The Real Estate Economy

Submitted by Rich Toscano on January 26, 2006 - 9:42am

This week's Voice column concerns a topic about which I love to prattle on seemingly without end. And that is the fact that San Diego's ostensibly robust economy is, under the surface, not very robust at all.

When discussing a potential housing downturn, many pundits contend that "it won't happen here" because San Diego is no longer dependent upon the vulnerable defense industry, as it was during the last housing bust into he early 1990s. While it's true that the defense industry no longer dominates the economic landscape, this argument ignores the inescapable fact that our economy is now beholden to the real estate industry itself. Should the trends of home price flatness or declining sales volume continue, San Diego's eocnomic vulnerability will be exposed soon enough.

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Submitted by powayseller on January 26, 2006 - 10:26am.

This is a great article. I found this myself when I researched the jobs data. Actually, manufacturing and high tech jobs are declining, while real estate jobs are on the rise. A recent example is the closing of the Sony plant in Rancho Bernardo: consumers are no longer buying the RB's plant TV's, but plasma TVs from China. Why don't we make plasma TVs at the RB plant? Can't - Chinese workers get paid so much less. I even heard that some local biotech work is now outsourced to China. So the job gains in the chart that are not RE-related, are probably in tourism and consumer-spending areas: fast food and retail.
I like the Fashion Valley mention - that place is always packed, with no end of well-heeled people looking for a place to park their dollars. Nordstrom, the Apple store, Neiman Marcus, Burberry - it's packed. Now you have 20-yr-olds buying $400 purses at Coach. It's a crazy world. The home equity withdrawal is fueling this spending. As refi activity continues to slow, this consumer prop will go away too. Read the retailer reports - there was a slower Christmas than expected. The slowdown will continue.
Rich - you ought to contact KPBS about doing an on=air interview.

Submitted by unclepappy on January 26, 2006 - 1:36pm.

Although I agree mostly with what Rich is saying, again it comes back to the very question that is asked again and again in households across America: If we sell the house where are we going to live, are we going to rent again (pooh pooh my wife says), what about the income tax writeoff (big mortgages mean lots of interest to write off!), and what if (oh my gosh it couldn't be true) the values actually keep going up???
Even a 5% rise in values isn't too shabby?

Let me answer if I can: No honey I don't want to move out of my nice neighborhood, and no honey I don't want to live in an apartment or a rental house, and no honey I like getting back 10k every year from taxes because of my huge tax writeoff (instead of owing money), and no honey what if heaven forbid the values only go up 5% instead of 25%.

Anyway that's my take (or rather my wife's take on things in the real estate world) so bite off what you can, chew it and spit it out.

Chicken Little

Submitted by speaker on January 26, 2006 - 1:46pm.

GAAAAHHH....every time I read Professor Piggington's analyses I want to print 1 meeeeellllllion (picture Dr. Evil) copies and hand them out to all of my family and friends. I can never get them to stop parrotting all of the naysayers:

you should buy!!! Why do you continue to waste money on rent!!! real estate always goes up!! Tax breaks!!! you better get in now otherwise you will be priced out forever!!! Just get in, take whatever financing you can!!! BRRRAAAAAAAACCKKKKKK!!!! polly want a cracker....

You know, the sad part is the biggest parrotts of them all have been the parents. Despite showing them the basic math they still can't fathom why we have not bought. It doesn't help much when my friends are buying homes with 100% financing and ARMS.

hmmmm lets see....rent my current home for 1700/month or purchase the equivalent and spend 4K/month (no taxes/insurance) only to watch my payment go up when I readjust.

no thanks.....

"End of line."

Submitted by powayseller on January 26, 2006 - 2:03pm.

Uncle Pappy - I enjoy your playful outlook. As a person who just sold a home, I have thought through all those objections.
1. Where to live?
Rental houses are available in almost every neighborhood. Take your pick. More choice in the summer. Investor buying has created lots of choices for renters. I looked at 20 houses before I picked this one for a rental.
2. Is renting so bad?
It depends on the neighborhood, right? It differs from homeownership in that you can't make your own improvements, but it's great in that you don't have the maintenance costs and diversions. Much more free time for my husband, who is pursuing personal hobbies now.
3. Mortgage tax deduction
The tax deduction is really a deduction on debt, so eliminating debt eliminates the deduction. That's a good thing. The rent is cheaper than the mortgage payment, and between the 4.5% interest on my CD on the housing gains plus the property tax savings, I am ahead financially despite the loss of the deduction.
4. Value keep going up?
They are already down. NAR report is out. Nationwide data is meaningless, let's look at SD from Nov 05 - Dec 05. Median price is down 2.1% (that's an annualized decrease of 25%), sales are down 2.6%. And this is just the beginning. Wait until the ARMs start to reset. Wait until consumer spending slows and real estate related professionals lose their jobs or have a reduced income.
Selling a house now gives you an easy windfall. This is the easiest money my husband and I may ever get. Of course, there are tradeoffs. We gave up our house, our neighborhood. We live in a rental, and can't upgrade it , whether it be kitchen counters or paint. But we have no debts, and to us, we are happy with our decision. Most people are too emotionally attached to their homes or in denial that the market could go down, so they will not sell and cash out. Some day they will want to sell: to retire, downsize, move out of state, move for a job, whatver. At that time, their equity will be much less.
So there is a cost for staying in your home. A financial cost only though - your equity gains will decrease. Probably by half. But that may not matter to you. Perhaps you can afford to lose the equity, or you love the house/neighborhood so much, that the money doesn't matter, or your house is almost paid off anyway and you love living in SD. There are reasons to stay put.
But if you want some easy money: sell!
Just some thoughts.

Submitted by powayseller on January 26, 2006 - 2:07pm.

We do try to get our parents' approval, don't we all? Show them the Bubble Primer. Wow them with your financial expertise. My brother is a securities lawyer in SD and he refuses to buy bec. of the bubble, despite his very high salary. He's the one who first taught me about the bubble. Wow your parents with your financial forecasts and expertise. It worked for me:)

Submitted by speaker on January 26, 2006 - 2:19pm.

Trying to wow my parents with logic and someone elses expertise is like trying to jam a square peg into a round hole.

after all, this is the parents we are talking about. at age 16, 33, 45 how successful have we all been at trying to convince our parents of the following:
hey, i know what i'm doing!

"End of line."

Submitted by unclepappy on January 26, 2006 - 3:42pm.

Very well written! I might be in a little different circumstance being from Seattle and all, although our gains have been spectacular over the last couple years as well. Our market is still pretty strong, but showing signs of softening. I keep very close track of the Ca. markets because I believe it's a barometer for the rest of the nation. Hopefully I can ride this EQUITY TRAIN for a little while longer and get out close to the top. As for your comments about rentals and life in general they make a lot of sense, although there are some drawbacks.

Be careful what you smoke, it might lead to enlightenment!

Chicken little

Submitted by requiem on January 26, 2006 - 4:44pm.

On the taxes:

1. If you get a 10K$ refund, you've essentially given the IRS an interest free loan of 10 kilodollars. That's a few hundred dollars in lost interest for you.

2. A tax deduction is not a tax credit. You don't deduct interest from income tax, but from taxable income. I.e., you're still spending actual earned money on both taxes and interest, just not as much as before the deduction.

Of course, the best thing to do is run the numbers (taking the deductions into account) and see which comes out cheaper.

Submitted by tliacono on January 26, 2006 - 8:11pm.

Here are a few posts I did last year on this subject with lots of charts:

There's a Housing Jobs Bubble In San Diego
More on San Diego Job Creation

The Leisure and Hospitality category has been the big gainer as far as the number of jobs created, although construction leads on a percent increase basis.

I continue to believe that restaurant help, by far the largest component in the Leisure and Hospitality category, is what's going to really suffer as people feel less wealthy and eat out less.

Submitted by lewman on January 26, 2006 - 8:45pm.

I think UnclePappy's raised an interesting point. If you haven't bought, I think most of us, if not all, would agree it may be wise to wait a bit longer. But if you're already in a comfortable home that you and your family love, and have already built a sizable chunk of equity, the cost may be high to sell now, rent for a while, then buy again later.

Intangible cost: There's of course the sentiment issue as mentioned (you're leaving a house you love, you cannot mess around with a rental unit, etc.). But people's circumstances do change. What if your employment situation changes in the future and therefore make it harder for you to get a loan when you're ready to jump back in ? If you bought anytime in the past few years and you took out a fixed rate loan, chances are your mortgage is priced at historically low rates so what if interest rate rises to a point where it gets more expensive to get a loan when you re-enter the market a few years later? These are all uncertainties that must be considered.

And then who can guarantee that we have already seen the peak of the property market ? And if you do a sell now, rent for a while, then re-purchase later at a lower price, there's also no guarantee that you can re-enter the market at a lower price ... low enough so that it also covers the rent you pay while you're out of the market and the potentially higher interest rate you have to pay.

Why do I not think property prices have necessarily topped out ? It's because there's a huge uncertainty in the direction of interest rate and the uncertainty can be summed up in just one word ... Ben ! None of us know what Ben tends to do because he's never done it so it's anybody's guess as to what his tendencies will be. He seems to be an inflation hawk with all the talks about setting inflation targets and that would suggest that he leans towards raising rates to contain the inflation beast. But then he also publicly noted he does worry about deflation and that if required he wouldn't dump money from a helicopter and that tells me there's a chance he'll just do a Greenspan and solve every problem by flooding the system with cheap money. It's a though one and I still can't make up my mind.

So my conclusion is I'm not selling my house in LA which I (actually my parents and I) have owned since 1991. However, I'm trying to find a way to hedge it in case a massive fall in prices does happen.

Lewis

Submitted by Steve Smith on January 27, 2006 - 12:15am.

Being in the hospitality industry for the last 20 years I'm not surpried at San Diego's rapid growth of late. This city is playing catch-up. When I moved here from San Francisco 2 years ago I found the exec job search difficult due to the small number of restaurants per capita. Compared to the regional competitive markets of SF, LA, and LV, SD lags behind. I believe the recent growth is simply an adjustment toward nation wide trends.

As for spending that household ATM dining out, here are the latest stats from the NRA (that's Restaruant, not Rifle);

1998
Households whose income was less than $70k spent $5.55/day dining out. Greater than $70k spent $11.85/day dining out.

2004
Households whose income was less than $70k spent $6.05/day dining out. Greater than $70k spent $11.84 dining out.

So, in theory, the dramatic rise in refi's and equity pulls hasn't exactly translated into a significant rise in national averages... Believe me, somedays I wish it had.

I think the pop is going to hurt the industry... but if most restaurants survived 9/11 (and believe me it was hell) thay can adjust to the changing market conditions of a post bubble economy. The staffs? Difficult question, but most of our industry is populated by non-professionals, students, and part-timers ususally with multiple jobs. There are very few homeowners (in this market) and a great deal of flexibility...

Fine dining servers avg. a little over $35/hour, casual dining servers about $25 (including wage).There will be some cuts, but mostly a reduction of hours, not jobs.

Submitted by North County Jim on January 27, 2006 - 12:22am.

Uncle Pappy,

You're sorta right. Those are questions that a lot of households are going to have to ask themselves. But only if they have the luxury of asking them.

Those that may not have the luxury may need to ask questions like "our mortgage payment just went from $2,800 to $3,600 per month. Can we afford that?"

If things play out as many readers and contributors here think, many of them probably won't be asking your set of questions. They'll be asking a much more depressing set of questions.

That's why I believe that Will Carless' piece in VOSD and Rich's companion post on desperate sellers are essential to understanding how the house of cards will fall.

Tax writeoffs and the security of homeownership will be cold comfort for those who are in over their heads when the music stops.

Submitted by powayseller on January 27, 2006 - 5:52am.

Steve Smith - how has household restaurant spending changed since 1998 in San Diego and other bubble cities? Is data available by city? I wouldn't expect an increase in TX or NE or WY, but certainly in the bubbly coast cities. You indicate you're not seeing a significant increase in diners over the past years. How do we explain the growth in hiring in fast food? Does the NRA include fast food restaurants? It's great to have your input to explain the numbers.

Submitted by tliacono on January 27, 2006 - 6:43am.

Steve,

That's interesting data - can you point me to the source?

The trend of above normal growth in restaurant jobs is true for the state as well as nationally. See:

California Jobs
California Dreamin'
More Restaurant Jobs

I'm curious how you would account for this trend elsewhere.

Submitted by Blissful Ignoramus on January 27, 2006 - 9:04am.

I think what's important is to look at your equity very conservatively and not let current bubble prices dictate what you have. Maybe you could sell your house today for $700K, and maybe if you wait three years you will only get $450K. But if you bought it five years ago for $300K you're still doing very well, and in ten years maybe it will hit $700K again.

The problem is that people are refinancing and spending that very volatile, bubble price-determined equity.

Submitted by Steve Smith on January 27, 2006 - 10:11am.

Yes, the CRA does include ‘Fast Food’ in these studies.

I’ll see if I can get the SD data through one of my CRA contacts and post. Stay tuned.

I didn’t say the numbers of diners were static; the growth in diners has matched the growth in restaurants on a per household basis. That’s different…

Despite wide held beliefs, the restaurant industry is driven by population growth and cultural changes in home cooking habits more than general 'spending'. The US is growing at the rate of about 3.2M people each year (including 1M immigrants) who are generally dining out more often (at cheaper restaurants) with two incomes required to survive and hectic schedules. So the math is... 3.2M people divided by 2.5 people per household means 1.28M new households/year. Multiply that by the avg. daily spending of about $7.75 gives new yearly revenues of $3.6B… that’s a lot of cash going into an industry producing the ‘least durable good’… and a lot of dollars going into payrolls.

Here is a summary of the 1998 CRA report...
http://www.restaurant.org/rusa/magArticl...

Here is the 2004 report...
http://www.restaurant.org/research/consu...

An interesting quote from your cited source… “Over 800,000 new food service jobs in the last five years, over 2.5 million in the last fifteen years - remarkably consistent at between 150,000 and 250,000 new jobs in this single category almost every year for the last fifteen years.” So through feast and famine, the industry has managed to consistently grow…

Submitted by powayseller on January 27, 2006 - 10:21am.

Tim, your articles are thorough and insightful. My husband and I were discussing the issues you raised in mid-December, and he asked for local employment numbers. I found it for him, and then I e-mailed the results to the Union Tribune, Voice, and KPBS. Hopefully the media will do a story on this topic of our housing-dependent economy. I also wonder why Mr. Smith finds, in his experience, that the restaurant business is stagnant.

Submitted by Steve Smith on January 27, 2006 - 11:16am.

I don't think the industry is 'stagnant', just matching population growth nation wide. As for the cosistancy in per capita spending, most restaurants have shrunk their expected profit margins while continuing to deliver reasonable values in the face of stiffer competition... I know that we can all name that local high end restaurant where a couple can't get out for less than $200, but for every one of those there are 50 charging less than $15 per entree.

Submitted by tliacono on January 27, 2006 - 4:29pm.

Thanks for the links Steve - I'll have a look.

Submitted by barnaby33 on January 31, 2006 - 12:08pm.

I find that interesting, because it has been my direct experience that of all the costs of living that have increased over the last few years, eating out has risen the most. My rent and other basic living expenses are basically static. Whether that is rent or food or payroll or even profit I can't say. I can say that I don't eat out that much more than in years past, yet its gotten way more expensive. I can't even get out of a Thai restaurant for less than 15 dollars. Thats just an entree, no drink not even a coke.

Josh

Submitted by Steve Smith on January 31, 2006 - 9:43pm.

Your perception is corect Josh, prices are going up... but that doesn't always lead to increased yearly spending (or profits*).

Just as in your case, as prices rise people dine out less often and buy less when there. It was common in the mid 80's for 3 out of 4 people to have dessert at $4 a pop, now you get less than 1 out 2 at $7. People are consolidating their orders at the beginning and end... sharing appetizers and desserts. As the avg. per price per item inches up, people dine out less often and with fewer courses. This offsets the rising menu prices.

Put another way, if you spend $30k on a new car that lasts 3 years then $50 on car that lasts 5, your total spending has gone up 67%, but the yearly expense remains the same, $10k...

Another trend that has kept the lower check average market expanding is the wide acceptance of bargain dining. At one time most 'foodies' wouldn't be caught dead using a coupon or frequenting the local 'hole in the wall'. That's all changed, bargains are 'in'...

* The 1st quarter of 2005 the price of dairy products nearly doubled at the restaurant level... Did you see the price of milk shake hit $10?

Submitted by powayseller on January 31, 2006 - 11:00pm.

Steve, are you still looking for the data I was asking about? Another question: the local employment numbers show large increases in hiring in the food industry. That was the point made in the article. Aren't you agreeing with that? I think your point is that there is more hiring, but that hasn't led to greater profits for restaurants. Ok, that sounds reasonable. The restaurant industry is competitive, and there is a low barrier to entry. However, it seems people eat out more because they are busy AND they can afford it. Thus, restaurant growth in the last few years exceeds the rate of growth of previous years. Tim's website has lots of data on this (www.themessthatgreenspanmade.blogspot.com). From a September entry: "Over 15,000 new restaurant jobs have been created in the last four and a half years". Leisure and hospitality was the largest category of job creation from 2001-2005, and restaurants were over half of those jobs. Since theer were only 800 hotel jobs added, we know the consumption of leisure is by San Diegans, not tourists.
I wonder how you explain the NRA findings relative to the San Diego data? I know people all over the country are refinancing and cashing out. Iowa, Missouri, etc. have attorney generals investigating sub-prime lenders.

Submitted by Steve Smith on February 1, 2006 - 1:16am.

I have a meeting with someone this Thursday who may be able to answer the question...

Yes, I agree that hiring is strong. But not that much stronger than recent years (since '92 or so). I've read Tim's stuff, but his quote that I keep coming back to is "Over 800,000 new food service jobs (California) in the last five years, over 2.5 million in the last fifteen years - remarkably consistent at between 150,000 and 250,000 new jobs in this single category almost every year for the last fifteen years." (December article) - He's nailed it perfectly, hiring has been very consistant state wide for a very long time. Through boom and recession. Remember, hiring a fast food cook counts the same as a fine dining Chef, don't jump to the conclusion that more restaurant jobs means more jobs in expensive resturants!

The only major 'boom' in restaurant hiring and income I've seen first hand was very localized in and around SF during the dot.con madness. Talk about expense accounts!

Looking at the the september article specifically, the chart of job creation is interesting... of the 5 or 6 categories listed, only Hospitality has shown positive growth every years since 1993. In fact, Professional Services show a stronger correlation with Contruction than Hospitality does...

"Over 15,000 new restaurant jobs have been created in the last four and a half years". That's about what I would expect. Here's the math... 240,000 new residents in San Diego since 2000 (sandag) each spending about $1,500/year dining out, thats $360M in new annual revenue since 2000. Let's say your average restaurant does about $1.5M annually with 50 employees, that's 14,400 new jobs. That's increases based on population growth only... no increases in tourism, etc.

As to the disparity between Hotel Jobs, it widely known that the construction of new hotels slowed dramatically after 9/11. SOSD had a pretty good article looking at the past few years and looking ahead in San Diego http://www.signonsandiego.com/uniontrib/...
Assuming the economy doesn't blow up the hiring trends should reverse over the next few years... Plus each hotel employee generates about 4 times the revenue of their restaurant counterpart.

I got in this business by accident. But believe me, in this dual income, nuclear family, no time to cook, instant gratification atmosphere, the only things I'd rather be selling is gas and coffins.

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