By DAVID LEONHARDT
Published: May 28, 2005
Four days after Alan Greenspan, the Federal Reserve chairman, pronounced the
nation's housing market frothy, a new report on home prices this week suggested
that he might have been understating the situation. Even after one of the steepest
run-ups on record, home prices have jumped another 15 percent over the last
Dennis Brack for The New York Times
Christopher A. Barson lives in a loft-style apartment in Washington and pays $2,300 a month in rent.
While gleeful about their apparent riches, homeowners in many of the hottest areas are also growing concerned. How, exactly, does one know if the family palace is sitting atop a bubble about to burst?
The answer might have less to do with the sale price of your neighbor's house and more to do with something most homeowners ignore: the local rental market.
The easiest way to gauge a home's value is to borrow a tool from the stock market. In the most basic method of analyzing a stock, investors look at its price-to-earnings ratio, a comparison of a company's share price with its annual profit. The higher the ratio, the more expensive a stock is relative to its underlying value.
Houses have their own version of such a ratio. Take the price of a typical house in an area, divide it by the amount that house would cost to rent for a year and the result is what might be called a rent ratio, an imperfect but still telling measure of real estate.
That ratio today shows that housing is not nearly as overpriced as stocks were in the late 1990's. But many areas are showing signs of irrational exuberance.
Rents act as a reality check of sorts for home prices, a way to see how economic fundamentals, rather than psychology, are affecting the market. In only a small number of areas - including Washington, Baltimore, Las Vegas, Jacksonville and the Long Island suburbs of New York - are rents rising at a decent clip.
In the last five years, the rent ratio in many coastal cities has more than doubled, according to an analysis for The New York Times by Economy.com, a research company. In San Francisco and San Jose, Calif., it has spiked to nearly 35 on average - or about equal to the price-earnings ratio Microsoft's stock reached in 2000. In West Palm Beach, Fla., and San Diego, the ratio is almost 30. In New York, Miami and Los Angeles, it is about 25.
A typical three-bedroom house in Mill Valley, Calif., about 10 miles north of the Golden Gate Bridge, now costs about $1 million, said Vanessa Justice, a real estate broker with Cagwin, Seymour & Hamilton there. A similar home would cost less than $40,000 a year to rent - for a rent ratio of more than 25.
Some of these regions seem to be the places Mr. Greenspan was describing when he said last week that there were "a lot of local bubbles" in housing. Speaking yesterday at a conference in Berlin, Roger W. Ferguson Jr., the Fed's vice chairman, said, "Right now, housing prices in many markets in the United States are relatively high when judged by conventional valuation measures."
In the lands of rising rents, companies are adding jobs, giving workers more money to spend, and the population is growing. Near Logan Circle in Washington, for example, one-bedroom apartments at the Hudson, with stainless-steel appliances and dark-orange concrete floors, now rent for about $2,100 a month, up more than 5 percent since 2003.
But in places where rents have trailed inflation or even fallen outright - the Bay Area of California and much of the New York region - the case for soaring home values looks harder to make. More families in these places seem to be relying on aggressive mortgage terms to buy homes.
"Investors think housing prices are going to go up 15 percent, 20 percent, every year - so they're not worried if it makes much sense in terms of intrinsic value," said Edward E. Leamer, an economist at the University of California, Los Angeles, who has written about the price-to-earnings ratio of houses.
"But assets have fundamental values," he said. "That tends to be forgotten in these emotional surges that drive values up and down."
In the Washington area, the rent ratio remains just below 20, or almost exactly equal to the price-earnings ratio of the stock market today, as measured by the Standard & Poor's 500-stock index. More of the rise in home prices around Washington, in other words, seems to reflect economic changes than it does in other places.
The growth of the federal government, especially the Department of Homeland Security, has strengthened the local economy. With one of the nation's best-educated work forces, the region has also attracted high-paying white-collar companies.
Booz Allen Hamilton, the consulting firm, announced last year that it would add 4,600 jobs, paying almost $80,000 a year on average, in Herndon, Va., near Washington Dulles International Airport.
The growth has created more demand for rented houses and apartments, even as thousands of renters have used low mortgage rates to buy their own homes.
Two years ago, Christopher A. Barson, a 40-year-old interior designer, moved out of the first floor of a row house on Capitol Hill that cost about $1,700 a month, he said. He now lives in a loft-style apartment at the Hudson and pays $2,300 in rent.
But there is a Starbucks in the bottom floor of his building and a Whole Foods supermarket across the street, and Mr. Barson does not have to battle the traffic to get into the city. "The convenience factor is fabulous," he said.
A number of apartment buildings in northern Virginia have also recently been converted to condominiums, reducing the supply of rental units. Sandra Graves, an agent with Long & Foster, said she recently rented an apartment in Fairfax, Va., for $250 more a month than two years ago, largely because of a shortage of apartments in the area.
In California, by contrast, tenant-protection laws are stronger, making conversions more difficult, said Howard Ruby, chairman of Oakwood Worldwide, which operates short-term corporate apartments.
Over all, rents for Class A apartments, which are newer and bigger than others, have risen 13 percent over the last five years in the Washington area, nearly equal to inflation across the economy. In Boston, they have increased just 3 percent, according to Global Real Analytics, a research company based in San Francisco that publishes the National Real Estate Index.
Class A rents have fallen 12 percent in Atlanta and 22 percent in San Jose, even as home prices have soared. New York rents have been roughly flat over the last five years.
"The rental market has obviously become more tied to underlying economic conditions at this point," Mark Zandi, the chief economist of Economy.com, said. "It's not necessary to have a strong economy to have booming house prices."
Rent ratios are hardly a perfect measure of a region's housing market. Comparable rental data exist for only about 50 metropolitan areas.
And simply because home values have risen more than rents does not mean there is a bubble waiting to burst. For many reasons - the long-term decline in interest rates, the fall in mortgage costs as the Internet has increased competition and the extension of credit to low-income families - buying a home is easier for many families than it once was. It makes sense that house prices have risen in recent years, economists say.
But rent ratios have many advantages. They account for many of the factors that people often cite as justifications for the surge in home prices, like the growth in incomes, population and house sizes.
If a region is booming, rents and home prices alike should benefit. If it is busting, both would seem vulnerable.
In places like the Bay Area, south Florida and much of the Northeast, though, the two parts of the housing market have become unhinged. Even in Las Vegas and in Riverside, Calif., where rents have risen, home prices have gone up so much more quickly that local rent ratios have soared above 23, from less than 12 in 2000, according to Economy.com.
This kind of analysis also helps explain why most economists, even the nervous ones, consider today's housing market to be a different beast from the 1990's stock bubble. Nationwide, the rent ratio of houses remains around 17. At its peak five years ago, the ratio of the S.& P. 500 hit 35. Yahoo's price-to-earnings ratio nearly hit 1,000 in late 1999.
Yahoo stock has since lost more than two-thirds of its value. Not even the most dour real estate analyst expects a plummeting of that magnitude for houses in San Francisco.
On other hand, some economists say even Washington is in the midst of a run-up that is likely to end badly. Dean Baker, who predicted the stock market's fall and now says the housing market is headed for its own troubles, sold his Washington condominium, not far from Mr. Barson's loft apartment, last year for $445,000, after having bought it for $160,000 in 1997. Now Mr. Baker rents a similar-size apartment nearby.
"I felt stupid not doing it," said Mr. Baker, co-director of the Center for Economic and Policy Research, a liberal group. "To me, there's no doubt about the direction. The only question is timing."
Housing bears like him often point to the growing disconnection between rents and house prices. They also argue that history shows what can happen when house prices get ahead of themselves.
After soaring in the 1980's, average house prices in the New York region fell significantly in the early 1990's. Adjusted for inflation, they did not return to their 1988 peak until 2002. Since then, they have risen more than 40 percent.
|Region||Home Price/ Rental price: 2000||Home Price/ Rental price 2005||Growth in home price: 2000-05||Growth in rental price: 2000-05|
|San Jose, Calif.||14.1||34||7.9||-3.5|
|West Palm Beach-Boca Raton, Fla.||11.6||29.4||23||2.1|
|Orange County, Calif.||11.8||25.7||18.8||3.4|
|New York City metro area||10.6||25.4||14.1||0.4|
|Los Angeles-Long Beach||12.3||24.9||19.6||3.1|
|Fort Lauderdale, Fla.||11.6||24.5||19.6||2.4|
|Riverside-San Bernardino, Calif.||11.9||23.1||21.2||7.7|
|Minneapolis-St. Paul, Minn.||12||18.7||10||Unch.|
|Salt Lake City-Ogden||10.9||12.9||3.3||-0.3|