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Jim Scott
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The Double-dip

    Last month Fiserv, the company that provides the raw sales data for the Case-Shiller home price indices, predicted San Diego real estate values will decline 8.5% next year.  Conventional 2010 wisdom has been prices next year would be flat early with a chance of appreciation over the second half, assuming positive national and local economic growth. The numbers and predictions from these two sources are widely respected and for good reason; Case-Shiller indicators were earlier harbingers of the housing recession and their price-tracking model, in my view,  is the best at reflecting market realities.

    There are plenty of reasons this unsettling scenario could play out next year. Banks hold substantial inventories of seized properties and delinquent mortgages. Unfortunately, the true of extent of latter is not known and represents much potential for economic mischief. Taken along with local unemployment, still hovering around ten percent, (this figure ignores the under-employed and those who have given up looking for work) one can see how Fiserv arrived at their conclusion.

    It is always easy to fret about all of the things that could go wrong. Economists and other general worriers, like this writer, spend too much time peering into shadows. There is some truth to the old saw that some wise seers predicted ten of the past three recessions. Still there are real concerns; unemployment, expired residential real estate tax incentives, and the growing prospect of higher mortgage rates sooner rather than later. But eight and half percent?

    If this gloomy forecast becomes our reality, the local market might be better off by year's end. There is an argument that the elusive recovery in housing is being delayed precisely because banks and loan servicers have not faced their own ugly reality, either by choice or political necessity. There is always a price for expediency as 'extend and pretend', the policy of keeping failing borrowers in their homes, may not be the smartest play. It fosters market uncertainty and encourages prospective buyers to sit on the sidelines. Price appreciation will not begin until lenders purge their portfolios of troubled loans and dispose of their real estate inventories. The public has to embrace a common consensus that the market has bottomed and that will not be possible until the Bubble's failures are purged.

    The problem is political and economic. There is limited upside for those inside the Beltway to resolve this problem quickly. It could be argued that avoiding a purge is both good politics and economics, witness how the FDIC and the Resolution Trust Corporation combined destroy the commercial real estate market during the 1990-95 recession. To refresh your memory, these agencies acted swiftly, scooping up all sorts of failing and under-performing banks and then seizing their 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 the policy of slow bleeding. It may be unsettling, but it is not usually fatal.  Real estate is local but risks and rewards are probably going to be determined more in Washington and less in San Diego. Houses are not commodities these days but their pricing can depend on decisions made thousands of miles away.

The Safety of Quality

     Buyers should pay attention to other factors when making a purchase or rent decisions. Money is cheap and should remain so until unemployment starts to be in the sixes and sevens. Mr. Bernanke at the Fed has made it clear his top priority is fighting deflation, and that he is not worried about the dollar falling or inflation. The Fed is not looking at shift their current monetary stance until perhaps 2013.

    More important than low rates is the fact that San Diego is a preeminent example of a supply-constrained market. Land, energy, capital limitations, politics and environmental factors will ensure a chronic under-supply of new housing over the next five to ten years.  Unless you are able to completely pull up the drawbridge, local real estate will be a safe investment play over the medium and long term.

    One of my dictums is to always buy quality in down markets. Prices in Mission Hills, as an example, have been remarkably flat following the initial meltdown, averaging around $450 per square foot. I assumed this is because owners of property in mature and more expensive neighborhoods would be less vulnerable to economic downturns compared to new communities with lower incomes. Active listings in this sub-market, for example, have an average net equity of about about 34%.  (call me if you want the details of my methodology). I would presume this would be a negative number for newer communities or neighborhoods with younger demographics.  The net equity for the past six months of sales averaged 22%, so on average sellers were able to walk out with proceeds. This does not happen in Eastlake.  

    Inventories are about 20% down from the earlier record highs. Properties in the 92103 zip code benefit from being one of the most supply-constrained markets and this safety feature, along with mature owners with substantial asset bases, means even if a double-dip of the magnitude predicted by Case-Shiller occurs, the impact in this desirable area will be minimal.     

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