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Jim Scott
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Real Estate's Lost Decade?


     There is a school of economic thought that argues that residential real estate values will not recover in the same manner as they have following past recessions. Last week Moody's released a study concluding that it would take at least ten years for California home prices to return to 2005 levels. This is uncomfortably reminiscent of Japan's experience following the 1990 global downturn, characterized by ten years of no growth and asset deflation.  To quote Moody's report precisely, it will be "after 2023" to "regain the market peak" in the southwest.


     This is unsettling at best and is at odds with past recoveries. Moody's relies on the newer Case-Schiller methodology, which tracks the prices of specific homes rather than market averages. Which market-watch tools are the best is subject to debate and not worth discussing in this space. What is important is that many industry experts are arguing that a Japanese-style housing recovery is possible. Their argument is enhanced by the unprecedented losses of the past three years, up to fifty percent in some major metro markets. Given our likely economic future, it probably will take a long time to add fifty percent back to the current pricing structure. The housing shock of the past 36 months, they argue, was not an ordinary recession but the start of a structural re-pricing of the nation's housing stock.  


In California, for example, there is a reasonable chance that prices in the Central Valley and in the Inland Empire could take up to a decade to recover recent losses. Demography, resource limitations and globalization may fundamentally restructure the economies of areas with lower community incomes. Like Las Vegas and Miami, California's past economic boom was generated by real estate development. The local economy cannot grow in the long run when it is based on one set of carpenters building homes for another group of carpenters. Resources such as water, capital, roads, and land are already in limited supply. As a region we cannot continue to use in-migration and population growth as the catalyst for economic growth. Without fundamental changes in the way California's economy functions, the citizenry could have a difficult time maintaining the existing residential and commercial real estate debt structure. If all real estate continues to re-price, the lost decade scenario could be our future. 


San Diego Exceptionalism


     The parvenus of the last real estate boom have been the biggest losers over the past three years. The trials of each neighborhood largely reflect the socio-economic levels within those communities. This logic can easily be expanded to communities and states. There is a cautionary tale here: buy the best location you can afford in any market.   


High quality San Diego real estate should be immune from the more dire predictions noted above. The problem in that segment, beyond pricing, is low sales velocity. Sellers restrict supply either by over-pricing or by withholding product from the market. Owners are largely able to do this, at least for now, because credit is cheap, they have savings, and they still have their jobs. One has to conclude that in upscale areas there is a low probability that prices will fall in any meaningful amount. Homes in desirable locations will operate with their own set of rules.  Even in our economically-austere future, money will still be around to bid up quality items that have some degree of rarity. San Diego's better neighborhoods will outperform the best parts of Stockton. 


The ultimate villain in this play was too much democracy. Our previous President wanted to expand home ownership rates. This noble goal ended up as a failure as it went against some unspecified economic law of natural selection. This is not some elitist sentiment; too many people were given easy credit when all hands knew there was a high probability of failure. The irony of this well-intentioned folly is that when this debacle is finally settled, our culture will have a larger and more permanent renter class plus an unprecedented national debt. 

We cannot afford to nurture this part of the American myth. There are too many other pressing needs competing for scarce resources. California's budget problem is but one example of this problem. I do not believe our nation can afford to return to an era when people eagerly pledged sixty percent of their net income to support a mortgage. Further, we will not be able to borrow our way to salvation as the geniuses on Wall Street sunk all of the life boats.   


     I wrote two years ago that the post-recession pricing structure of residential real estate would come to resemble pre-Vietnam America. Homes should appreciate modestly, generally in line with increasing rents and perhaps a point or two over the rate of inflation. I still believe this to be true with this caveat; most people will have less money to spend of housing with the exception of our economic betters. Accordingly the rate of home ownership will decline except for those near the top of the economic food chain. This is the ultimate irony of this mess; more people will become life-long renters. If you can afford it, now is the time to risk your chips on quality real estate. The free-fall at the top is over, the length of the trough is unknown and therefore there is little reason to tarry.   










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