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Jim Scott
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The Reluctant Buyer

Beginning in the spring, residential real estate sales volume sagged and appreciation rates followed suit. An adjustment was probably inevitable given the market’s blistering and unsustainable 2013 performance. There are many plausible theories as to why this occurred such as the lack of listings; my view is the market changed because the buyer class, for a variety of reasons, were not very enthusiastic about the offerings and their prices.

The business press dutifully noted the market’s change, but offered little in the way  of an explanation for the marked reduction in the rate of price appreciation and in the number of sales. This seemed to be an anomaly, considering the major local and national  economic markers were reflecting nothing but good results. The Dow Jones burst through the 18,000 mark, a long way from below 7,000 seen during the Great Recession’s worst days. The national economy grew at a healthy 5% rate for the third quarter and consumer confidence improved. San Diego’s job creation is outperforming the state and national economies, and the sun is still shining. All of this begs the question, why is the housing market shambling along in the midst of what seems to be an local economic boomlet?

Many argue that rising prices have depressed the foreclosure-investor industry and encouraged owners to keep their homes. Others think 2014 was the flipside of the 2013 bubblette. My own view is that many buyers  virtually ‘withdrew’ from the market by offering far less than sellers were expecting, tempering sales, prices, and the number of listings.  Additionally, there remains an economic and psychological hangover from the past recession which discouraged many newer entrants into the market. The desire to own your residence may now be less of an important core principle of our economic belief system. This ideological change has resulted in a new group of discretionary and very patient buyers--they alone have dampened the animal spirits of 2013. Or to quote The Who, they “Won’t Get Fooled Again”.   

This new caution is best illustrated, for example  by how Millennials view homeownership. Last year several outlets ran stories about how younger consumers are not following in their parent’s path when it comes to homeownership. The Great Recession, so it is argued, is responsible for what appears to be a sea change in how this important group views this traditional rite of passage. This cohort observed first hand the social and economic havoc created by the home equity line of credit and more importantly, many believe renting is the smarter economic choice.

There are several economists who support this economic idea. Robert Schilling, the co-founder of the widely respected Case-Schiller Index, is just one of many economists whose research supports this position. He contends that capital invested in a primary residence, the down payment plus the ordinary operating expenses, could earn a far greater return if placed in alternative investments. His research shows the annual inflation-adjusted long-term historical return for stocks is about 6.5% and 3.5% for bonds. National home prices, according to his research, have increased less than half of one percent over the rate of inflation since 1890. Using this metric, owning stocks and bonds appear to be the preferable investment option given no other external factors.

The problem with this research is that real estate is local and dynamic. For example, since 1970 the average price of a home in Mission Hills has grown at a rate of about 3% per year adjusted for inflation (slightly more than the CIty rate).  While lower than stocks, this comparison ignores the significant additional investment return that is derived from leverage, inflation, and government subsidies(the mortgage interest deduction and Proposition 13). These three factors give ownership a huge comparative advantage over stocks and bonds.

Take inflation as an example. The monthly cost of homeownership, plus the opportunity costs of the capital invested, is a ‘rent’ that becomes cheaper in real dollars over time. Renters, on the other hand, are victims rather than beneficiaries of inflation. Today renters spend nearly half of their disposable income for housing. Homeowners, on the other hand, service their debt with inflated dollars, earning huge returns on their capital in the long term.

Rent increases higher than the rate of inflation, is inevitable in San Diego. It remains very difficult to build apartments and homes in San Diego. Add to this the local births-over-death ratio and in-migration and you end up with a lack of housing supply. Renting, as an economic option, will be relatively more expensive over time.

Appreciation rates of residential real estate in San Diego may pale in relation to the Dow, but the alternative to owning a personal residence will get less attractive over the next decade. Patient buyers and millennials probably slowed down the market last year and restrained price increases. Eventually there is no question the comparative advantage of ownership will even greater in the future. It is renting will become less attractive, forcing these reformed buyers off of the fence. There could be another small bubble, perhaps as early as the fall.  


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