Is It 1991 Yet?
by Jim Scott

One of the disadvantages of writing for a monthly publication is that this article may be rendered moot by events in the Middle East. My deadline occurred in the opening days of the war with Iraq, the status of which might be significantly different by the time you read this. This is important because if this conflict goes poorly and lasts past the summer, interest rates will rise and housing prices will take a substantial beating. If the war is over quickly, our current and past allies will help defray the expense of rebuilding Iraq-and all will be well in the world of San Diego real estate.

Because of the impending conflict this winter, I have not written my regular article in this space over the past few months. The fog of war had obscured my view of the San Diego real estate market. I was concerned by the eerie similarities of the period leading up to the Gulf War I in both the local and national economies. Bad signs abounded; four of five stories appearing in the financial section of the Union-Tribune were more negative than positive. The University of San Diego's index that tracks the San Diego economy was on a yearlong plunge. For the first time since the last recession, California is starting to lose population. Yet no amount of bad news seemed to temper the demand for San Diego property. San Diego was one of the two counties in California in 2002 with positive job growth. It was if our local economy was safe in the eye of a hurricane.

The Bad One

What concerned me was that I could have written most of the above in January 1991.Lest you have forgotten, the recession that followed our last military adventure in Iraq was long and brutal. For four years after the rest of the nation had recovered economically, our region staggered through the worst of the three recessions this broker has witnessed. The county lost up to thirty to forty percent of its real estate value by 1995. Notably, the three-year period leading up to 1990 saw annual appreciation rates of over twenty percent, record housing starts and rising rents. Sound familiar?

The Lessons of Wall Street

Local recessions aside, the local housing market seems far more stable than The Street. Since 1969 there have only been three significant downturns in the housing market in San Diego. During he first two nominal prices actually rose. (they fell when adjusted for inflation). The calamitous decline of the mid 90s', while serious, pales when compared to the recent pratfall of the NASDAQ index. This historical safety record along with low interest rates is why money seems to be pouring into our market. The appreciation gains in residential properties in 2002, over twenty percent, and similar gains in the commercial arena may be more indicative of the public's disenchantment with the Street than anything else. And our accommodating party hosts, Alan Greenspan and the Fed, do not seem to want to take the punch bowl away just yet.

Low interest rates are intended to stimulate the lagging economy. If you own property here, you are the unintended beneficiary of this national policy-even more so because of the unique strength of our local economy. The Chairman indicated last month that the cycle of "equity extraction" (Fed-speak for refinancing) is coming to a close. However, if the national and state economies continue to lag, rates can be cut further, sparking another round of refinancing (and consumer spending) and increasing housing prices. To a point, the downside of the San Diego business cycle can be postponed for some time as real interest rates approach zero. As long as the national economy remains stagnant, we will have the best of all worlds, a sound economy and cheap money.

Is It Time To Buy?

The answer to the above depends largely what you buy and how the war plays out. There are some segments to avoid and some that are suitable given the uncertainties of the moment. I would buy any single family home, two to four family property or condominium in most neighborhoods of San Diego that is at or below the median price. The lack of land for future development, the strong local economy, job creation and interest rates bode well for this market segment over the next few years. This sub-market will probably outperform alternative investments even in a recession. Low fixed rate financing will be our collective lifeboat if times get hard. (In 1990, fixed rate mortgages were over nine percent) Compared to rents, the after-tax expense of moderately priced homes is a bargain even considering the appreciation of the past three years.

Apartments remain very expensive and should be purchased only with substantial down payments. The vacancy rate is moving upwards and the potential for higher interest costs (nearly all commercial loans are variable) remains a concern. Investors purchasing units and converting them into condominiums are distorting the market place making it more difficult for long-term investors to purchase property. Given the times, I would purchase "B" and "C" apartments in the Metro area. The long-term prospects for these vehicles are excellent and should outperform financial instruments over time.

I am less sanguine about the prospects of other areas of the market. Homes priced in the upper end of the market remain the most vulnerable at the moment. Investment properties in premium parts of town seem to make little economic sense at current pricing levels. If you have the staying power to hold these premium products through the next few years, they will be profitable. But bring your wallet.

The Price of War

The cost of the current adventure in the Middle East will be measured in many ways. Hopefully the President has calculated that the long-term benefits will outweigh the expense. We average citizens do not know many things and we have placed our faith in our elected leaders.

This war has the potential to create an economic backwash that will temporarily sink this market. Congress will give Mr. Bush his seventy-five billion dollars and he will have to borrow it on the open market. Rates will be forced to move up. There is no other way other than the printing press or taxation. The Fed will fight the latter and the ruling party the former. When rates start to move up we will see in the short term another wave of refinancing and purchasing as people what to capture the last of the cheap money era. As ten year treasuries move down in price (and yields move up) mortgage rates will follow. Buyers will be able to afford less house, which translate into lower aggregate demand and lower prices.

On the front page of the San Diego Union there was a evocative photograph of several Marines fighting in the streets of Nasiriyah. In the forefront was a young Marine with glasses, nervously pointing his M-16 down an Iraqi street. I marveled at the sheer courage and will of this unidentified Marine. I wondered if others will truly appreciate this frozen moment in time. It is hard to understand just how this must be to a twenty year old far from home. Just as with this young warrior, our real estate market will ride over these bumps and by 2004 or 2005 prices will resume their move upwards. For now, buckle your seat belts.

I welcome your comments; my email address is jimscott@sqre.com.

You can reach Jim Scott at his office, conveniently located in the heart of Mission Hills, at 1111 Fort Stockton Drive. Founded in 1982, Scott & Quinn is the oldest full service real estate firm in Mission Hills and is still locally owned and operated. Jim has been a homeowner in Mission Hills since 1976. He is married and has two boys. He can be reached at 296-9511, extension 100. Scott & Quinn features professional property management as well as 15 sales associates. Click here to see Jim's past Market Reports .You can also download Jim's 26 page research paper on San Diego County apartments.