# Is San Diego Market Underpriced or Overpriced? - A Thought Experiment for August 2008

Let's do a thought experiment. Any market in any commodity has two components: The demand, or willingness and ability to pay for that good, and the supply of that good.

Let's consider the demand half of that first. Specifically, ability to pay.

According to the most current credible statistics I could find, San Diego Demographics & Household Information, we have 421,952 workers in San Diego.

Let's consider what this means, first in terms of how much they make, and how many dollars they can afford to lay out:

Column 1 is the range, column 2 is how many workers reported that income, column 3 is percentage of workers in that bracket, column 4 is taking the middle of the range and translating that into dollars per month, and column 5 is what percentage of the total working population can afford that much or better.

Here's the income ranges and frequency:

 Range < \$10,000 \$10,000-\$14,999 \$15,000-\$24,999 \$25,000-\$34,999 \$35,000-\$49,999 \$50,000-\$74,999 \$75,000-\$99,999 \$100,000-\$149,999 \$150,000-\$199,999 \$200,000+ number 8463 25,745 54,563 54,499 70,654 87,022 50,494 43,452 13,558 13,502 pct 2.0 6.1 12.9 12.9 16.7 20.6 12.0 10.3 3.2 3.2 midrange monthly \$416 \$1041 \$1666 \$2500 \$3541 \$5208 \$7291 \$10,416 \$14,583 \$20,000* afford pct 100 98.0 91.9 79.0 66.0 49.3 28.7 16.7 6.4 3.2

Now, let's stop a minute here. Someone making less than \$10,000 per year is not a full time employee. Minimum wage is \$8.00 per hour in California, times 40 hours times 52 weeks is \$16,640. So the folks in the first two ranges are not working full time. Period, end of discussion. I think they should have housing, but I have my doubts whether we should be concerned about whether they can afford detached single family residence type housing on their current wages. In most cases, I would posit that they're either teenagers working for pocket money or retirees working for whatever reason strikes them as sufficient. Also, I should mention that I arbitrarily used \$240,000 per year as midrange for those folks making over \$200,000. Such an estimate is probably too low, but let's face it: Those folks are doing fine.

Now, let's look at what these folks can afford: I took the midrange monthly for that salary range, and assumed they bought, with 5% down, a condominium with HOA dues of \$225 per month, or a single family detached home with insurance of \$100 per month. This assumes they do all their own maintenance for the detached home, but someone sufficiently determined can at least approach this. I assume property taxes of 1.25% per year (slightly high for most of California), and a fully amortized FHA type loan at 6.5%. For purposes of this exercise, I didn't stress about Jumbo or conforming, as I used the FHA as a basis, nor did I concern myself over whether it fits within FHA limits, as the point of this is simply to perform a thought experiment: How much house people can afford under these assumptions, which are quite reasonable. Once again, it would break down at the higher end of the scale, but folks on that end of the scale are doing fine. I was mostly after was Joe and Jane Average can afford. These numbers given are in terms of the loan amount, not purchase price, which the loan amount was assumed to be 95% of (in other words, \$95,000 loan amount means it was \$100,000 purchase price).

Column 1 is once again, that monthly midrange, Column 2 is 45% of that, the traditional back end ratio. Column 3 is the maximum condo loan they can afford, under the conditions described, Column 4 is the single family residence, and Column 5 is, once again, what percentage of all workers can afford this level or better.

Let's take a look at the results:

 midrange monthly \$416 \$1041 \$1666 \$2500 \$3541 \$5208 \$7291 \$10,416 \$14,583 \$20,000* Housing+debt serv \$187 \$468 \$750 \$1125 \$1593 \$2343 \$3280 \$4687 \$6562 \$9000 condo limit n/a \$32,000 \$70,000 \$121,000 \$184,000 \$285,000 \$412,000 \$601,000 \$854,000 \$1,183,999 house limit na \$49,000 \$87,000 \$141,000 \$201,000 \$302,000 \$428,000 \$618,000 \$871,000 \$1,199,000 afford pct 100 98.0 91.9 79.0 66.0 49.3 28.7 16.7 6.4 3.2

So even though someone making \$12,500 per year is not a full time worker, they can still afford roughly a \$70,000 condo if they want to own badly enough to do what it takes. I'm assuming fully amortized 30 year fixed rate loan, which when the loan is paid off, gets your monthly cost of housing down under the inflation adjusted equivalent of \$300 per month in current dollars. There may be only 35 of these currently for sale as I log onto MLS, but I can't tell you why there are any.

Put two of these folks together, a married couple or two friends, it doesn't matter. Remember, neither of them is working full time, and they can afford a \$250,000 condo loan under conditions described (Remember, there's only 1 HOA fee, and taxes are only collected once). Insist it be a minimum of two bedrooms, even. There are 3600 Active Listings right now that are asking at or under this price, and almost 3000 have sold in the last twelve months in San Diego County. No, these places aren't right by the beach or in downtown La Jolla, but they are affordable, they're livable, and they put your housing situation and cost forevermore under your own control.

Someone making \$15 per hour, in the middle of the fourth range, is about where most folks would start saying, "This is someone who should be able to buy something," and they can: \$129,000 worth of condo loan. 594 Actives asking that or less, 383 sold in the last twelve months. Get a roommate, friend, or spouse making the same amount, and you're looking at \$273,000 worth of condo, more or less, or \$290,000 worth of house. 4100 actives are asking \$273,000 or less, even if you restrict your search to two bedrooms or more, and over 3700 of them have sold in the past year. Even if you restrict the search to detached housing, there are 1700 actives where the asking price is \$273,000 or less. Two-thirds of all workers can afford this level of housing. In a market where the restrictions on building artificially limit the supply of housing. They may not have travertine floors and granite counters, but the majority of the people in the world would jump at the chance to live in them.

Let's consider someone in the middle of the sixth group, with a spouse in the middle of the fourth. By themselves, that professional can afford \$285,000 of condo loan, \$302,000 of house loan. Add in the spousal income, and you've got \$437,000 worth of condo, \$454,000 worth of house. Now, we're just talking over-inflated expectations, unwillingness to economize in other areas of your life, or some combination of the two. In any case, it's no longer affordability - it's that the folks don't want to do what it takes. My Gran had a standard answer for children like that, humiliating and painful, but a lot less so than missing this opportunity will be. Tough old gal, my Gran. Raised a family of six by herself through the Great Depression after second husband died, and she didn't take nonsense or whining from anyone. There are 9500 Active listings where the asking price is under \$437,000. I can find you a fairly nice piece of property in pretty much any area of the county for those prices. Just under half of all workers, including part timers, are at this level or better, and the breadwinner (or main breadwinner) is smack dab in the middle of the most common earning range for all workers, and the secondary worker, if we're using one, is two income groups down. People have the ability to pay these prices if they want to. The ones who want to will find themselves sitting very pretty in a few years.

Why do I say that? Because of the supply situation. It's not like we can expand indefinitely in all directions. The Pacific Ocean is wonderful, and it brings a lot of people to visit and most of them want to stay and it helps moderate the climate, but you can't build housing in it. Lots of San Diegans like visiting Mexico, and quite for a number of them, the proximity of Mexico adds a lot to being here in sunny Southern California, but once you cross that border, you're no longer living in San Diego, with all the advantages of life in the United States that start at economic opportunity, run through a government that's actually somewhat accountable to its people, and where there's something resembling a rule of law. Great place to visit, Mexico, but I don't want to live there, where everything is subject to the whims of one of the most corrupt and unaccountable systems of government ever. It appears that pretty much everyone agrees with me. Then there's Camp Pendleton on the north. You can try and take it away from the Marines if you want. I'm not that stupid. They've got the US Government bankrolling them - their armor and weapons and ammo are government issue, which means that you're paying for them to shoot at you. Yes, this is more than a little over the top. The point is, Camp Pendleton is off limits to expansion.

So is most of the eastern portion of the county. Cleveland National Forest, don't you know. Great place to visit, hike, sightsee, camp - but people aren't allowed to live there. 300 million Americans, including all of your neighbors who have already bought and want prices to rise for when they sell, have set up the rules setting that land aside. This might change at some point in the future, but it would take, first, over half of all 300 million Americans changing their mind, then fighting epic court battles as the minority takes every chance possible to keep developers out. They have quite a lot of avenues to stop it; fifty years probably wouldn't be enough. Not to mention eighteen Indian Reservations, and none of the tribes appears eager to sell land to outsiders for tolerably obvious reasons. Lease it, yes. But most people want to own the land, and leasehold property has a fraction the value of land owned outright, even if it's held in a common interest development, because at some point, all leaseholds end and the property, together with all improvements, reverts to the actual owner.

Even in the settled areas where development is possible, look out your window, anywhere in the urban and suburban areas of San Diego. Chances are you're not seeing vacant land. Even if you are, there are zoning and use restrictions and open space preserves. Beyond that, there are permits required and environmental studies to fund, and let's not forget the court battles than pretty much anyone looking to develop open land can expect these days. They started fighting over what's now the 56 corridor in the late 1970s, and the battle still isn't over, by which I mean there's people who want to develop but still have court battles to win and environmental hoops to jump before they can. Question: Do you think all of this makes the supply of available housing greater or less? What do you think constricting the supply of housing does that do to the price of housing? Every time somebody wants to move to San Diego, and there isn't the housing supply for them, two things happen. One, the price goes up by just that little bit necessary so that one person can no longer afford housing. Two, you've either created a homeless person, or someone has been forced to leave.

There are an awful lot of people that want to live here. Add the weather and the beach to the economic opportunity and everything else that the area offers, and you're repeating those two events from the end of the last paragraph many times over. Price going up, people becoming homeless or forced to leave. Multiply them by three million residents of the county, and what do you have? Pricing goes up, up, way up. The "Sunshine Tax" people talk about that we pay for living here is quite substantial. There are areas of the country where two people living on minimum wage can buy a pretty good house. This isn't one of them, and never will be again. The supply is too limited, and the demand too high. Nor is it all housing that we're considering here. It's only that fraction that the current owners have voluntarily decided to sell. If 99% of the current owners are happy where they are and don't want to sell, only 1% of the properties that exist are available for those who want to buy. They bid against each other until enough people drop out of the bidding that there is a one to one match between sellers and buyers.

Let's look at what it took to bring the market to this pass. For several years, more than eight out of ten properties was purchased with an unsustainable loan. People literally did not believe me when I quoted official SDAR and SANDAG statistics that said forty percent of all purchases were with a negative amortization loan, and another forty percent via an interest only 2/28 or 3/27, and both of these were usually stated income. Agents didn't want to tell people to settle for what they could afford, and in the Era of Make Believe Loans they didn't have to. Nor did they want to risk their commission checks by having buyers find out they couldn't afford the prices they were agreeing to pay, and if one loan officer was telling people what they really could and could not afford, there were plenty of others who'd keep their mouth shut and pocket the commission check. Buyers, for their part, weren't exactly models of restraint either. If anyone did try and buck the tide in order to tell them they really couldn't afford a certain property they had their heart set on, they would simply find someone else who'd keep their mouth shut and make it happen.

This all ended rather predictably. Wile E. Coyote looked down, by which I mean that buyers stopped buying. In one of my first on-line articles, I wrote how I had called our county assessor out over this wishful thinking. Prices stopped rising. The increases in value all of the agents, loan officers, and buyers were banking on in order to make the situation not self-destruct came to an abrupt and screeching halt. No increases in value meant that refinances wouldn't fly. Few people could afford new payments, closing costs, pay their loans down enough to enable them to refinance, or do anything else to salvage the situation. Indeed, the sudden wave of all this happening meant there was a veritable tsunami of people who had no other choice but to sell. Indeed, inventory through most of the last three years has been four times or more what it was when the market was hot. When four times as many properties come onto the market, and their owners have no bargaining power, and suddenly nobody wants to buy, it's no surprise the momentum of the market has shifted. It would have been a miracle greater than parting the Red Sea if it hadn't gone the opposite direction just as strongly as it had been going up before. Remember, Supply and Demand.

Let's look at what's happening now. The forgoing chaos created a limited window of opportunity, and that window has started to close. Active Inventory is currently 17,344 listings in San Diego County. This is down almost 1000 in the last month, 5000 in the last four. It's a 24 week supply, down from 26 at the beginning of July. People are figuring this out, despite heavy negativity in the media. The ratios of short sale to foreclosure are shrinking also, as the distressed properties move through the foreclosure cycle. Furthermore, as I said a couple of months ago, a lot of what's out there is still in denial. I was searching detached properties with asking prices below \$460,000 in La Mesa earlier in the year and getting roughly 140. I just searched at or below \$500,000 and only came up with only 107. Furthermore, it's hit the good stuff disproportionately - all ten of my most recent Hot bargain Properties are off the market. The situation is similar in Santee (104 under \$500k now as opposed to mid 130s below \$460k), El Cajon (311 vs nearly 400, same circumstances), and San Carlos (18 now vs 33 last time I checked, once again with the maximum search price raised now).

So, does this sound like an overpriced market due for more of a fall, or an underpriced market beginning a recovery? Shrinking inventory at higher prices. Heavy competition for the bargain properties. People able to afford the prices that are being asked with full documentation loans, fully amortized, instead of needing stated income, interest only or negative amortization loans to qualify?

The time of greatest affordability is in the past. If you're looking to buy in San Diego, the time to get off the sidelines is now. The current generation of executives at the lenders who enabled the Era of Make Believe loans has learned their lesson. The ones that survive are not going to relax loan standards to where they were two years ago any time soon. There's not going to be another bubble fueled by speculative loans. There will, however, be an extended period where the disparity between supply of and demand for housing in San Diego is going to get wider and wider, rents are going to increase, if anything, faster than purchase prices, and it's only those who have bought who are in control of their housing situation. Quit trying to time the market - you've already missed bottom, and even the lenders have started admitting it - removing the declining market designation. In case you are unaware, that's a trailing indicator, happening after the fact, not a predictive indicator. If you want to buy here in San Diego at the best prices possible from here on out, it's time to get off the sidelines and act.

If you want to talk, here's my contact information.

For the sellers who have managed to hold off this long, it's only going to get better for the forseeable future, and therefore I'd hold off if I had other options. The only exception is if you want to move up to something more expensive, in which case, let's get a move on! Otherwise, wait. If you're selling to move elsewhere or move down, things are only going to get better as inventory drops and more buyers figure out that we've already hit bottom and are on the way up.

Now, as to whether these conclusions apply outside San Diego County: They do not. There is no such thing as a national housing market, and even a countywide market like I'm talking about here is pretty much a fictional idea, applying only as an amalgamation, as each and every neighborhood of every city in the county is different. But these methods of analysis apply everywhere. In the case of San Diego, they yield an increasingly coherent picture of market recovery. Your local results will vary with your local conditions.

Caveat Emptor

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This page contains a single entry by Dan Melson published on August 4, 2008 7:00 AM.

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