Market Report: January 2006

Dear Friends...

Last Fall was certainly a rocky period for San Diego real estate. In spite of that, 2006 should be a fair year with several bright spots. Investment real estate will have another very good year and I would encourage anyone with an highly appreciated property to consider a tax-deferred exchange in one of my partnerships. As you will read below, housing will do OK.

--Jim

It Was a Good Year

2005 was more than a reasonable year for real estate in San Diego. OK, the number of sales went down about 12% and the current inventory needs a visit to Jenny Craig. But prices increased a significant amount over inflation; that is a winner by any investment standard. We are all spoiled and need to adjust our expectations. I know this when I try and sell an investment that produces an internal rate of return of just over twenty percent. I often get that look that screams, "Only twenty percent?" Real estate remains a wonderful refuge and profit center if you have patience and do not believe that past few years were ordinary. Our current problem is not the market but rather adjusting to diminished expectations.

One Needless Worry

Interest rates are still favorable even though the Federal Reserve Board let us know last month that they going to continue raising rates. The cost of money, while central to the health of real estate, still has to reflect economic reality. If residential, and to some extent investment, real estate falls on hard times you can bet the Fed will answer the alarm and douse the fire with plenty of cheap money. They are like the parent who has grounded us for our economic misbehavior; but deep down we know that if things get too desperate our parents will let us out of our room. So stop worrying about the Fed. They like to swagger and slap housing around, but only so much. The last thing they want is the housing economic engine to grind to a halt. That would seriously maim the Fed's prime constituency, the financial institutions centered in the eastern seaboard. I am not trying to sound like William Jennings Bryan with that last sentence, but there is truth enough there.

As long as the inverted yield curve is around, the Fed is really limited as to how much they can punish housing. Long-term lenders are acting like inflation is not going to be a problem. In an ironic way, the Fed's own success in fighting inflation since 1982 has hampered their power today. They cannot prick the real estate bubble as easily as Paul Volker did in 1979; globalization has seen to that.

This is not to say there are not worrisome elements in housing. I have heard every doomsday scenario possible and after the failure to appear of many of my past predicted recessions, I have learned to appreciate that I often am staring at the wrong trees.

Some Investment Ideas

It does make some sense to diversify if you are fortunate enough to have investment real estate. San Diego is a gold standard to be sure but it makes some good sense these days to move accumulated gains to other regions and related products. I have been moving local money out of state and to Europe. I suspect as we move further into a globalized economy, real estate, largely thought to be strictly a local phenomena, becomes a global commodity. We are forming some local partnerships to build three self-storage projects in Madrid, Spain. Thus far Europeans have embraced the uniquely American institution of storing goods not where they live or work. Our cultural inventions create openings for capital and expertise to flow across borders for profit; my partner Jeff Quinn is taking his considerable development and language skills to Spain. His experience is a natural consequence of the cross-Atlantic cable and the long-range passenger jet.

I am not oblivious to our local charms but a cagey investor is always looking for other safe havens that will be profitable. Our world is global and the most local product of all, real estate, is also going global in a certain sense. If you take local appreciation profits and apply them in another region or similar product, you can perhaps duplicate the San Diego of 1976. For those who were not around in those days, apartments units in North Park traded at $10,000 per unit, quite a distance from the $120,000 per unit commanded by the market in 2005. Our partners are simply taking San Diego real estate to a global level in order to minimize risk through diversification.

I have less worry about 2006. A less robust market and more expensive money for sure but probably not a disaster. Time and staying power is always the best ally of real estate and the lesson is always to be patient. Residential sellers have surprised me thus far by not caving in. I have been spectacularly unsuccessful in trying to get my sellers to cut prices. As long as this market retains its strength these sellers will sit firmly on their prices. Buyers will have a tough choice coming out of the chute in January. Buyers who are waiting for the collapse, if Sellers maintain their current resolve, may be waiting for a change that might never happen, or at least not next year.

Click here to see Jim's past Market Reports. You can also download Jim's 26 page research paper on San Diego County apartments.

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