The ‘San Diego Indicator’ Suggests a Recession Is on the Horizon

• A vital port city, San Diego is as much an economic hub as it is a desirable destination city, making it a useful benchmark.
• However, the comparative ratio between income and apartment rentals suggests that an economic downturn may be on the way.
• It’s not time to panic but investors must be aware of the macro risks ahead.

With a rarefied title like America’s Finest City, it’s easy to assume that such highbrow praise is actually meant to be taken ironically. However, San Diego, California makes a powerful case for itself that it fundamentally deserves this distinction. Featuring lush landscapes, surfable beaches and almost year-round sunny weather, seemingly everyone -- except professional football teams -- wants to call San Diego home.

More than just self-absorbed hype, the big city with a small-town feel has the data to back up its claims. For instance, information from the latest census confirmed that San Diego increased its population by 6% over the last 10 years. As well, the area became more diverse, which isn’t at all surprising given its southern border with Tijuana, Mexico, along with a direct flight to Tokyo, Japan.

Further, San Diego is a warm-weather port, vital to both commercial activities and national security. Logically, the climate advantage draws people from around the country who may have grown tired of extreme seasonal shifts. As a result, the labor market for San Diego is incredibly robust, tying to multiple industries ranging from tourism, defense, technology and retail, among many others.

Ultimately, then, San Diego is a useful benchmark with which to compare the vitality of America’s most promising economic regions. Unfortunately, due to the unique circumstances stemming from the COVID-19 crisis, the city might be acting as a harbinger.

A Look Back Before the Great Recession

Depending on your degree of pessimism, the U.S. economy either faces a serious challenge or a devastating calamity for which no acceptable answer exists. But generally, the consensus is that the country is suffering from an affordability crisis. With soaring home prices and ridiculous energy costs sadly becoming the norm, regular folks don’t need much convincing that something is wrong.

But how do circumstances today compare to what happened prior to the Great Recession? Understanding the framework of the past will help investors better navigate the treacherous waters of today.

Back in 2008, the average monthly rent for a two-bedroom apartment in San Diego was $1,355. On an annual basis, the tally comes out to $16,260. According to the U.S. Census Bureau, San Diego County’s median household income at the time was $62,820. Subsequently, this figure represented the peak until 2014, when the city and the nation began recovering from the Great Recession.

Doing some quick back-of-the-envelope math, the median San Diegan household spent about 26% of its (gross) income on rent. Fast forward to the period between 2015 through 2019 and this ratio between rentals to income jumped to 35.5%.

While publicly elected officials and policymakers love to wax poetic about how the U.S. recovered from the Great Recession, the data doesn’t support this notion, at least on a net basis. Yes, incomes increased but the cost of living increased even higher to the point where the median household actually moved backward.

Enter the New Normal

If you were to perform the above exercise for the year 2020, you’ll notice that the ratio declined in favor of your everyday family. On balance, the median income in San Diego jumped to $87,126, while the average monthly rental for a two-bedroom apartment was $2,344, a slight decrease from 2019’s average of $2,389.

Comparing median income to annual rental cost, San Diegan households were now spending 32% of their wages on rent, a conspicuous improvement from 2019’s ratio of 34%. So, why all the fuss about the affordability crisis?

In 2021, a two-bedroom apartment cost an average of $2,599, at the time a record. Assuming that income levels stayed around $87,000, the rent-to-income ratio hit around 36%, a sizable increase but still not a record. No, the real kicker is what’s happening this year.

From January into the current month so far, rents for two bedrooms are averaging $3,021. Even assuming a jump of household income to $90,000, the rent-to-income ratio would exceed 40% -- which is a record. But that’s not all. With inflation soaring out of control, especially a 32% increase in energy costs year-over-year, your average San Diegan family is veritably bleeding.

If inflation cannot be tamed, it’s not inconceivable for San Diego households to eventually be paying half their income to rent. Keep in mind that lenders prefer to see applicants with a total debt-to-income ratio of less than 36%. When rental costs are 40% of income not counting other obligations, that’s a serious red flag.

Stretched but Not Yet Broken

Some folks assume that an inflationary environment isn’t quite so problematic because wages also rise. While that’s generally true, the focus isn’t so much that incomes rise but rather the magnitude variance when compared to rising costs. In our current situation, costs of nearly everything are rising much faster than wages.

Further, no automatic process exists outside of imposed governmental controls to raise the income base. In other words, just because the cost of living is rising doesn’t mean that employers will likewise hike payrolls. On the contrary, employers may wait until their business adjusts to the new reality before compensating their workers.

But since inflation causes consumers to close their wallets than open them, layoffs are the likelier outcome unless the government can mitigate rising prices. Now, such developments usually take time, meaning that it’s not yet time to panic. However, investors must be aware of the present harsh circumstances to avoid unpleasant surprises.