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APRIL 11, 2005
What's Your House Worth Now? Is the price of your house about to plummet? There's no one foolproof indicator of a local housing bubble, so the best approach is to evaluate the situation from many angles. It's important to gauge such factors as construction permit issuance, local incomes, job growth, and rental rates to determine if you're living in a danger zone. "You have to triangulate," says Susan M. Wachter, a real estate economist at the Wharton School. By these measures, prime candidates for trouble include such places as San Diego and Los Angeles on one coast and New York and Miami on the other. One of the best indicators of potential problems is the National Association of Home Builders-Wells Fargo Housing Opportunity Index. This measures the percentage of homes sold in a given area that are affordable to middle-income families, defined as those with incomes at the midpoint of all families' incomes. The index takes into account property taxes and current interest rates, and assumes that families can afford to spend 28% of their monthly gross income on housing. Certainly, many people in hot markets stretch to spend more than that on housing, but there comes a point where prices are simply too high. By this measure, Los Angeles ranked dead last in the final quarter of 2004, with only 5.2% of area houses affordable by a median-income area family. San Diego was barely better with 5.3% affordable. Other areas that look bad include New York (10.8% affordable), San Francisco (11.6%), and Las Vegas (36.2%). By contrast, middle-income folks could afford 90% of the homes in Buffalo. By itself, the Housing Opportunity Index doesn't prove that a bubble has formed or is about to pop. The case for an overinflated market gets stronger if you can rent a nice house for far less than the monthly carrying cost of buying it, including mortgage and maintenance. High price-to-rent ratios mean that people are paying a premium to own rather than rent, presumably because they expect their homes to appreciate and earn capital gains. The bigger the premium, the more unrealistic their expectations are likely to be. WHEN RENTS LOOK GOOD San Diego is the most bubble-icious big city by this measure. According to Torto Wheaton Research of Boston, it cost only 40% as much to rent as to own in San Diego last year. The ratio was 45% in San Francisco, 54% in Las Vegas, 55% in Los Angeles, 59% in Washington, and 63% in Miami. In these cities, "It's much better to be a renter than a buyer unless your horizon is longer than five years," says Gleb L. Nechayev, a senior economist at Torto Wheaton. Still not sure if you're living in a bubble? Then look at the share of houses that are being bought for investment purposes only. By this yardstick, Las Vegas looks frothiest among big cities. Of houses bought with mortgage loans last year, 16% were bought just as investments or purchased as second homes, nearly twice the national average of 8.6%, according to data compiled from loan service companies by a San Francisco-based company, LoanPerformance. Phoenix, a market that looks relatively tame by other measures, wasn't far behind Las Vegas at 13%. (The National Association of Realtors reports a much higher national average -- 23% -- but it uses a broader definition of investment property and includes houses bought without mortgage loans.) Most of the metropolitan areas at the top of the LoanPerformance list are smaller cities -- places like Redding, Calif.; Tallahassee, Fla.; and Trenton, N.J. -- that look cheap to investors living in big, expensive ones. "These are the markets that make me nervous," says John Burns, president of John Burns Real Estate Consulting Inc. in Irvine, Calif. "That's where the dot-com mentality is going on." Typically, home prices in most of the country don't rise much above the rate of inflation, because it's easy to increase the housing supply by expanding the suburbs outward. That's why the doubling of prices over the past five years in places like Las Vegas, where the supply did dramatically increase, is so surprising. Eventually, though, market forces are apt to correct the anomaly. From 1999 to 2004, permits for single-family construction in Las Vegas rose 59%, though employment grew by only 23%, according to the homebuilders' association -- so the fresh supply should cool off the market. Similarly, in Phoenix permits rose 48%, vs. a 10% employment gain. ROOM TO GROW Those cities can grow because they're surrounded by open space. Most of the speculative markets are on the East and West Coasts, because when demand rises on the coasts, it's harder to create the supply. Population densities are higher, so there's less available land, and local zoning laws are generally tougher. In fact, despite zooming prices, the number of construction permits actually fell from 1999 to 2004 in many coastal locales -- 19% in Boston, 23% in New York, and 25% in the San Francisco Bay area. The flip side is that when demand slackens or supply finally picks up, prices on the coasts can fall as quickly as they rose. That's why Los Angeles and Miami appear fairly high on Standard & Poor's (MHP ) list of areas with the highest risk of a price decline, based on their history of wide price fluctuations and recent price increases. "At some point something has to give," says Francis Parisi, an S&P structured-finance analyst who helped devise the new measure. Right. And if you're thinking of buying a house in, say, San Diego, what might have to give is your own net worth.  By Peter Coy in New York
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