Is It 1990 Yet?
by Jim Scott

It is difficult to look at any financial section of a newspaper without reading about the bubble. Whether it is stocks, bonds or real estate, business writers are concerned about which market bubble is about to burst. Lately the talk centers on residential and commercial real estate.

There is little question that San Diego real estate values have done well in 2002. They seem insulated from the national economic malaise. The steady drumbeat of negative press about the nation's recession and poor business conditions seems to have had little effect on the enthusiasm for San Diego property. This has translated into a market featuring rapid and sustained price appreciation--at least so far.

The Last (3) Times

This writer taught history at one time and as such tends to look to the past for guidance about the future. I have spent countless hours constructing elaborate economic models that I hoped would give me some extra insight into market cycles. The one thing I have learned for certain, from those efforts, is that the seeds of each recession are more dissimilar than similar. Trying to predict the future price behavior of San Diego real estate is probably a fool's game at worst and a educated guess at best.
1990

Looking back to our most recent real estate economic downturn, it is useful to look at the economic circumstances in 1990. A recession is nothing more than correction of a market distortion. In other words, if housing prices and rents rise more rapidly than incomes over an extended period of time, those prices eventually have to adjust downward, particularly if there are substantial job losses. People can only pay up to a certain maximum percentage of their income for housing. If the price of shelter becomes too dear, people either leave town, live in their cars or double up. That decreases aggregate demand that in turn affects prices and rents breeding disinflation, the current economic boogeyman.

An example of this happened during 1991-1995 when the County suffered extensive job losses. Tenants forced rents down by doubling up, leaving the region or moving back in with their parents. Rents declined 15 to 25% over this period, unleashing a wave of apartment foreclosures and deflation. Rent increases during the latter part of the 1980s' were moderate; job losses were primarily responsible for falling demand. The apartment debacle extended the length of the residential recession.

Home and condominium prices, which went down about 30% over the same period of time, are a better example. Price increases during 1986-1989 rose sharply and far outstripped wage growth. When incomes stagnated and unemployment rose during the early part of the decade, home prices had to adjust downward until there was market equilibrium in 1995. Both circumstances are eerily similar to today's market both in apartments, commercial and residential real estate, driving all of the bubble-speak.

There is a Difference

Even though the economic and geopolitical circumstances today are not unlike those of 1990, there are two factors that suggest that any adjustment will not be as severe as the past decade. First, low mortgage rates continue to sustain purchasing power and are in sharp contrast to the nine percent rates of 1990. Second, our regional economy has not imploded as happened in the early part of the decade. San Diego's economy is more diversified and less dependent on large corporations for the employment base. (I remain less optimistic about the apartment market, but more on that subject next month.) To be sure, other economic signs are negative and there is little question the local economy has lost ground since 2000. Low interest rates are keeping consumers in the game and preventing an ugly round of deflation.

The Right Questions

Charting the past three housing recessions has yielded some clues as to when the market might adjust. One particular market signal, which has correctly forecast the three past downturns, indicates relatively clear sailing ahead. That particular indicator of buyer demand is driven primarily by interest rates and confidence in the economy. My concern is not so much future moderate rate increases or declining consumer confidence, but rather that the Fed has little room to maneuver in the event deflation becomes a problem. My signals aside, it probably makes more sense to keep an eye on Wall Street instead of the Fed.

Read Jim's back articles at www.sqre.com or call him for selected back 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.