Guns and Butter
by Jim Scott

Guns and Butter
Since a war is possible in the Middle East, it is worthwhile to discuss the economic impact such an event may have on the San Diego real estate market. If the past is any guide, there will be local economic consequences. Housing, our investment superstar over the past five years, will surely take some losses if this country engages in a protracted conflict and occupation. There will be a new set of winners and losers.

The Last Time

Looking back to 1990, when we were on the cusp of the Gulf War, economic circumstances were eerily similar to today except for one very important factor, interest rates. As the country proceeded to remove Iraq's armies from Kuwait, the national and local economies were in a recession. The dislocations and ordinary economic adjustments that spring from a war tipped San Diego into a downturn that outlasted the nation's recession by several years. This recession saw home values fall thirty percent over a five-year period, mirroring the disaster in commercial real estate.

Mortgage rates, however, were fifty percent higher than today. Current low rates have subsidized housing markets and have provided, through refinances, the means for consumer spending. Since businesses have reduced capital expenditures, it is the consumer that has cushioned our region from the recession affecting the rest of the nation. The health of future consumer spending and the local real estate market is, to a major degree, dependent on the generosity of the Fed. My concern is not Alan Greenspan but rather the Federal Government, which have to borrow money to finance a major military invasion and subsequent occupation. Wars must always be paid for in blood and treasure; this one will be no different. And if you do not believe that inflation and interest rates will be affected, just ask the ghost of Lyndon Johnson. To pay for the war in Vietnam, President Johnson was faced with the Hobson's choice of either borrowing money or raising taxes. He chose to borrow setting the stage for the hyperinflation of the Carter years. I doubt very much the current President will look to raise taxes to finance the war.

Oil

The easy and cheap price of oil products will probably be affected creating a certain amount of economic havoc in America. As you may recall, when the Iraqi army left Kuwait they practiced their own version of a scorched earth retreat. It took about two years to restore the Kuwaiti oil infrastructure; counting on captured Iraqi oil may be foolhardy.

Higher oil prices means a rise in the consumer price index. This increase will trigger higher interest rates and a round of economic adjustments in the economy. None of this can be good. It will be a difficult for the SUV driver commuting from Temecula to San Diego. That person will have to spend more on fuel and less on other consumer goods, which will negatively impact employment and wages. If that happens, rents and real estate prices will have to adjust. The silver lining in all of this is inner-city real estate will fare much better than property in the suburbs. That is exactly what occurred in 1973 following the first oil crisis. When gas quadrupled at the pump, many people in San Diego rediscovered the Metro area.

The Other Shoe

I think some of the potential negative economic effects of the war on terrorism are already in the price of investments, both real estate and financial. Since recessions are the result of certain economic events, it can be argued that the economy has already adjusted to the possibility of war. I remain cautiously optimistic because I believe consumers and businesses have already modified some of their spending habits. The less we have to adjust our economy to fight this war the better.

The Commercial Side

I remain concerned for investment real estate. This market is a bubble due to burst and the pin will be higher interest rates. The vast majority of commercial loans are variable and when they began moving up, we may see some bargains appearing on the market. So if you think war is coming, be patient. Tenants, both residential and commercial, in the medium run will have to pay more for their space assuming owners can pass through the additional borrowing costs. They were not able to in 1991-1994 and we witnessed a record wave of foreclosures.

In the meantime, we are buying mobile home parks and mini-storage properties for their impressive cash flow and as a hedge against inflation and recession. Call me if you have any interest in investing in a limited partnership that is yield-focused. It is not exciting but pays well.

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.