Sunday, April 24, 2005

Home prices soar while rents barely budge

In San Diego County, owning a home is more than the American dream. It's considered the ticket to financial security, the great dividing factor between haves and have-nots. It's an article of faith that home ownership is better than gold: homes provide a place to live and an investment that's surer to gain value than buying into the risky stock market.

Believers in that faith have been amply rewarded in the last decade. While the stock market has risen and crashed, home prices have gone in one direction ---- up. Double digit annual increases in housing prices have become normal. In the last few years, those who have warned about a real estate bubble have been seemingly disproved with each new month's report.

But in the last few years, something strange has happened. While the cost of buying a home in San Diego County has soared, rental costs have barely kept pace with inflation. Although rental costs are still going up, the increases have been progressively smaller. That's a red flag to some real estate experts, who say it's a sign the real estate market is out of whack ---- and that home prices are unsustainably high.

It's not possible, of course, to compare directly home ownership and renting. And local real estate experts stress the special character of San Diego County's real estate market, which has defied expectations before.

However, the costs of renting and housing historically have moved in the same direction, because both are driven by supply and demand. So a widening gap between the monthly cost of renting and a mortgage indicates a real estate market out of whack, say experts who warn of a bubble.

Fall ahead?

Robert J. Shiller, a professor of economics at Yale University, cites one eye-opening statistic that implies San Diego's double-digit price increases are an anomaly. In a new edition of his book, "Irrational Exuberance," Shiller has calculated that since the 1880s, home prices nationwide, when adjusted for inflation, have increased by just 0.4 percent a year.

Shiller's book, as the title implies, was written to warn about the dangers of stock mania. It was published at a timely moment in early 2000, just before the stock bubble burst. Now he warns in an updated edition that real estate is in one now.

Shiller's warning is reinforced by a survey from Torto Wheaton Research, a Boston-based business unit of CB Richard Ellis. San Diego's rent/ownership cost disparity, which has increased substantially over the last four years, is now the greatest of the 21 metropolitan markets the company surveyed.

The average monthly cost of renting in the county in 2004 was just 40 percent of an average monthly mortgage, according to the Torto Wheaton survey. That percentage is down from 57 percent in 2000. Nationwide, the ratio was 92 percent, compared to 95 percent in 2000.

The average price of a home in San Diego County was $269,000 in 2000 and $552,000 in 2004, an increase of 105 percent. Meanwhile. Rents rose from $1,027 in 2000 to $1,177 in 2005, an increase of just 15 percent.

Such an increasing disparity obviously can't go on indefinitely. The only question is when it will stop.

There are three possibilities, said Gleb Nechayev, a senior economist at Torto Wheaton who conducted the survey. One is that rents start to rise more rapidly. The other is that home prices will stagnate or even fall. The third is that both will happen.

Nechayev said the second option is most likely.

"By 2006 or 2007, we should see the beginning of a slowdown in home prices" in San Diego, Nechayev said.

Depending on what happens with interest rates and the economy, the slowdown could take the form of five or six years of flat prices, Nechayev said. That's the more painful possibility, Nechayev said. Alternatively, home prices could actually fall briefly, allowing price appreciation to begin again at a more sustainable level.

Nechayev projects that San Diego County rents will stay nearly flat. Increasing by an inflation-adjusted 1 percent per year for the next five years.

"With all the new construction, as well as condos being purchased for investment purposes, there will be some saturation on the supply side, and that will be affecting rent growth to some degree," Nechayev said.

A special market

This analysis is disputed by many local real estate experts. They say San Diego County has such a long-term housing deficit and dwindling supply of unused developable land that it is in no danger of saturation.

"I really don't see (housing) prices going into the tank," said Diane Miramontes, an investment specialist with Grubb & Ellis BRE Commercial. "This is Southern California and San Diego, a unique animal. ... We've got Mexico on the south, ocean on the west and Camp Pendleton on the north."

As long as the economy holds up and people can afford to buy, there's no reason to expect the real estate market to slump, Miramontes said.

Carlton Lund, a broker and agent with Prudential California Realty in Carlsbad, said some sellers still have unrealistic expectations. While he doesn't forecast a collapse in prices, Lund cautions that it's no longer possible for sellers to look at comparable recent transactions and automatically slap on a premium. He worries that sellers with that attitude are setting themselves up for a big disappointment.

It's still possible to get those hefty prices, Lund said, but it takes a lot of work, and the property must be special. One home he recently sold, at the southeast corner of Pacific and Tyson streets in Oceanside, brought an eye-popping $2.77 million.

But that massive home, adjacent to the beach with a magnificent ocean view, had been recently rebuilt almost from the ground up. It took a year to sell, Lund said, and had actually been taken off the market for a time.

Rents to increase?

Another way to narrow the gap ---- besides falling home prices ---- is for rental prices to increase more rapidly. Miramontes, who specializes in selling apartment complexes, said this is likely to happen over the long term. People who want to live in San Diego County who can't buy a home will rent, she said, and that demand will drive up rental prices.

However, Miramontes said, landlords have different philosophies and financial needs when it comes to setting rent prices.

Landlords with relatively new properties need to charge more than landlords with older properties that have already been paid off, Miramontes said. And some landlords stress getting the last possible dollar, while others think it's more important to minimize the hassle and expense of losing tenants when rents increase.

"It just depends on theories of management," said Darcy Miramontes, who works with her mother. "Some people are very aggressive ..."

"... and some people not at all," Diane Miramontes said, completing her daughter's thought.

Condominium conversions, increasingly popular in San Diego, are not much of a factor in rent prices, Nechayev said, because they only amount to a small fraction of rental units.

Since September, 2,800 rental units have been converted into condominiums, according to a March report from MarketPointe Realty Advisors. However the report stated that this amounts to only 2.5 percent of the rental housing stock.

In addition, many of the new condominium units are purchased by the renters, Nechayev said, removing them from the rental market.

Owners as landlords

Last week, the San Francisco-based research firm RealFacts released a survey that found rental prices "listless" throughout the West, and barely keeping up with inflation in San Diego. In addition, the survey stated there's not much rental construction going on in San Diego or elsewhere in the West, because it's more profitable to build condos and single-family homes.

New apartment construction, when it occurs, tends to be high-end, the survey said. One local example of new high-end rentals added to North County is Monarch at Shadowridge, a high-end development of 314 units that resembles an upscale condominium community. Rents for one-bedroom apartments start at $1,275 a month, two-bedrooms for $1,700 a month and up, and three-bedrooms start at $2,275 a month.

These facts don't easily fit together. All else being equal, economic theory predicts that if rental construction is slowing down, rents should rise as the population grows. San Diego's economy remains strong, with a March unemployment rate of 4.3 percent according to the California Employment Development Department.

There is an explanation that resolves the "disconnect" between soaring home prices and stagnant rents, said Gerald P. Cox, RealFact's marketing director. If a substantial proportion of home buyers are investors who don't live in their homes, they rent them out to repay the mortgage. Cox said he does not know if this explanation is correct.

But if it is, he said, demand for homes for sale would be artificially increased over normal demand, boosting prices. However, rental prices could not increase so rapidly, because there is not a corresponding increase in rental demand. Indeed, the homes would add to the existing stock of rental units.

While the buyers will try to charge enough in rent to cover their mortgage, Cox said they can't set their price above the going rate.

"The local market will set what the rental price is," Cox said.


At 5:46 PM, Anonymous Anonymous said...

While it's true that the costs of renting and housing have historically moved in the same direction, something has changed. The gap between the rich and poor, the haves and have nots has increased dramatically. San Diego County is a perfect example of this. It has a lot of very well off people and a lot of people living in trailor parks.

While in the past a huge divergence between the cost of renting and the cost of housing would have been a cause for concern, it's no longer the case due to this increasing gap between the haves and have nots. As a result, the rental market is no longer an accurate predictor of what will occur in the housing market.

At 12:00 PM, Anonymous Apartment Locator Houston said...

It is unfortuante to hear apartment rent is going up. Apartments are a great home for many and I belive they should be affordable.

At 3:23 PM, Anonymous Anonymous said...

San Diego renters need an adovate. Many apartment conversions to condo are leaving renters to scramble. Atlantic & Pacific Managment Company has ignored my emails and phone calls to reduce my rent while heavy construction is occuring outside my sliding glass doors. This is in LaJolla where I am paying over $2000 a month. Currently they have time share occupants who are having loud parties and breaking doors. Break-ins have occured in the middle of the day. Who is speaking up for those less fortunate? Then, I am having difficulty finding other places since I have encountered false advetising in rental properties by realtors looking for clients and managment company like American Heritage are completely unprofessional and difficult. Where is person to turn to? Where is someone who is on a budget going to turn to. This market is making renters having to suffer while companies have their way.

At 9:33 AM, Blogger cantaloupejones said...

Los Angeles is seeing such a surge in construction, worked by illegal aliens by the way, that buying versus renting is just a fallacy.
We natives can no longer afford to live in our own city.
On my block alone, there have been 10 apartment demolitions, while construction on 4 very large overpriced, i.e., 750,000 to one million priced condos have replaced these affordable apartments.
The investors? They are from out of state and out of the country. I researched this. So, who is looking our for us? not our elected officials!

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