Andrew Samwick at the Crossroads
General Relativity Made Concise

Variance of Price/Rental Ratios

General Glut makes excellent points:

General Glut's Globblog: There are many bits of evidence one can muster to identify housing bubbles. The Sunday New York Times trotted out a lot of data on purchase-to-rental price ratios to further bolster the argument that in California, Florida and parts of the Northeast, it's bubblemania.The logic of the indicator is, of course, that if purchase and rental prices both increase at roughly the same pace, there are some actual economic fundamentals driving the inflation: population growth, job growth, income growth, whatever. Of course, the ratio can increase somewhat if the quality of the purchased housing stock rises more than the quality of the rental housing stock, but there shouldn't be a complete disconnect between the two.

Read the entire article to get a flavor for the data, but check out this chart for something to chew on. What stands out most remarkably to me is that in 2000:I, before the US asset-based economy switched from stocks to housing, the purchase price to rental price ratio across all major US housing markets (data for 54 of them are reported) was virtually the same. The national average stood at 11.6, with San Jose at the high end (14.1) and Pittsburgh at the low end (10.5). Note that this gap was not wide: San Jose was 122% of the national average and Pittsburgh was 91%.

It's quite a different story five years later. In 2005:I, the ratio for the national average is up to 17.1, with the top and bottom at an amazing distance from one another. The peak is now San Francisco at a stunning 34.1 (San Jose is a close second at 34.0); the trough is Albuquerque at 11.8 -- still above the national average from five years ago, I might add. Thus the high is now 199% of average; the low, just 69%.

Not only is the gap tremendously larger with the peaks in the stratosphere. The opposite motions of purchased versus rental home properties in a few markets has to be a harbinger of danger. Over the past five years, rental prices have actually decreased in frothy San Jose, San Francisco and Oakland, and have barely budged in New York, all while purchase prices have vaulted skyward...