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Jim Scott
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The Double-dip

    Fiserv, the company that provides raw sales data for the Case-Shiller home price indices, predicted San Diego real estate values will decline 8.5% next year.  The numbers and predictions from these two sources are widely reported and respected for good reason; Case-Shiller indicators were earlier harbingers of the housing recession and their price-tracking model, in my view, is the best measure of market realities.

    There are plenty of reasons to support this unsettling scenario. Banks hold substantial inventories of seized properties and delinquent mortgages. Unfortunately, no one knows the true of extent of latter and it represents much potential for economic mischief.  There are other concerns as well; unemployment, volatility in global financial markets, and the growing prospect of higher mortgage rates sooner rather than later. But eight and half percent?

    There is irony in this gloomy forecast.  If it becomes reality, residential real estate could actually recover at a faster pace. Many argue the elusive housing recovery is delayed precisely because lenders, either by choice or political necessity, are not closing the books on their failures. There is always a price to be paid for this expediency as 'extend and pretend', the policy of keeping failed borrowers in their homes, may not be the smartest play. It fosters market uncertainty and encourages prospective buyers to sit on the sidelines. Meaningful home price appreciation is problematic until lenders purge their portfolios of troubled loans and properties. The public has to accept as fact the end of price declines, and that will not be possible until the Bubble's failures are exorcised.

    As always politics trumps economics. There is limited upside for those inside the Beltway to resolve this problem quickly. Delaying the inevitable foreclosure binge is good for re-election and there is a strong argument to be made that this policy is also good economics. Real estate veterans remember how the FDIC and the Resolution Trust Corporation combined to destroy the commercial real estate market during the 1990-95 recession. To refresh your memory, these agencies acted too swiftly, scooping up all sorts of failing and under-performing banks and their non-performing commercial loan portfolios. The ensuing fire sale of good income properties crushed valuations even lower, leading to even more foreclosures and bank failures. There is much to be said for slow bleeding, unsettling but not usually fatal.  

    Real estate is local but outcomes are probably going to be determined more in Washington and less in San Diego. Houses are not commodities anymore, but their pricing depends on decisions made thousands of miles away. The status quo is to keep money cheap and should remain so until unemployment falls to the sixes and sevens. Mr. Bernanke at the Fed has made it clear his top priority is fighting deflation and this approach will only serve to prop up home prices. The Chair and a majority of the Fed see the dollar falling and the risk of inflation as acceptable risks, and the latter has always been a boon to leveraged real estate. The Fed is not looking at shifting their current monetary stance until perhaps 2013, or when unemployment hits their target.

The Safety of Quality

     Buyers should pay attention to other local factors when making a purchase decision. San Diego is a preeminent example of a demand-constrained market. Land, energy, capital constraints, politics and environmental factors will ensure a chronic under-supply of new housing over the next five to ten years. This applies to single-family homes and rental units.  Unless the region can pull up the drawbridge, quality real estate will be a very safe investment play over the medium and long term. The Great Recession has not supplanted the laws of supply and demand and a housing shortage is closer than you think.

    Always buy location quality in down markets. Over time, the best neighborhoods will outperform lesser ones in terms of investment quality. Prices in Mission Hills, as an example, have been remarkably flat following the initial late-2008 meltdown, consistently averaging around $450 per square foot. Owners of properties in mature and more expensive markets are less vulnerable to economic downturns compared to the residents of new communities with lower community incomes. Active listings in the North Mission Hills sub-market, for example, have an average net equity of about about 34% of gross value. (call me if you want the details of my methodology) I would presume this would be a negative number for newer communities with lower average family incomes.  The net equity for the past six months of sales in Mission Hills averaged 22% of selling price, so on average sellers were able to walk out of escrow with proceeds. This does not happen in Eastlake or in similar areas with near-zero real estate equity values.

    Properties in the 92103 zip code benefit from being in one of the most supply-constrained markets and this safety feature, along with mature owners with substantial asset bases, means price insurance. Even if a double-dip of the magnitude predicted by Case-Shiller occurs in the County, the impact in this desirable area will be less.   

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