Today, the Orange County Register published an op-ed where I discuss the probability of a housing bubble forming in Southern California. The description should be enough to give pause to any positive feelings about rising housing prices, but in case not, a picture can be worth more than 750 words:
The white line (rents) is a baseline for looking at whether housing values are overpriced. There clearly is a re-emerging bubble as compared to the last housing bubble. Does this mean trouble ahead? This is what the data says:
So how do we determine if Southern California is experiencing the birth of a new bubble or a true recovery? The ratio of home prices to rental costs in a given area is a measure often considered when studying housing bubbles. Rents are closely tied to market supply and demand and are rarely susceptible to bubbles, so they serve as a baseline in determining if housing prices are inflated.
Between 1991 and 1999, the Federal Housing Finance Agency reports that home prices in the Anaheim-Santa Ana-Irvine metropolitan statistical area increased 11 percent (unadjusted for inflation). During the same period, renters in the same area saw their housing costs grow 12 percent, according to the Bureau of Labor Statistics. Translation: the price of homes was not inflated during the 1990s in Orange County – and in fact might have been undervalued a bit.
The story quickly changed, though. From the first quarter of 2000 to the same time in 2006, housing prices in Orange County jumped 155 percent. In the greater Los Angeles area prices spiked 178 percent. But BLS rental prices rose just 38 percent. Translation: the price of homes was significantly inflated relative to rents, signaling the housing bubble.
The year 2006 marked the top of the housing bubble for Southern California, and prices quickly collapsed for more than three years, according to FHFA data. Both Orange County and Los Angeles saw prices stabilize in 2009, and from the summer of 2012 through 2013, prices steadily climbed back to 2004 levels.
The warning sign for today's market is that housing prices are once again growing much faster than the BLS rental market trend. Entering 2014, homes in Orange County are 20 percent higher than rents by BLS standards. In Los Angeles, home prices are 6 percent higher than rents.
Read the rest of the discussion at OCR's website.