San Diego 2008 real estate assessment

“It began with low-income Americans being encouraged to borrow mortgages they couldn't afford.” So wrote David Teather in his British Guardian on-line insightful essay, From the sub-prime to the ridiculous: how $100 billion vanished: Mighty institutions and powerful figures undermined by pitiful little property deals, dated December 31, 2007.

Starter teaser rates with adjustable-rate, negative-amortization financing for fixed-low-income families and low- and no-document, stated-income loans for seminar-fresh eager “get-rich-fast” investors and real-estate “flippers” initially fanned the mortgage embers. Enter outright loan-fraud schemes – 103 percent loan-to-value mortgages on homes appraised at 20 to 25% percent above market value for straw buyers – and the flames burst forth setting the stage for the mortgage conflagration that has now begun burning overseas financial markets.

Teather pointed out that bad mortgage debt “had been packaged up and sold on around the world’s financial system. Nobody, not even the banks themselves, knew who owned the toxic debt.” Teather concludes, “Confidence appears to be ebbing.”

Indeed, fear, emanating from uncertainty, seems to have been the emotion that dominated the U.S. real estate and mortgage markets during 2007. Yet, we sense a meeting of pent-up buyer demand and sellers coming to recognizing current market realities.

We believe the U.S. Federal Reserve will continue to lower interest rates, although that may have only a nominal effect on residential conforming rates, currently in the low six-percent range. Recent government measures to improve mortgage lending practices are not addressing the corruption that led to and continue to contaminate the mortgage industry. In fact, the new regulations are simply going to make borrowing more difficult for many investors and further diminish demand.

While many believe that interest rates are going to have to drop significantly in order to salvage the damaged housing market, financial guru Jerry Klein of Klein, Pavlis & Peasley, Financial, Inc. (www.investtalk.com) observed, “Lower loan rates would not solve the mortgage crisis.”

Klein believes that the U.S. government will have to step in aggressively and soon to support the housing financial markets. As do other informed sources, he sees a prolonged recovery period of at least several years with further value erosion before an upturn.

James DeFrancia, Trustee and former Vice-Chairman of the Urban Land Institute and former national director of the National Association of Home Builders, commented, “There really is no such thing as a national real estate market…all real estate is local.” DeFrancia, who is also a principal and co-owner of Lowe Enterprises, a national real estate development company engaged in a urban residential, mixed use and hotel and resort development, predicts 2008 as “… a flat year as we see bottoming out of the housing market in combination with a general economic slowdown.” He added, “…however, there remain several geographical areas of market strength while others will be weak well beyond this year.”

With that in mind, what’s in store for San Diego real estate in the year 2008? Well, first off, people do need to live in homes.

Secondly, real estate – at least the land part – is an indestructible asset. Not much more land is being made available for development in southern California; this is particularly true in San Diego County. Yet, more people want to live here each year – in no small part due to the favorable climate. This bodes very well for the long-term.

Thirdly, many developers are now dumping inventory at below cost (a major developer on a recent purchase of ours took away a bit less than $20 at close of escrow – and that was before computing in the company’s administrative and marketing costs). The result of this third factor is that developers are cutting way back on future projects.

The stage is being set for an acute housing shortage in San Diego County within the next four to five years.

Downtown San Diego is an interesting micro-market to observe. In the past rather sluggish 18 months, remarkably, downtown resale inventory has managed to diminish from over 750 units to around 560 units while developers have been moving their remaining new-construction inventories and abandoning plans for new projects. We see a dramatic reduction in resale condo inventory by early 2009 and an acute shortage of downtown San Diego condominiums by 2010.

We forecast a continued softening of prices in San Diego for the first two quarters of 2008 with a leveling by late 2008. We see conforming 30-year interest rates between 5.75% and 6.25% for the coming year.

The combination of value erosion of U.S. real estate and the plummeting U.S. dollar have resulted in considerable off-shore interest in U.S. real estate. Appreciable infusion of off-shore investment capital may well play a role in stabilizing the deterioration of U.S. real-estate values.

Even though most predict continued value decline, developer incentives to buyers are only going to last until current inventories are reduced to manageable levels – these incentives may begin to disappear by mid-2008.

Due to these significant incentives now being offered to buyers by developers, this is an excellent opportunity time to consider buying a brand new home. As in 2007, buyers should focus on quality and prime location.

On the other hand, those with homes for immediate resale have to take a hard realistic look at current market conditions. They need to prepare their properties in a manner competitive with new homes and at prices that will attract prospective buyers to make offers.