Housing Bubble in SD Again? | Blog

  • Felica Jerbasi on Facebook
  • Felica Jerbasi on LinkedIn
  • Follow Felica Jerbasi on Twitter

Tiny Housing Bubble may be forming amid buying pressure - By Dan McSwain SD U~T

Is the San Diego housing market blowing another bubble?

It quite probably is, but it's still a great time to buy a home. In a market that is unusually prone to boom and bust, we are very early in the process, judging by market fundamentals.

Indeed, our latest bubble is minuscule compared to the global bank-wrecker that triggered the Great Recession. Yet it's still worth taking seriously. The questions now are how big it will get, when it will eventually pop, and what — if anything — you should do about it.

For families who dream of buying a home for the long run, bubble risk should be way down the list of considerations. Except for last year, now is the best time to buy since 1997. Mortgages are near historic lows, but risIng, while prices are climbing fast from their lowest levels in a decade.

Still, investors and speculators should be wary, and do plenty of homework. Buying a home is vastly easier than making money on a rental house or timing the market.

The best evidence for a nascent bubble in San Diego County is behavioral: Buyers are showing signs of growing impatience. As detailed in a slew of stories by Lily Leung, the U-T's housing reporter, homebuyers returning to market over the last two years have encountered tight inventories and stiff competition from investors.

Meanwhile, prices have rebounded strongly. The value of the overall market was 12 percent higher in March than a year earlier, according to the S&P/Case-Shiller Home Price Index, which is the gold standard because it tracks recurring sales of the same homes.

Dataquick figures show the median rising a scorching 21.4 percent in April, with price inflation accelerating over the past year. The homes were flying off the shelves: In March, there were 3,762 sales and only about 4,200 active listings, yielding a sales velocity that's probably a record high.

Coupled with fears that mortgage rates will rise, this has buyers in a tizzy. In scenes reminiscent of pre-crash 2005, they are joining waiting lists for new construction, writing offers on the hoods of cars, and sending "love letters" to persuade sellers to pick them.

The sense of urgency is increasing along with prices. It's the classic sign of early bubble formation.

"In a normal market, higher prices mean that sellers sell less. But the market becomes pathological when higher prices cause more buying," said Ed Leamer, an economist at the UCLA Anderson Forecast who in 2002 warned of the last bubble. "People are starting to think, 'I've got to buy a house before it is too late.' That's a bubble."

Leamer hastens to add that he doesn't think California has entered true bubble territory — yet — based on market fundamentals.

Prices are still below their long-run trend. Mortgage payments haven't outstripped incomes. The cost of owning and renting are roughly comparable. So value inflation could continue for some time.

Although I admire Leamer's precision, there is no academic consensus on the definition of an asset bubble. And economists say nobody can reliably predict the timing of its demise.

Still, history suggests that we're already in a bubble, however momentarily modest. Robert Shiller, the Yale economist who foretold both the 2000 stock market crash and the recent global housing crash, has shown that housing markets are unusually prone to boom and bust cycles, using transaction data from Amsterdam, Norway and the U.S. housing markets from 1628-2005.

San Diego is more susceptible than other markets. Strict zoning, which is popular with the public and unlikely to ease, keeps land prices relatively high and delays new developments. This prevents builders from quickly responding to higher prices by adding new houses, a dynamic that moderates price volatility in much of the nation.

Combined with tight financing conditions for smaller builders, zoning restrictions have sent San Diego County's inventory of new construction plummeting – down 89 percent since 2006 to just 1,783 units in the first quarter, according to Russ Valone of MarketPointe Realty Advisors.

Certainly, construction will come roaring back if prices rise enough. In the meantime, zoning gives the housing market a built-in supply lag.

San Diego has produced three housing bubbles in four decades: 1976-1982, 1985-1989, and 1997-2006. The market rarely purrs along at the rate of general inflation.

That's not to say prices will keep rising at today's blistering pace. Increasing values will flush out more sellers, increasing the resale supply. A sharp rise in mortgage rates would clip affordability and dampen demand.

Yet Shiller argues that such fundamentals are surprisingly weak at explaining housing prices. "The market for homes is a very risky place," he says. Psychology is a major factor.

Leamer says that the next phase in a bubble is for banks to relax lending standards, as rising values build optimism that foreclosures won't cause big losses. My reading of Federal Reserve data suggests we are very early in this process: 10 percent of banks reported easing standards for "prime," or low-risk, loans in the first quarter, up from 5 percent in the previous quarter. And more buyers are seeking loans; the Mortgage Bankers Association's purchase index in May is about 10 percent higher than last year.

Meanwhile, the federal government, which dominates the mortgage market, continues to boost demand with loans requiring 5 percent or zero down payments.

We are a long way from the reckless lending that fueled the 1997-2006 mega-bubble, which burst and triggered a global financial panic. But those who say bankers have learned their lesson don't read history.

For homebuyers, the lesson is to avoid getting carried away. If you can cover the costs, save for retirement, and keep a prudent cash reserve for emergencies, then by all means buy a house.

If we are lucky, this bubble will be mild. The U.S. housing market last had a "soft landing" in 1947. One can always hope.