The Recession Next Time
by Jim Scott

One year ago in this column I opined that the residential real estate market was now hostage to the vagaries of the stock market. I wrote that the 'wealth effect' created by real and unrealized gains in the stock market was the primary engine driving price growth in real estate.

After the smoke settles on New Years Eve, the financial markets will have had a very difficult year. Yet residential prices have increased between 12 and 15%. Does this mean that those of us invested in San Diego real estate have dodged the bullet? Is our local economy really that special that we need not fear the long arm of Alan Greenspan, the chairman of the Federal Reserve Board? Or is the other shoe getting ready to drop? I suspect the answer lies behind door number three. I would argue that the effects of the past year have not reached our market but will likely do so over the next year. Prices for property appear to be stable even though there is far too much bad economic news floating around. There is a reason-real estate prices tend to move up far more quickly than they move down. Put another way, when the demand for homes begins to fall, prices do not react immediately. At the beginning of each of our last three real estate recessions, prices continued to increase even though demand was dropping. It is almost as if the buyers don't get the word that the party is over.

Mr. Greenspan, in order to reign in what he perceives as incipient inflation, believes he must take away some of our real estate and stock gains. If we feel less rich, his argument goes, we will not be indulgent consumers and overheat the economy-therefore protecting us from an inflationary cycle. Therefore the Fed must constrain demand for homes in order to reduce the 'wealth effect'.

The nation appears to be heading toward a recession. Even Alan Gin's economic index, a very reliable gauge of our local economy, has been flat since April and has been in negative territory for the past four months. I presume that when the Fed meets before Christmas (and after my deadline) we will see a rate cut of 25 basis points. This will temporarily cheer the financial markets. But what about real estate demand?

Demand, in my view, as already softened. By that I mean the character of housing demand has changed. Considering the price momentum of the past six months, this might seem to be a contradiction. It isn't if one looks beyond the traditional yardsticks used to measure prices. Readers of this space know I favor price per square foot as a broad market gauge. Others favor median or average prices of homes. Both methods are valid tools to measure past behavior. What counts now is the nature of demand and how it will behave in 2001. And that is inextricably woven into the price performance of 2000.

Buyers are behaving far more cautiously, making more demands of sellers and tendering offers substantially below asking prices. The price per square foot, heading toward the $350 mark in North Mission Hills, reflects only the upper end of the market. More sales are south of $300 per square foot. Considering the distribution of wealth in our society, this should not surprise.

Our economic future has several storm clouds over it; oil that has more than doubled in price, increasing utility bills, sagging financial markets, high comparative interest rates and a potential collision of the President-elect and the Fed Chairman. Mr. Greenspan is rightly concerned about future inflation problems relating to higher energy prices and will use his one weapon-higher interest rates-to combat it. This will not play in our housing markets or in the political arena. Once the full effect of oil prices begins to ripple through the economy, Mr. Greenspan may have to rethink his recent conversion to a neutral bias on rates.

The linkage I spoke of last January is still in play. The nature of real estate demand has already softened, responding directly to interest rates, higher energy costs and the turbulence of Wall Street. Home ownership is not just about shelter. It is also a statement about how we feel about our collective economic future. Buyers still are out there aggressively seeking property. But they are a far more cautious lot. If the price of oil and utility rates get out of control this year, I suspect we will see an erosion of the value of San Diego real estate.

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.