Sep032012

OC housing market ratings and historic city values

California has a long history of real estate bubbles. Cycles of boom and bust range back to the gold rush in the nineteenth century. Over the last forty years, California has experienced three major real estate bubbles. Each of them had different causes and sprung forth from different circumstances, but they all shared the common cycle of irrational exuberance leading to a boom followed by a crash back to fundamental values of rental parity.

Historic Valuations by city

Over the last month, I commissioned Brian Nadel (thanks, Brian) to download MLS rental data back to 2000. From other sources, I extrapolated rental rates back to 1988. I also purchased the resale data back to 1988 from DataQuick. From these various sources, I calculated rental parity for each OC city back to 1988. I compared these values to the median resale price to determine the historic relationship between rental parity and the median. In particular, I focused on the period from 1993 t0 1999 which was the last stable period between housing bubbles. By establishing the relationship between rental parity and the median during this period, I have a benchmark to where prices should bottom in the aftermath of our most recent housing bubble. Below is the result of this analysis.

What I found most interesting in this study was how inflated the beach communities have always been. I knew these communities were never at rental parity, but I didn’t realize some of them were more than 50% inflated even at the bottom of the last bust. In fact, some of these communities which are still inflated are less inflated than ever before. For example, Coto de Caza is trading for near rental parity today, an over 50% reduction from its normal level of price inflation. In other words, Coto de Caza is a relative bargain today.

Long history of OCHN ratings

When I developed the OCHN rating system (read this for more information), I used history as a guide to weight the variables of resales prices and rental rates in a way that timed the housing cycle. A useful rating system should say not to buy when prices when the timing is poor, and it should say to buy when the timing is right. You can see the results below.

Anyone using the OCHN rating system would have avoided buying when they were likely to end up underwater. The system even warned about buying in 2009 when everyone else was calling the bottom. Since interest rates have declined along with prices and rents have gone up, affordability is at record highs, and the OCHN rating system is issuing a strong buy signal. The last such strong buy signal was in 1998, the bottom of the last housing bust.

If you would like to use this information in your house search, you can request it below.