The Things That We Know
by Jim Scott

We are now experiencing a very uncertain residential marketplace that is unsure of its direction and seems intent on giving as many mixed signals as possible. Certain segments of the market continue to perform well, but others remain stubbornly dormant and underperforming. Seasonal patterns are becoming a less reliable indicator. The only way I can make any sense of our market is to look at what we do know and at the considerable uncertainty of the current marketplace. Whether this will illuminate the market character for next year or obfuscate it is entirely up the reader.

What We Do Know
Interest rates will go up. The dizzying appreciation of the past four years will have to moderate as effective demand drops. Some of the effects of higher mortgage rates will be moderated by tax cuts but I suspect it will be minimal. We need to remember that cheap and easy money was the catalyst of the (past?) bull market in house prices.

Demand for homeownership will not abate. Effective demand, however, the economic ability to act upon the desire to purchase property will be diminished because of higher rates. This is not all bad when compared to our past nasty real estate recession where effective demand dropped off the table. I am not seeing any diminished enthusiasm for owning real estate. People have money and credit, and while getting more expensive, will still seem cheap by historical standards.

Overall housing demand will still exceed supply. Our population is growing and producing new housing will remain difficult and expensive. There are simply too many structural reasons this is so. There are the usual convenient villains in this set piece and only partial solutions.

One of which is attached housing in dense clusters. This trend is well established and the train has left the station. There are no other practical solutions to affordability and supply. We will continue to evolve into a mature city. Like it or not, San Diego will become more like Manhattan and less like Kansas .

2004 is different than 1990. This particular market peak, assuming this is the top, is different than the last one. It does not appear we are in for the price free fall of 1991-1996 and the tsunami of foreclosures. Our local economy is richer, more diversified and better at job creation than in 1990.

What We Don't Know
Oil is the main joker in the pack. Higher oil prices will exacerbate the already incipient inflationary pressures; this will lead the Fed little choice but to continue to raise interest rates. The good news is that the Fed will do this steadily and will not give us a Paul Volker-style cold bath. The direction of oil prices depends on the political and military landscape of the Middle East and you know how unpredictable that is.

The second major unknown is just how big Federal deficits will be going forward. This will impact Federal borrowing and therefore the rates ordinary consumers pay for consumer and real estate loans. The administration, politics aside, has been playing a shell game as to the exact expense of the Iraqi adventure. Another round of tax cuts, which means lower federal revenues, coupled with the expense of rebuilding or securing Iraq , will mean woes for borrowers and those markets dependent upon cheap money.

The fate of the sinking dollar is the final unknown. The administration has made it clear that it will allow the dollar to fall to its natural level. To the chagrin of our Asian and European allies, the U.S. will not prop up the dollar. Our friends have already tried to stem the dollar's decline but without the cooperation of America the dollar will continue to drop. There are many scenarios that follow from this event that are too numerous to discuss in this space. A cheaper dollar can revitalize our manufacturing sector and help the trade deficit; it can also plunge the Western and Asian economies into a recession. The end result could be either extreme, but probably something between the poles.

I'm Not Worried (really)
To be sure, the rate of sales of existing and new homes has dropped substantially over the past six months. Prices have stabilized and perhaps gone down in some segments of the market. But that is only part of the story. The year 2004 was still a stellar year. Actual sale prices, if you ignore the anomaly of last spring, have increased. To focus on the change between last spring and today is ignoring the larger picture. When interest rates shifted direction in late 2003, buyers, as is typical, rushed into the marketplace. Finding an unusually thin inventory and the prospect of higher rates, buyers threw caution to the wind. By the end of the spring the imbalance of supply and demand drove prices up twenty percent. Sellers coming on line by May priced their properties assuming February, March and April sales were the grail. This mistake led to our recent and current bloated inventories feeding the misperception that record inventories are priming the market for a huge price correction. What we really have are two inventories; more on that next month.

I suspect next year will be about the same in terms of volume and prices will move up around five to seven percent. Low-end segments of the market will outperform the middle and upper ranges. Still a good day at the office.

Read Jim's back articles at www.sqre.com or call him for selected b ack issues, 619 920 9511

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.