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Jim Scott
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The Blind Men and the Elephant

This article is the first of a series on the current state and future of San Diego urban real estate prices. I got the idea because, as a real estate professional, I can count on being asked about the market within the first two minutes of any casual conversation. Usually the best I can do is: “It depends....” This is not the information my friends and new acquaintances want to hear

from me, but a proper response is long and complicated and has the danger of becoming a windy lecture. So I decided to spread out my tea leaves on the table for your perusal. As in the parable noted above, it may be impossible to assess the health of the real estate market or to gain any insight into future pricing. There are traditional metrics , however, that  suggest prices will be stable going forward.

The causes of this crisis are well known. Defaults quickly repriced San Diego real estate sending home prices plummeting in 2008.  Since 2009 the rate of depreciation has moderated significantly, or even gone away in some sub-markets, and that is positive news considering the unrelenting onslaught of foreclosures and short sales. Bank sales are only one part of the problem. The expectation of lower prices also contributes to market malaise. Deflation and low sales volumes will persist if most potential buyers believe prices will be lower in the future.

Many potential owners remain on the sidelines waiting for the market bottom. I am speaking mainly of discretionary buyers driven by the fear or expectation of further real estate deflation, not those who have non-economic reasons to buy homes. The former view houses as financial instruments and seek to purchase them at the optimal point in the business cycle. The latter buy and hold them for their economic shelter value, as was the practice of their parent’s generation.  

In the past home buyers purchased homes as their primary shelter or as long-term rental investments. Other than during a few garden variety recessions, prices appreciated modestly every year. One global event, the second Arab-Israeli War, transformed the market for homes. Leveraged San Diego real estate became a very profitable inflation hedge as the nation waged a long and ugly nine-year struggle with inflation. Speculation in homes ushered in a new kind of real estate cycle with more pronounced boom-and-bust cycles. Demand-based market pricing supplanted older pricing mechanisms, a combination of rents and community incomes.

Those traditional metrics are valuable today as a tool to see if this market is over or under-priced in relation to historical standards. Rents are a useful indicator of home values as they reflect the economic worth homes as shelter. For example, prior to 1976 a mid-priced home in North Mission Hills would sell for about 12 to 14 times the annual rents. By 1980, these same properties fetched 18 to 22 times annual rents, as speculation in homes decoupled the historical relationship between rents (the monetary value of shelter) and resale prices. At the recent top of the market, 2007, that same home would command a resale price of 25-30 times annual rents, far more than today where average homes command about 16 to 19 times the annual rents.  

Community income enables effective demand for homes. The California Association of Realtors Housing Affordability Index is a useful tool to evaluate the relationship of aggregate(community) income and house prices. At the market peak of 1989, 22% of households could afford the median priced house in the County. At the worst point of the previous recession, 1993, 41% could qualify and by the zenith of the next bull market, 2006, only 9% could purchase the average home. The Index peaked in 2009 at 41% and is now around 38%, which indicates market prices are about to turn upward.

The rent and income examples presented above suggest prices have aligned to historic levels consistent with periods of stable or increasing prices. Accepting these traditional yardsticks would mean the correction phase of this recession is finished, or nearly so. It would appear values have adjusted to levels that can be sustained given the area’s income and rental rates. If aggregate income and rents continue to move upwards, homes prices should follow, or in the worst case follow the rate of inflation.

I know matters are not as simple in the Brave New Global World. You could argue old measuring sticks mean little and this time is truly different. I am mindful of the huge actual and unseen inventories of failed mortgages, the fact that about one-third of all homes have negative equity, global pressures on wages, and the precarious state of our local economy. One can partially define the the state of the market by feeling parts of the elephant, and by some traditional measures the worst appears behind us. What worries me is in a Tule fog, we are all blind. Next Month: Globalism and Future Home Prices

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