Business As Usual
This September will mark the sixth anniversary of the collapse of Lehman Brothers, at the time the nation's fourth largest investment bank. The economic shrapnel from Lehman's implosion shredded real estate values everywhere. Our sunny weather did not spare us; a tsunami of foreclosures, wrecked balance sheets, lost jobs, and postponed dreams were the legacies of Wall Street’s financial tomfoolery. Not surprisingly, San Diego’s economy bounced back, but six years on, this particular recovery, even after Herculean efforts by the Federal Reserve Board, should charitably be described as tepid. Perhaps many old assumptions no longer apply and today’s economic landscape is as good as it is going to be. If true, we should get used to housing's new normal.
Last year’s real estate market performance was similar to 1976, 1985, and, 1997, years following recessions that featured big appreciation. 2013 was such a time, but I think it was an anomaly, a correction for an oversold market. As evidence of this, note housing’s decent but unspectacular market performance in 2014. Home buyer’s are being careful, reflecting what we can afford and how much financial risk we are willing to assume. This attitude is affecting real estate markets and financial portfolios as well. People are holding record levels of cash. This year’s appreciation does not even approach the gains posted in 1977, 1986, and 1998.
This is because buyers have become more risk averse and certain economic classes have fewer resources. The past will not necessarily be prologue, at least for the next five to ten years. I am not so naive to believe our recent trip to the financial woodshed will cure us of what John Maynard Keynes called our "animal spirits". There will always be the potential for bubbles in any marketplace and it is possible San Diego’s home buyers will not be immune from another bout of irrational exuberance. I believe, however, we will not witness another period like 2001-2006 for perhaps a half-generation or more. We do not have the community income growth to drive real estate appreciation higher than a few percentage points over the inflation rate. It is not unlike how America is fiscally restrained from embarking on another cowboy foreign adventure---we do not have the money to fight another multi-trillion dollar bootless war.
Another factor that will limit effective demand is that structural economic changes have exacerbated income and wealth inequality. Politics aside, It is hard to argue that in the medium term real estate will not be negatively affected by this trend. An active and profitable housing market needs to have entry level buyers. Unfortunately, family incomes of the lower sixty percent of wage earners have declined in real dollars for some period of time. Incomes and house prices are diverging instead of converging or staying even. If this trend continues, we will eventually become a nation of renters.
On the supply side, urban San Diego is a constrained market and I see little political appetite for increased growth, even though natural population growth (births minus deaths) will eventually lead to a politically significant undersupply of housing. Resistance to development is partially the result of a drawbridge mentality among residents, but in my opinion there are practical reasons to restrict growth. Roads, traffic, air quality, and, most importantly water, are at the top of the list. It is expensive to accommodate the collateral effects of new dwellings and the local body politic is very resistant to higher taxes. The imbalance of supply and demand should ordinarily be the ingredients of another surge in prices over the next few years. I doubt there will be enough growth in incomes and in wealth redistribution to create another bubble.
None of this is bad news. In the future, real estate in San Diego will be even more of an international gold standard, a widely recognized place to safely park capital. There is and will be a reasonable expectation of modest but steady appreciation. Over the next decade, San Diego property will be a very safe place to put capital, with a low probability of a bubble or a crash.
Relative stability, therefore, is the new normal. 2013, like 2008, was a transition year. Buyers are far more circumspect and cautious and will be less likely to distort home prices. Low inventories are going to be with us for a while for a variety of reasons, but that in itself will not bring about a price spiral. The mutual caution of buyers and sellers points to a stable, albeit dull market for the next few years. The 1950s are back.