Dynamist Blog


Back in the late 1980s, Steve and I knew the L.A. housing market was in a bubble because it cost so much more to buy than to rent. (We bought our condo in 1992, year of recession and riots, near the bottom of the market.) Now UCLA economist Ed Leamer calculates that a similar bubble is at work, particularly in Northern California. The San Francisco Chronicle reports:

Leamer calculated the average P/E for homes in several California metro areas by dividing the median price for a single family home by the average annual rent for a 2,000- square-foot apartment in each region. (You can get more and better data for apartments than rental homes, and the two tend to track each other.)

His findings: In the Bay Area, the average P/E for a house shot up to 13. 8 in the first quarter of 2004, compared with 7.2 in 1999 and 2000. Today's ratio is more than a third higher than it was 1989, just before housing prices started a multi-year descent.

In Santa Clara County, the average P/E is 15.8 today, compared with 10.3 in 1989.

"We are in a situation that is more extreme than it was in 1989," says Leamer, director of the UCLA Anderson forecast.

In the Bay Area, P/E ratios are skyrocketing because rents are falling while home prices are escalating, Leamer says.

In San Francisco, the average rent has skidded to $22.01 per square foot from $31 per square foot in 2000, while the median home price has risen to $606,000 from $450,755.

In Southern California, where the economy is stronger and more diverse, rents are rising, but housing prices are rising even faster. As a result, P/Es are also rising, though not quite as far as in Northern California.

In Los Angeles, the price of a median home rose to $399,000 in the first quarter of 2004 from $215,652 in 2000. Rents rose to $19.35 per square foot from $18.07.

When the economy is booming, investors are willing to pay higher prices for stocks and houses because they think the earnings from these assets will grow faster than normal. Occasionally, they throw common sense out the window and start believing that earnings will continue upward in a never-ending spiral, untouched by forces like competition and economic equilibrium.

Our L.A. condo was recently assessed for more than twice what we paid for it, so at least on paper we're rich. (Keeping it was certainly a better investment over the past four years than selling it and putting the money in the stock market.) But we're in the market for the very long term--think retirement. If you're buying for the short term, don't.

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