From an article I published in my San Diego real estate newsletter. - You will recall that the focus of this newsletter two months ago was the much ballyhooed "real estate price bubble" wherein I provided some facts regarding the local market and events which nearly always occur prior to any decline in home prices. My bottom line was that local conditions and housing economic fundamentals (employment, unemployment, housing supply & demand, cost of development, etc.) did not point to price declines of any significant amount. However, I also noted some concern about the possibility of "self fulfilling prophecy" if enough folks swallowed the media´s "bubble" theory. I ended by noting that homeowners who take the prudent buy-and-hold approach will surely enjoy continued appreciation of their investment.
OK, I believe that it´s time to follow-up with this issue as it is receiving a tremendous amount of press coverage. Let me offer some additional perspective for your consideration.
On the one hand, there are those folks who insist that there is a classic "bubble" and that homes in many areas, including homes in San Diego, are overvalued and that just like the stock market in 2000, a significant pull back is the only feasible outcome. This in turn could push the entire economy into a recession. For almost five years now, we have heard pessimistic pundits proclaiming the existence of a bubble and that prices were going to get rolled back like a Friday night at Wal-Mart. I mean, after a while, even the most optimistic of real estate bulls has to at least flirt with the notion that the market just couldn´t go on like it had forever and they all offer up a different theory of the coming crash.
Then there are those who contend that there is no bubble. Yes, there is no doubt that the market has cooled but, economic prosperity should sustain modest increases in housing valuations. Yes, a 4% growth in GDP just last month indicates that the national economy is indeed doing very, very well.
So, here then is Joe Homeowner who is wringing his hands over who to believe. Does he fold, hold or use his swelling home equity to buy investment property? Should Brandi Buyer take the plunge now before interest rates and prices go higher or wait, rent and take her chances that she is missing yet another opportunity?
OK, so what´s your "take"? Do you think that our local market is in the midst of a huge correction? If so, my personal response would be "don't you believe it". Instead, my belief is that we will probably experience a period lasting approximately the next 8 to 12 months wherein we enjoy across the county, a narrow range of from plus 5% to minus 5% growth. During this time, a lot of the inventory of homes which came on the market over the past 12 months will come off the market, the new Chairman of the Federal Reserve will have shown that he is not about to upset the financial markets with precipitous moves, and mortgage rates will stabilize. Thereafter, we should then begin to see appreciation start to pick-up albeit not at the torrid rate that we enjoyed in the late 1990s and early 2000s.
Not yet convinced? Well, I have some additional pertinent issues for you to consider. "Bubble" theorists (and the media) want so badly to be right that they rarely miss an opportunity to cite short-term data that supports their opinion while ignoring the realities of the bigger, more accurate picture. Generally, they only discuss demand while avoiding the often more meaningful supply issues. They also note that the affordability index suggests fewer households have the income sufficient to qualify for the median priced home, arguing that sooner or later most people will be priced out of the market and that prices must decline. Well, here's what they don't but should, tell you:
More people own homes in American than ever before. So much for the validity of any sort of affordability index. When the marketplace actually produces a result contrary to the hypothesis of the experts, the conclusion is obvious. How we pay for homes has changed. Outmoded assumptions about affordability drive this comparison.
In San Diego we have a critical existing shortfall. There is no infinite sea of available houses. According to SANDAG, during the past decade, new construction has fallen behind population growth to the tune of 100,000 units. So while the current inventory might exceed the immediate demand, the fundamental driving force of this market is an acute shortage that grows more severe with each passing year.
The population is continuing to grow. During the past twenty years, the population of San Diego County has increased by over one million people and is continuing to swell at a rate of 52,000 people per year. Already, the average number of occupants per San Diego County household (2.7) stands above the national average of 2.4 occupants.
Boomers change everything. Just about every industry has been surprised by the impact of baby boomers as they make their way through the life cycle. Their wealth, both earned and inherited, and their need to shelter income for what might be a very long life has led to a dramatic increase in second-home ownership. Interestingly, according to the U.S. Census Bureau, home ownership rates continue to increase through age 70. This means that baby boomers will continue to also be a factor as first time home buyers.
Builders cannot replace them for less. What little land remains is the most difficult and costly to develop. Environmental restrictions and the increasing cost of labor and material make it a certainty that the next wave of housing stock will come to market at a higher price than the last. Housing is expensive here because that is what it costs to replicate it.
This is a long term historical trend, not a recent phenomenon. I've been in the real estate business in San Diego for a while now. Despite interest rates in the high teens in the early ?80s and a recession or two, I've seen only one period of declining values and it would have to be characterized more as a slow leak than an implosion.
Leverage maximizes economic power. New real estate agents like to tell people that the three most important things about real estate are location, location, location. This can be devastating news to those of us who cannot afford to live in Rancho Santa Fe or La Jolla! But one can be consoled by the thought of using someone else's money to buy an appreciating asset, deducting the interest on the loan, living in that asset, and keeping all the profit when one does sell. "Other people's money" has long been the mantra of the rich and they'll tell you that the best thing about owning real estate is that it gives them the best vehicle to attract and use the capital of others.
Real estate has utility. Housing, unlike stock, does not exist to provide capital for business growth and expansion. Market value is the by-product of negotiation between buyer and seller, not a fraudulent earnings report signed off on by some big name accounting firm with a wink and a nod. Hence, there is no national marketplace to collapse. Instead, real estate can be lived in or rented. Thus, it has desirability and intrinsic value. We instinctively seek comfort, security, and shelter. We do not instinctively seek a bluechip portfolio. And best of all, if prices do decline temporarily, there is no margin call nor will the lender call your loan due.
The impact of the Tax Payer Relief Act of 1997. Part of the phenomenal price appreciation of recent years can be attributed to a little-understood change in the tax code that was intended to make the profit on the sale of a personal residence free of capital gains tax. Section 121 of the IRC eliminated the rollover provision and allowed for home sellers of any age to exempt their gain up to $500,000 in profit if filing jointly. This has the unseen impact of increasing the value of real estate by reducing and eliminating the tax liability. It encourages those that can afford it to own at least two residences simultaneously. When Section 121 is combined with the benefits of a 1031 Tax Deferred Exchange, the possibilities are such that real estate will remain extremely attractive to those in the know.
The Passage of Proposition 71. One of the most significant outcomes of the November elections for San Diego County has been the three billion dollars now earmarked for stem cell research, and it all must be spent in California. With 505 bioscience-based firms and the presence of the Salk Institute on the governing board, that $3 billion will be like a magnet for other bio-science investment locally. That bodes extremely well for the local economy.
Well, so much for Tom´s "take" on the "bubble". I will close by merely stating the obvious: that the concept of "planned real estate ownership" allows for temporary local market fluctuations but, never forget that the benefits of ownership vastly outweigh the potential risks... especially if you execute the buy-and-hold approach mentioned earlier and plan to live in your homes for anything but the short term. Think of it this way: if you can qualify for 100% financing you wouldn't even be risking your own money but the money of people who know a heck of a lot more than we do about the future. For the savvy long-term player, any time is a good time to own real estate.
Note: Excerpts w/ permission of San Diego Association of Realtors ®.
