Let's talk about investors in this San Diego real estate market. Are they driving prices up? GIN: I'm sure they are. There's a lot of money flowing into the market. A lot of people are buying in distressed markets like Las Vegas, Arizona. Investors were moving in and picking up properties in those areas. BRUVOLD: About 30% of the current purchases are cash fires. CAVANAUGH: Which is really high. BRUVOLD: It is high. And it's interesting in markets with the most fizz, if you will. Many of them have fairly robust technology and innovation economies. A high percentage of their income is realized in preferred stock, stock options, and the sorts of things that don't show up in government income figures. So we think if we unpacked that, we would see that there's a fair amount of buzz and demand being fueled in these markets by these type workers who sat on the sidelines with cash during the downturn. Now as the asset price seems to be stabilizing and increasing are coming into the market and paying near full cash value for the homes they are buying. CAVANAUGH: You are conducting a survey of where the real estate market is, Erik. And what areas of the county are we seeing the most real estate activity? BRUVOLD: There's stuff all over. But the places with some of the biggest price increases are north of state route 52, and south of SR-78. And that is sort of this band where we have had good job growth in the kinds of industries and occupations that can afford to be home purchasers in San Diego. CAVANAUGH: I want to put this idea out to both of you. Gary London, the San Diego real estate economist with the London group, says we are not seeing the start of another real estate bubble. He says the housing price boost is just part of the volatility that we'll see as the market gets back on its feet. He says it's a sign of the recovery. That 24% year over year boost was pretty dramatic, but do you basically agree with that assessment? GIN: I basically agree. There are a lot of strong fundamentals that we've talked about today behind this surge, including strong demand due to job growth and low interest rates and classic supply and demand driving a lot of this price increase. BRUVOLD: I take a slightly more cautious view. I think that Alan and Gary are right, that there are really strong fundamentals. I think what's holding this market back from being a bubble is strong lending standards and strong regulatory pressure. What we saw in the bubble years was that there was so much external pressure and there was greed to lower lending standards that the market could get out of control and start to inflate without too much push if those lending standards are decreased. CAVANAUGH: Just a word about lending standards, what we're seeing now is that the number of banks reportedly easing their lending standards has increased from 5% last year to 10% this year. We still have government-backed loans that are demanding 5% down or in some cases, 0% down. BRUVOLD: That's not the concern to me. The question is what will the regulators and the external forces do in terms of these knottic loans that we saw in the past? CAVANAUGH: The subprime loans. BRUVOLD: Well, either adjustable rate mortgages with teaser rates at the front-end. Loans that require only a stated income as opposed to approved income. The lower lending standards that were partly greed, partly external pressure come really allowed people to basically try and be in the housing market as a short-term asset play which is not good for keeping the underlying fundamentals in line. CAVANAUGH: If job numbers and incomes don't improve, but the housing prices keep going up, then might we have a problem? GIN: Then that would be a worry. But I do see that job growth is pretty solid in San Diego. We're on pace to add about 30,000 jobs in the local economy this year, which would be the best number since 2000. The worry is that in a year or two, interest rates might start edging up, and that'll slow the growth of prices. But I think we're generally in solid shape. BRUVOLD: Again I think that there are some clouds on the horizon. It's generally good news because housing is important for San Diego. And the thing to watch for if you want to try and figure out if we are or aren't in a bubble is to look at prices and what's going on with lending standards. CAVANAUGH: Gentlemen, thank you.