Market Report: May 2008

Saving housing is moving to center stage. Even the Chair now recognizes the vital link between real estate and recession. But as noted in my article, inflation may have a greater impact on the market than any rescue package dreamed up by the Congress or the next President.

The Age of Scarcity

Four bucks and climbing. The era of this country devouring global resources on the cheap is coming to an end. Our future is going to be an ongoing alley fight with all of those people wanting better housing and more food. The Chinese and Indians, among others, are using their earned foreign exchange dollars to muscle in on the natural resource market, driving up prices at your corner store. Globalization over the past decade has aided the Fed in fighting inflation as low-priced imports have kept domestic producers from raising prices. The success of these emerging market powers has fueled rising expectations and income, creating demand for the stuff of a middle class lifestyle.

We can, and should, conserve resources but the price of nails, concrete, wood and fuel is no longer in our control. The building blocks of real estate are not going to get any cheaper relative to our local earning power. The billionaire real estate investor, Sam Zell, values existing real estate thusly: look to replacement costs. There is a lesson here for us. Replacing housing stocks, even ignoring land and permitting costs, is going to be relatively far more expensive in the future.

The next time around there will be no cheap housing alternatives. Merchant builders will be passing on higher materials cost driven up by expanding global demand and foreign governments eager to unload dollars. If you own and can hold property in the city center you will have a hedge against this coming upset and could even potentially profit. And do not forget the silent assassin of future growth-water. Just as we are competing with emerging markets for resources, we have to battle with our neighbors in the Southwest for what, for the time being, appears to be a dwindling resource. In the west, water is the new oil. There is no regional consensus on how to reconcile population growth and the dwindling snow-pack, just talk and hand-wringing.

The slide of the dollar will also play a role in this story. Just as we are seeing in oil markets, more commodities could be priced in currencies other than dollars. At some point the Fed may have to change their cheap credit policy. Raising interest rates would prop up the dollar but also dampen economic activity at home. This classic central bank response to inflation carries political and economic risk. In this political season, no one is suggesting money become more expensive. But without some fundamental changes, double-digit interest rates are not out of the question.

The interest expense of owning housing consumes a huge percentage of our take home pay. The ongoing foreclosure disaster speaks volumes about this fact. Many homeowners had little room in their budget for the recent wave of payment adjustments. Like the Feds, we seem to live on the economic edge and the rising prices of basic goods are not helping the situation. There seems to be a direct line between the real rate of inflation and the sub-prime crisis, probably passing through Baghdad.

The last two times we experienced American-style hyper-inflation, were in 1973-75 and 1977-83. Both periods were characterized by double-digit mortgage rates and rising living expenses. Today housing prices are heading south along with the cost of money, the opposite direction of inflation, an anomaly compared to past economic patterns. The Fed has decided it is better to tempt the inflation gods than risk a deep recession and has acted counter-intuitively. That policy will eventually have an impact on the cost structure of future housing in San Diego.

I believe our dynamic economy will eventually adjust to the troubling energy and raw materials markets by a combination of conservation and by inventing and exploiting alternatives. Still land and water are not in infinite abundance no matter how clever we are or how parsimonious we become. Housing, like oil, will continue to be rationed by price. We are at heart free-booters when it comes to markets and real estate prices will have little place to go but up. In the future, the cost of Mr. Zell's replacement housing in San Diego is going to be frightening.

It will be a bumpy ride over the next few years but this country has the demonstrated ability to redefine the economic landscape to suit circumstances. In addition, the presidential campaign has exposed that a new and different political consensus has materialized in this country. These cross-party voters, tired of senseless foreign adventures and economic uncertainties, will demand change and be less loyal to the party ideologies. The past few years has brought about a sense of national fatigue and this fall the body politic will have the election of our discontent. There will be, no matter the results, significant changes in our foreign and economic policies. Cowboys will be displaced by consensus builders. The new government will eventually enact policies to mitigate the current mortgage crisis. This along with future inflation means there are few better places to be invested in than real estate.

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