Market Report: November 2006

Dear Friends:

This month I am peering into my past as a way get some clarity on the market. As you can see by the numbers, I am not sure how much light got generated by the following analysis. I do remain convinced that the worst is here and we are just going to experience more of the same for the next two or three years. If you subscribe to that notion, market-wide buying opportunities will be no better in two years than today. As always, I believe good deals are made from the general lot available for sale. Unlike 1991-1995, you will have to work to find a great deal.

On the subject of a good deal, my partners at JK Investments have brought out their latest partnership opportunity; a well-located medical office building in Denver. The kicker in this one is it comes with an additional acre which we will probably develop. This investment throws off immediate cash flow and has the value added potential with the lot. Call me if you wish to discuss participating. --Jim

The Numbers Please

There is universal agreement that there is a housing recession in San Diego. The central point of the debate seems to be whether or not there is a bubble to be burst. Bubble-sitters believe the landscape will soon be littered with great real estate bargains. This theory springs from the ugly experience of 1991-1996 when housing and investment property prices fell thirty percent. A good question to ask is this; is 2006 a rerun of 1991?

Slowing sales and slipping prices marked that watershed year. By 1992 the real bleeding started and continued for four more years. So just what was the economic scene in 1991 compared to today? Looking at the key indicators speaks volumes.

Using my tracking data, here are some annual percentage price changes that speak to the question noted above:

Assuming 2005 (like 1990) was the peak of the market, 2006 prices are actually 6% higher than 2004. It appears the loss of value in 2006 has not been as precipitous as in 1991 and later, probably reflecting the fact that underlying economic fundamentals, both local and national, are stronger today. (The above numbers are not adjusted for inflation and use prices per square foot to determine pricing levels)

Recessions 101

Recessions are nothing more than a correction to market distortions. The traditional argument goes that if home prices rise too rapidly in relation to incomes, eventually the market will self-correct and values will drop. Therefore the trajectory of the bull market should give clues to the severity of the correction. Eerily, prices from 1986 to 1990 rose 86% and 83% from 2001 to 2005. This suggests a train wreck is coming.

However looking even further backwards, prices from 1976 to 1980 increased 150% and that bull market was followed a very mild recession. (Utilizing the events of this period has to be tempered by double-digit inflation rates from 1976 to 1982 as well as interest rates near 20%. Those facts limit the applicability of this period to today.)

R.I.P. 1996-2005

Nine years is a long time for any bull market regardless of commodity. The length and dimension of the departed housing boom is a concern when using historical analysis. The economic landscape of 2006 is far different than when Bush 41 launched his Mid East war. Globalization kept inflation low which allowed the Fed to maintain historically low interest rates. This, more than any other factor, kept the bull running far longer that it should have when it comes to land.

To look at this another way, globalization means that gauging this recession by using recessions past is treacherous. There is a new economy and the rules governing housing cycles are not the same as before. What happens to a bicycle manufacturer in Singapore will affect your housing prices. Cheap money, courtesy of even cheaper imports, enabled a huge increase in real estate equities over the past decade. People could afford more house payment, thanks to all of those Chinese toys, and as a result were much more willing to bid up the price of shelter. That effect is played, as prices need to pause long enough for increasing wages to enable another round of price spikes.

I need to make a leap of faith and discard most of my lessons learned from the past three recessions. All the major players operate with a new set of rules; the problem is that most of us retail consumers have some economic notions firmly rooted in the past. It is difficult to square our Puritan heritage with our love of debt and risk. Americans will buy more and push at the margins of their own economic comfort zone because they can. It is our own peculiar secular religion. We fear economic profligacy, heeding the warnings of our grandparents, but embrace the cult of debt-driven acquisitiveness.

We are the ideological sons and daughters of Fredrick Jackson Turner and as such will not likely abandon our fascination with land. The building industry cannot create enough housing to offset immigration and births and the prognosis for adequate supply going forward is grim. Density remains the third rail of San Diego politics. Bubbles-sitters beware.

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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