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August 2014 – Dog Days and Other Ideas

After a decent spring season, the residential real estate market in San Diego has hit a speed bump. The inventory of residential properties for sale is forty percent of normal and the number of sales off the pace of last year. This change would appear to be an anomaly because prices increased dramatically last year, as much as twenty percent in some markets. Since homeowners recovered a substantial amount of equity in their homes, it should follow that 2014 would be another robust year for the market.

This has not proven to be the case. Ordinarily fewer closings, low inventories, and tepid appreciation signal the beginning of a recession or at the least a market correction. Although the frothy post-bust recovery has run out of steam, I do not believe the recovery, which began in earnest only twenty-four months ago, is finished.

There are many factors mitigating the downside risk in owning property in urban San Diego. First, the current doldrums are seasonal as residential real estate markets still operate on the school calendar. If the kids are not in a classroom, chances are home buyers are taking a break as well. Vacations, weather, and other seasonal factors tend to tamp down demand during this time of year.

Second, there is the phenomenon known as “lock-in”. Many homeowners either recently refinanced or purchased at unusually low interest rates. They are understandably loathe to sell and lose that three percent mortgage. Today’s loans are dearer than last year but at 4.1%, they are a screaming bargain. I fail to understand the logic of “lock-in”. If a person or family needs to change their living situation, either for a more suitable home or a job relocation, they are being penny-wise.

Third, there is an ‘economic lock-in’, an unpleasant leftover from the Great Recession. There is less job mobility which has had the effect of reducing the rate of internal migration. Fewer 49-state residents are relocating to San Diego, lessening demand for resale homes and discouraging new construction. Beset by the same employment anxieties, fewer local owners are listing their homes and moving on for better opportunities. Additionally, many potential listers would sell and move but cannot; forty percent of local homeowners have little or no equity in their homes.

Even though prices are increasing in 2014, albeit modestly, they are not going up fast enough to energize the move-up market, the traditional engine that creates healthy real estate market velocity. If values rise five to eight percent in 2014, as they are now on track to do, it would still not free up that much inventory. (it should be noted that Dr. Alan Gin, a respected local economist recently opined that prices will increase 10 to 14 percent for 2014) The expense of selling and buying, and moving can amount to seven to nine percent of the value of the home. It stands to reason it will be another two years before the aggregate residential equity in San Diego homes increases enough to restart the vital move-up market.

Looking past the near term, there is another socioeconomic factor that may impact residential real estate values within the next five years. Growing income and wealth inequality in America has the potential to alter traditional home buying patterns. It is logical to assume rents will escalate higher than income growth as the renter-class grows faster than the supply of rental properties.

This is best illustrated by looking at the Millennial’s real estate behaviors. Building permits for San Diego multi-family projects are on the upswing as merchant builders understand millennials are not embracing their parents’ white picket fence story for economic and social reasons. The under-35 set, about one-third of whom do not have education appropriate career-type jobs, have different ideas about single family home ownership, marriage, child-rearing, and careers. No one knows how much of this value shift is driven by their diminished economic prospects but I suspect that is the biggest factor. This cohort cannot afford their parents’ lifestyle.

Millennials are not the only group facing these changes. For example, the growing number of under-employed workers, along with the long-term jobless population, has to have an impact on the real estate market. Without any policy changes to address the economic prospects of these groups, San Diego’s coveted real estate market will come to resemble what you would find in older established European cities and in places like Manhattan. In those locations being a permanent renter is an acceptable life style. Real estate will be inherited rather than bought for the average middle class person. Perhaps this explains why apartment investors in San Diego are bidding prices up to very rich levels. They are betting, rightly so I think, the pool of renters will outstrip the supply of rentals in San Diego in the not-to-distant future.

Many move-up buyers have also figured this out. They are just as likely to keep their old home or condo and rent it out. I have no real data yet, but anecdotally I see this trend developing. This reluctance to list and sell is another, and perhaps longer-lasting reason, we see so few properties on the market.

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