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Are national economic trends affecting San Diego's investment market?

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As the San Diego real estate market progresses through the fourth quarter of 2004 and gears up for 2005, some investors have raised concern about how the national and global economies may impact local market shifts and trends.

Bruce Haulley

The good news for investors is that San Diego has been the exception to many recent national market shifts that have significantly impacted other major U.S. cities. San Diego benefits from a diverse real estate climate, good job production, steady population growth and a persistent lack of housing for the people who live and work here.

Yet, despite the local market's relatively strong track record, it's important for local investors to stay apprised of the latest developments on the national and global fronts. Doing so can be very helpful in forecasting certain local trends and in making sound investment decisions.

No more 'easy money'

The United States is currently running a large balance of payment accounts -- last month's was the second largest in history. The United States and its prodigious appetite for imports is vitally important to Asia and its industries.

Approximately one-half of the world's economy is run in currencies pegged to the American dollar. This means that if international currencies truly floated, monthly adjustments would have already devalued the dollar. The American dollar is being propped up in value by the Bank of China and Bank of Japan. Half of all treasury bills sold to cover the federal deficit between August 2003 and August 2004 were bought by these two banks in order to support the American dollar and encourage Americans to keep purchasing Asian exports.

Alan Greenspan's doctoral thesis in the 1970s described creating wealth in the United States by raising the value of real estate. This thesis has become the basis for the feeling of wealth that American consumers have enjoyed for the last decade. As the head of the Federal Reserve Board since 1994, Greenspan has managed an "easy money policy" marked by low interest rates to flood the economy with money.

As a result, household debt levels are the highest in U.S. history, primarily because homeowners felt they made money on the appreciation of their properties over the last 10 years. Homeowners could get home equity loans at low interest rates, and many subsequently chose to take more extravagant vacations and purchase cars. If interest or unemployment rates increase (both are likely), many families will find themselves overextended -- and the market value of their homes will be less in a downturn.

This easy money philosophy continues to be embraced by the Federal Reserve Board because it is extremely popular to have easy money, and unpopular to have tight money restraint. Both political parties have used "prosperity" as political capital and taken credit for it. But it's easier to start it than to end it.

The problem with Greenspan's easy money policy is that it has gone on too long and is coming to an end because the national economy simply can't afford it. We now have large federal deficits because of the Bush Administration's tax cuts, at the same time the federal government's spending has gone up 7 percent a year for the last three years.

Eventually, Asian banks will have to stop buying U.S. treasury bills, if only because they'll run out of money. However, before that happens, they likely will acknowledge that the dollar will fall in value -- whether or not they support it. As the U.S. has no agreement in place for Asian banks to support the American dollar, they can stop anytime they wish. Simply ceasing to buy treasury bills would be enough to raise interest rates.

In mid- to late-2005, some experts predict that the U.S. economy will experience a credit crunch, while the stock market will decline.

The term "twin deficits" will become more widespread as the problems become noticeable, describing the concurrence of both large federal deficits and balance of payments deficits. Each will amplify the other.

How will the San Diego market do?

Nationwide, many buyers of real estate are waiting to see what happens next, as sellers must weather the downturn or sell at a lower price. Since commercial real estate is valued on income produced, an increase in interest rates will decrease a buyer's net cash return.

With higher interest rates, buyers will expect to pay less for the property they're buying.

So, what is the best choice for investors in San Diego? One excellent option may be multifamily investments. Few affordable apartments have been built in San Diego County since the 1980s, and many families will not be able to afford a house -- especially with interest rates increasing.

Existing apartment buildings can be purchased for less than replacement cost, even assuming a builder could get approvals to build.

Also, office and retail properties may be good investments on a case-by-case basis.

Sellers should sell now, if they're not going to hold their properties for at least five years. Investors may want to remain in cash positions.

The bottom line is that while the San Diego market remains relatively strong, despite less-than-promising news from the global market, investors would be well served to pick and choose their next real estate endeavor carefully.

Working with an experienced broker who is well versed on how the latest developments may affect the local market is key. The goal should be to make well-informed decisions that take into account all pertinent factors.

As the real estate market is constantly changing, having up-to-date knowledge both locally and globally can be a powerful tool.


Haulley is a vice president specializing in office and industrial properties for GVA IPC (formerly IPC Commercial Real Estate). More information about the company is available online at www.gvaipc.com.>

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