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Jim Scott
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Budget Wars and Real Estate

The resolution of the sequestration debate, if one occurs, and the impact of recent changes in federal fiscal policy will affect real estate demand this year. Unless the GDP starts growing at a rate around 3% or there are substantial local wage increases, there can only be one outcome from these significant budgetary changes; nearly all Americans will have less disposable income in 2013 than they did in 2012. This will be true regardless of whose ideological vision prevails in Washington. There will be fewer dollars chasing properties. Yes, the weather is great but the law of supply and demand always wins.

Pols on both sides of the aisle rightly acknowledge it is time to address the nation’s debt and budget imbalances. Thirty-two years of living beyond our collective means has reached a tipping point. I am not moralizing nor wagging my finger, the borrowing and spending was not done recklessly; the money was used to provide the citizenry an economic and social safety net, when our comfy postwar world collided with the unstoppable forces of globalization, technology, and deregulation. From 1981 on, Washington used debt as a way to shield voters from the worst effects of the new economic order. We borrowed to maintain our collective lifestyle while our economy struggled to adjust to challenges such as outsourcing and a needless war. All was well until the Great Recession struck and the Feds found themselves low on credit and answers. Fortunately, Mr. Bernanke and Mr. Geithner calmly righted the ship. The former is still running his printing presses. Perhaps his 2007 moment is coming.  

There are three possible solutions for our debt problem at hand; higher economic growth rates, harmful levels of inflation, or new fiscal policies featuring higher taxes and lower government spending. The beltway crowd cannot easily control the first two options as they are more the province of the Federal Reserve Board and global economic forces. Recognizing this, Congress and the President have already put into place game changing austerity measures. Beginning with the Budget Control Act and following that by the mini-Grand Bargain late last year, both parties seem committed to budgetary temperance. These changes mean that in 2013, upper-income Californians could be paying up to 6 percent higher marginal rates and will be losing some or part of their tax expenditures, such as the mortgage interest deduction. Capital gains are going back to the old rate plus an additional 3.8% healthcare surcharge. And, as a sign of the times, tax-averse Californians approved increases in income and investment taxes for those in the upper reaches of the income stratum.

Even though the wealthy have taken the first punch, the rest of us are next in line. Government spending reductions, split roughly between defense and entitlement programs, will spread economic pain around to all economic classes in our region. No one knows, for example, how deeply defense cuts will impact San Diego’s economy. Our history is replete with real estate busts caused by changes in federal spending in San Diego. It should be noted there is an outside chance the President and the Congress will punt on sequestration and continue business as usual. This possibility could occur if a meaningful compromise is not reached March and some workaround is brought into play, emasculating the sequester.

Regardless of how the drama plays out in Washington, monetary and psychological forces are already at work on the residential market. The past real estate bubble, which popped in 2007 and 2008, was fueled by an avalanche of credit and a sea of poor judgement. Too much cash and too many marginal entrants into the market bid prices and debt to unsustainable levels. This year the opposite may occur, significantly reducing effective housing demand. No matter how the economic medicine is administered, prices and rents in most market segments will take a minor beating in the short run. There are two reasons for this. First, there will be fewer disposable dollars to bid on real estate and other consumer goods. Second, the this momentous change will inadvertently sow uncertainty in markets than crave certainty, such as real estate.  

Even so, I believe 2013 will end with higher prices and rents than were posted at the end of last year. I think there will be an increase in investment activity, by both businesses and individuals, after the uncertainty of this budget debate is removed. No matter what comes from the Son of the Grand Bargain, firm rules are needed to grow the economy. With an accommodative Fed still throwing money around, keeping 30-year mortgages cheap, and a new fiscal plan, national and local economies will gather steam by year end and reboot the recovery in residential real estate alive, boding well for 2014.

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