Waiting for the Shoe to Drop
by Jim Scott

It seems as if San Diego real estate has some special quality of late. National and local economic worries have not slowed down the demand for local houses and apartments. But don't be too quick with the champagne. Just because our values have marched smartly upward doesn't mean there is clear sailing ahead. You don't want to be caught, as the bard of Hibbing once said, "with both hands in the pockets of chance".

The Teflon Market

My thoughts of late have often wandered back events that followed the stock market crash of October 1987. The sudden loss of equity values triggered a recession on the eastern seaboard. The term 'rolling recessions' became part of our economic lexicon. As the price of New Jersey real estate plummeted, prices in San Diego continued to increase. Eventually the recession reached our shores and our real estate market collapsed in 1990. In the end, the California recession was far more brutal and lengthy. Prices and rents declined and the fall was not arrested until 1996.

Unless Wall Street starts getting it right, we may be in for our share of economic pain. I am concerned about Japanese economy and its affect on our financial markets. All of the good news locally, such as the County unemployment rate of 2.8%, will mean little if the Japanese start dumping U.S. bonds. But that is only part of the story. The unemployment rates in the two counties that comprise Silicone Valley are 1.6 and 1.8 percent. In spite of that, real estate values are coming down in those regions. High employment and population growth are not guarantees against real estate and rent deflation. The reverse wealth effect can quickly deflate the price of real estate.

Our county has done a great job is diversifying the economy. Diversification does not mean you are recession proof. Our economy is linked to Silicone Valley in 2001 just as in 1962 we were a economic colony of the Department of Defense. After Robert McNamara, then Secretary of Defense, decided to downsize the federal presence in San Diego, we ended up on the cover of Time magazine as a "bust town". You might remember all of those houses selling in Pacific Beach for $15,000 at foreclosure sales.

The Fed Rides to the Rescue

The most recent half-point cut in interest rates was widely perceived as an attempt to put additional liquidity into the financial system in order to prop up sagging stock markets. As of this writing, the blood-letting over at Wall Street has not stopped. I suspect the indexes will continue to decline for several months. But there is a silver lining--the real beneficiary of these rate cuts is real estate.

Real estate prices have always been rate sensitive and the 150 basis points (1.5%) in Federal Reserve Board 2001 cuts has served to spur demand for real estate. As the financial markets stumbled, real estate has been insulated, at least for the time being. I can't help but wonder if the current bull market in real estate is being artificially prolonged by the Fed. If you believe that, it is time to sell.

Over the next year, the Fed will have little choice but to increase liquidity and lower rates. What we are seeing is the 'soft landing' in action. I suspect demand will remain robust for most parts of the residential marketplace in San Diego for at least 12 to 18 months unless the Fed reverses course. The same will be true for income property. Sellers looking to eventually exit the market should capture profits now, especially if you own income property. For the latter, there is more downside risk than upside gain over the short term. Residential inventories are unusually high for this time of year.

Sellers probably will have a more difficult time moving property this summer and fall even with the Fed pumping money into the economy.

Buyers are about to experience the best of times within the current seller's market. By this summer rates will be lower and inventories higher, making it the best buying opportunity in the last three years.

You can reach Jim Scott at his office, conveniently located in the heart of Mission Hills, at 1111 Fort Stockton Drive. 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. Scott & Quinn features professional property management as well as a sales division with 12 sales associates.