Wednesday, May 16, 2007 | The speculative housing bubble that launched San Diego home prices so high is now in the process of deflating. Prices have been on the decline for over a year, but they remain well above the levels that would be justified by the economic fundamentals now that the bubble-era forces of rampant buyer optimism and unsustainably lax lending are disappearing before our eyes.
Using the analytical framework described above, and considering the precedents set by past boom/bust cycles in the San Diego housing market, it sure seems that the most likely outcome is for San Diego home prices to continue declining for some time to come. But nothing is ever for certain in the financial markets, so today I’d like to discuss the following question: what could prevent a serious decline in home prices?
As I see it, there are two potential factors that could help out the housing market.
The first is economic growth. If home prices are too high in comparison to rents, incomes, and other fundamentals, then it’s at least possible that those fundamental factors could rise to meet home prices rather than the other way around.
The problem is that this just isn’t very likely. Home prices are so out of line with rents and incomes that, given the current pace of their growth, it would take many years for rents and incomes to catch up. Meanwhile, the oversupply of inventory (especially that of the must-sell variety) would be exerting downward pressure on prices the entire time.
The only way that economic growth could single-handedly bail out the housing market would be for regional economic activity, employment, and incomes to grow in great excess to their current levels. Such a gold-rush style boom is certainly within the realm of possibility, but it’s not an outcome that I would consider likely.