the recovery: is it real? san diego economic conference, residential real estate section, may 2010

The Recovery: Is It R

eal? 2010 San Diego Econom

ic Forecast Conference Volu

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BEACONECONOMICS

Economic ForecastConference

2010 SAN DIEGOReal?Is It

RECOVERY:The

BEACONECONOMICS

Residential Real Estateby Patrick S. DuffyMetroIntelligence Real Estate Advisors

ContentsKey Chapter Findings 72Overview 72New Home Sales 74Existing Single-Family Home Sales 76Existing Condominium Sales 77The Apartment Rental Market 79Foreclosures and Defaults 81Residential Building Permits 82

Residential Real Estate Beacon Economics

Key Chapter Findings

Falling home prices in San Diego County have made them exponentially more affordable, with 48% ofhouseholds able to buy the median-priced home at current interest rates, up exponentially from the midsingle digits noted from the last half of 2004 through the end of 2006.

Although the S&P/Case-Shiller Index has shown small increases of home prices in recent quarters, thoserises could be short-lived as interest rates rise and support by the federal government in the form of taxcredits expire.

A combination of state tax credits favoring new homes as well as cost cutting by home builders has helpednew home sales rebound by 11% since the trough in the first quarter of 2009. Although prices here tooklonger to crest during the boom versus the overall state, they did hit bottom during the fourth quarter of2009 and have since rebounded by over 14% to $432,603.

Due to continuing price declines of 17% over the past two years, sales of existing homes - of which about35% are foreclosures - rose by 48% during the same time period. However, since the fourth quarter of 2009sales have fallen by 12% while prices still rose by 1.6% to $371,401.

Due to price declines of 26% over the past two years, sales of existing condominiums rose by 65% duringthe same time period. However, since the fourth quarter of 2009 condo sales dipped by nearly 9% as pricescontinued to rise by 1.2% to $224,833.

A combination of the soft economy, poor housing market and shadow supply will continue to pressurethe local apartment market, keeping vacancy rates north of 5.5% through the beginning of 2011. Askingrents are thus projected to continue falling to $1,429 during that same time period, or by 2.0% from thefirst quarter of 2010.

Although both foreclosure and default filings did decline between the fourth quarter of 2009 and the firstquarter of 2010, more recent indications show rises in loan defaults between February andMarch of 2010.

Overview

Although San Diego County didn’t see the signifi-cant overbuilding of new homes that characterizedother regions, such as the Inland Empire and theCentral Valley, its housing market was still groundzero for the type of rapid pricing escalations thatwere so disconnected from the basic economic fun-damentals that the incredible boom had no choicebut to devolve into a crushing bust. In the wake ofthe steepest decline in prices since the Great Depres-sion, the new-home industry remains in tatters, withmost of the demand sated by deeply discounted fore-

closures and—more recently—short sales. However,the correction in home prices has occurred faster andmore steeply than witnessed in previous downturns,which should help bring prices back into balance with

…at current household incomes, 48% of thecounty’s households can afford themedian-priced home at prevailing

interest rates.

household incomes and potential rental rates soonerrather than later, thereby setting the stage for slowbut steady growth.

72 2010 San Diego Economic Forecast Conference

Beacon Economics Residential Real Estate

S&P/Case-Shiller Tiered Price Index, San Diego Metropolitan AreaFebruary 2010 (Percent Changes, Seasonally-Adjusted)Comparison Low Tier Middle Tier High Tier AggregatePeriod (Under $312,655) ($312,655 - $466,339) (Over $466,339) (Overall Market)Feb-09 to Feb-10 9.4 4.9 3.4 7.6Feb-08 to Feb-10 −20.8 −13.9 −16.1 −17.0Feb-07 to Feb-10 −42.6 −31.5 −26.6 −33.0Aug-09 to Feb-10 11.1 5.5 3.4 5.9

Peak to Now −84.0 −55.0 −42.1 −57.1

Source: Standard&Poor's/Case-Shiller

In fact, San Diego’s affordability index, as measuredby the NAHB/Wells Fargo Housing Opportunity Index,reached 48% during the first quarter of 2010. Whilethat’s a bit lower than the recent peak of nearly 59%during the first quarter of 2009, it’s still exponentiallyhigher than the mid single digits seen from the lasthalf of 2004 through the end of 2006. This means thatat current household incomes, 48% of the county’shouseholds can afford themedian-priced home at pre-vailing interest rates.

From an historical perspective, the earlier increase inhome values throughout the county, state, and nationreduced home affordability to levels never seen be-fore. After last bottoming out during the fourth quar-ter of 1995, the S&P/Case-Shiller Index for San DiegoCounty—which compares the sales prices of the samehomes over time—began to consistently rise by thefirst half of 1998. At first the rise was gradual, but bythe early years of thenewcentury, it became exponen-tial. Between the first quarter of 1998 and the secondquarter of 2003, the index doubled; it tripled by thesecond quarter of 2005 and eventually peaked in thefirst quarter of 2006, after rising by about 210% overan eight-year period.

When the pricing bubble in the county finally did popduring the first quarter of 2006, the decline in the in-dex was initially contained, because home prices tendto be sticky. It fell by less than 9% over the next year.However, by the end of 2007 the pricing decline began

to gain momentum, with the index falling by 25% be-tween the fourth quarters of 2007 and 2008. It wasn’tuntil the second quarter of 2009 that San Diego homeprices finally hit bottom, falling by 42% since the peakand landing at levels not seen since early 2003.

Although prices in the county did rise again betweenthe second and third quarters of 2009, the size of theincrease—an anemic 3.1%—demonstrates the fragilityof the housing rebound. During the same time period,the index rose by only 3.4% throughout California andby a mere 1.8% for the entire United States.

From an historical perspective, the earlierincrease in home values throughout thecounty, state, and nation reduced homeaffordability to levels never seen before.

Moreover, mid- and high-priced homes could con-tinue to face pricing declines because, according tothe index, these homes did not see the declines expe-rienced by homes in the entry-level sector. BetweenFebruary of 2007 and February of 2010, prices forentry-level homes priced under $312,655 in San DiegoCounty fell by 43%, compared to a decline of just 32%for mid-level homes (those priced from $312,655 to$466,339) and 27% for the higher-priced homes (thosepriced over $466,339). Between the pricing peak inApril of 2006 and February of 2010, the pricing indexfor entry-level homes fell by 84%, compared to 55%

2010 San Diego Economic Forecast Conference 73


for mid-level homes and just 42% for higher-pricedhomes.

Eventually, homes in the mid- and high-pricedtiers—especially those originally reliant on jumboor option adjustable-rate mortgages—could see thesame types of price declines already noted for theentry-level tier. Because the housing market typi-cally provides a financial ladder for most homebuy-ers—that is, starter condo to townhome to smallsingle-family home to larger single-family home toluxury condo—without sufficient equity to purchasemid-level homes, entry-level buyers who can affordtheir mortgages often have little choice but to remainin place. Consequently, in order to sell their homes,

Between the pricing peak in April of 2006and February of 2010, the pricing index forentry-level homes fell by 84%, compared to55% for mid-level homes and just 42% for

higher-priced homes.

owners of mid-level units may eventually have to ca-pitulate on price. Similar trends could also affect thehighest pricing tier, although that segment also cap-tures buyers with greater resources who bring in eq-uity based not just on previous home sales but also onprior gains from stocks, bonds and other investments.

However, for now the specter of further price declineshas been avoided, as the S&P/Case-Shiller Index forSan Diego County rose 7.6% between February of 2009and 2010 (ranging from 3.4% to 9.4% for each pric-ing tier). Moreover, the entry-level tier has enjoyedthe strongest rebound, rising by 9.4% over the pastyear. The rise in the index is likely owing to the bar-gain hunters who have taken advantage of sharplylower prices and have thus provided a floor to housingprices, a floor that could prove to be temporary if therecent wave of foreclosures continues.

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Q1-88 Q3-91 Q1-95 Q3-98 Q1-02 Q3-05 Q1-09

San Diego (MSA) California United States

Source: 1010Data

Single-Family Home Prices, Q1-88 to Q4-09Case-Shiller Index

New Home Sales

As one of the major real estate markets in Califor-nia, San Diego County might be expected to reflectstatewide patterns, but the county slightly precededoverall statewide trends during the recent boom-and-bust cycle, with total new home sales (includ-ing those not part of major subdivisions) reaching apeak of nearly 4,300 units in the second quarter of2005—about three quarters before the peak reportedby Los Angeles County. However, seasonally adjustednew home sales subsequently fell much faster thanmost experts had anticipated, bottoming out at 643units by the first quarter of 2009 for a peak-to-troughdecline of 85%. Since then, due in large part to gener-ous incentives provided by both the federal and stategovernments for buyers of new homes, new homesales have rebounded by about 11%. Nonetheless, newhome sales in the county have been generally bounc-ing around between 650 and 900 units since the thirdquarter of 2008. While sales did rise by 13% betweenthe first quarters of 2009 and 2010, they fell by 18%between the traditionally slow fourth quarter of 2009and the first quarter of 2010.



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Q1-90 Q2-93 Q3-96 Q4-99 Q1-03 Q2-06 Q3-09

San Diego County California

Source: DataQuick

Q1-90 to Q1-10New Home Sales

While new home sales peaked earlier in San DiegoCounty than in California, new home prices in SanDiego actually peaked a bit later than they didstatewide. Whereas the statewide peak in home pricesoccurred in late 2005, here prices peaked in the firstquarter of 2008, at $522,468. After this peak, accordingto DataQuick, new home prices ranged mostly from$430,000 to $480,000 for several quarters before dip-ping to a new trough of $378,160 in the fourth quarterof 2009—about the same level noted in the first quar-ter of 2002. By the first quarter of 2010, prices did riseagain by just over 14%, to $432,603, but they are stilldown by 3.6% from the same quarter of 2009 and downby 17% from the same quarter of 2008.

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Source: DataQuick

Q1-90 to Q3-09New Home Median Prices

According to new home data provider Hanley WoodMarket Intelligence, new home prices for the homes

they track are also on the rebound. Between thefirst quarters of 2009 and 2010, median minimumasking prices rose by 8.2%, to $531,945. Still, var-ious sectors of new homes performed differently,with asking prices for single-family homes—often lo-cated in outlying submarkets—falling by over 10%,to $589,740, whereas those for condominiums fell by8%, to $437,667. At the same time, prices for town-homes/plexes rose by 27%, to $466,990. Of course ask-ing prices do not include incentives, which can sub-stantially lower the effective sales price of a newhome.

During the same time period, new home sales trackedby Hanley Wood—sales helped to a large degree byfederal and state tax credits—rose by 21%, to 673homes. Sales of new single-family homes rose by aneven sharper 45%, to 424 units, while sales of town-homes/plexes fell by 21%, to just 85 homes.

By the first quarter of 2010, prices did riseagain by just over 14%, to $432,603, but theyare still down by 3.6% from the same quarter

of 2009 and down by 17% from the samequarter of 2008.

Fortunately, cancellation rates are down sharply, av-eraging 8.6% during the first quarter of 2010, or nearly9 percentage points lower than the average noted ayear ago. In fact, cancellation rates for all new hous-ing sectors tracked by Hanley Wood were either rela-tively flat or fell sharply between the first quarters of2009 and 2010, ranging from 6.3% for condominiumsto 9.4% for single-family units.

Accompanying the sharp rise in new home sales wasa 71% bump in the absorption of new homes—therate at which new home communities sell their in-ventory—to 1.67 sales per month per project. Notably,the absorption rate was strongest for new condomini-ums (1.74 sales permonth) versus single-family homes(1.66 sales per month).



San Diego County New Home SummaryJan. 2010 - Mar. 2010

2010 2009 % ChangedNet SalesSF 424 292 45.2TH/Duplex/Plex 85 107 -20.6Condos 164 156 5.1Total 673 555 21.3Monthly Sales/ProjectSF 1.656 0.896 84.9TH/Duplex/Plex 1.604 1.551 3.4Condos 1.745 0.907 92.4Total 1.670 0.979 70.6Median Minimum Sales PriceSF 589,740 657,191 -10.3TH/Duplex/Plex 466,990 367,400 27.1Condos 437,667 475,900 -8.0Total 531,945 491,495 8.2Median Price Per S.F.SF 215.05 205.26 4.8TH/Duplex/Plex 251.88 210.16 19.9Condos 396.71 384.10 3.3Total 236.52 227.42 4.0Cancellation Rate (%)SF 9.4 14.1 DownTH/Duplex/Plex 8.6 7.0 UpCondos 6.3 27.4 DownTotal 8.6 17.2 DownSource: Hanley Wood Market Intelligence

Due to differences in product type and constructionstatus, new home inventory can vary greatly fromquarter to quarter. It’s often common for larger con-dominium projects—because they are usually built inone or two phases—to offer more finished units forsale. At the end of March 2010, there were just 440total new homes completed but unsold, represent-ing a decline of 69% over the same period of 2009.In fact, declines in standing inventory were seen inall housing categories, ranging from 37% for single-family homes to 57% for townhomes/plexes. At cur-rent net sales rates, these unsold completed homeswould sell in just under twomonths overall, comparedto just over 2.5weeks for single-family homes andoversix months for condominiums. In addition, there werejust 161 new homes of all types under construction bythe end ofMarch 2010, which at current net sales rateswould be sold out within about three weeks.

However, there are also an additional 4,024 unitsplanned for development in the future phases of ex-isting projects which, at current net sales rates, wouldtake nearly 18 months to sell. Nonetheless, given therelatively low levels of sales in the current environ-ment, it’s likely that these units in future phases willbe absorbedmore quickly as sales eventually rebound.

The accompanying list summarizes active new homeprojects in San Diego County by city and sector astracked by Hanley Wood Market Intelligence duringthe first quarter of 2010.

Existing Single-Family Home Sales

After last peaking at nearly 10,000 units during thethird quarter of 2003, seasonally adjusted sales of ex-isting single-family homes in San Diego County begana constant slide that bottomed out at under 3,600 unitsby the end of 2007. Due to continuing pricing declinesas well as to tax credit programs, sales rebounded to6,699 units during the fourth quarter of 2009—a rise of88%—before falling by 12% during the first quarter of2010, to 5,883 homes. Over the past several quarters,

…there were just 161 new homes of all typesunder construction by the end of March

2010, which at current net sales rates wouldbe sold out within about three weeks.

sales have predominantly ranged between 5,800 and6,700 units per quarter. Although rising by 48% sincethe first quarter of 2008, sales are down by 4.4% sincethe same quarter of 2009.

According to Zillow.com, during February of 2010, 35%of these sales countywide were for homes that hadbeen in foreclosure, which makes it very difficult forboth homebuilders and sellers of market-rate existinghomes not at risk of foreclosure to compete. In addi-tion, according to DataQuick for March of 2010, with



27% of buyers of homes throughout Southern Califor-nia paying cash, another 39% taking on FHA-insuredloans, and 21% buying second homes or homes for in-vestment purposes, today’s buyers continue to lookfor lower-priced bargains rather than move-up hous-ing.

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Q1-90 to Q1-10Existing Single-Family Sales

According to proprietary forecasts by Beacon Eco-nomics, single-family home sales in the county areexpected to continue rising to approach 7,200 unitsper quarter in the second quarter of 2010 but willthen stage a slight retreat to a range of 6,300 to6,800 units from the end of 2010 through the mid-dle of 2012 as the popular tax credit programs ex-pire and as long-termmortgage rates start to rise. Yetby the tail end of 2012—and as the economy regainsstrength—quarterly sales are expected to continuerising again through the end of the forecast period(the fourth quarter of 2015). From mid-2013 throughthe end of 2015, pent-up demand and a stronger jobbase could push quarterly sales of existing single-family homes to nearly 7,500 units per quarter—afaster pace than even the boomyears of 2006 and 2007.

Not surprisingly, there remains a strong correlationbetween this rebound in sales and the continuing de-clines in median prices. After last peaking at nearly$572,000 during the first quarter of 2006, the medianprice for an existing single-family home in San DiegoCounty finally reached a trough of $324,210 by the

first quarter of 2009, for a decline of 43%. Nonetheless,prices have since rebounded by over 14%, to nearly$371,401, although they’re still down by 17% since thefirst quarter of 2008.

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Q1-90 to Q1-10Existing Single-Family Median Home Prices

Again, according to proprietary forecasts by Bea-con Economics, single-family home prices, after theirrapid fall in San Diego, are expected to continue ris-ing from now through the end of the forecast pe-riod (the end of 2015). After stalling from the end of2010 through the end of 2011, prices should push pastthe $400,000 level by the first quarter of 2012, reach$425,000 by the beginning of 2014, and end 2015 atnearly $460,000.

…single-family home sales in the county areexpected to continue rising to approach

7,200 units per quarter in the second quarterof 2010 but will then stage a slight retreat toa range of 6,300 to 6,800 units from the end of

2010 through the middle of 2012…

Existing Condominium Sales

Given their generally affordable prices, condomini-ums can be a popular investment for first-time buyersand investors when there is a housing boom. Yet when



a housing boom turns to bust, their sales can ebb andflow even more wildly than sales in the single-familyhome market.

In San Diego, the condominium boom in the down-town core and elsewhere helped boost sales by 167%between 1995 and 1999 before taking a breather in2000 and 2001. Thereafter, the housing boom that oc-curred after the September 11, 2001, attacks helpedto reinvigorate the condominium market, with sea-sonally adjusted sales peaking in late 2003 at over4,600 units. However, between this peak and the mostrecent trough in the fourth quarter of 2007, condo-minium sales fell to 1,738 units, for a decline of 62%.Although condominium sales have since recoverednicely to nearly 3,100 sales—rising by 65%between thefirst quarters of 2008 and 2010, and by 11.5% from thefirst quarter of 2009—over the last quarter alone theyhave fallen by 8.6% as prices have begun to rebound.

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Q1-90 Q2-93 Q3-96 Q4-99 Q1-03 Q2-06 Q3-09


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Q1-90 to Q1-10Existing Condominium Sales

Of course, like the sales of single-family homes, con-dominium sales rose because prices began a steep de-cline, falling by 51% to the latest trough of $197,809by the middle of 2009, after last peaking at nearly$401,561 during the fourth quarter of 2005. Follow-ing the second quarter of 2007, however, condo priceshave been on the mend, rising by nearly 14% by thefirst quarter of 2010. More recently, however, this re-bound has flattened out, with prices rising by just 1.2%since the fourth quarter of 2009.

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Q1-90 to Q1-10Existing Condominium Median Home Prices

However, given tighter lending guidelines by the FHAfor condominium projects, this sector could facemorepowerful headwinds if buyers are unable to locate ap-propriate financing. In past years, individual loanswere approved without regard to a condominiumproject’s status. Today, entire developments mustfirst be approved by the FHA. When approving a con-

…given tighter lending guidelines by theFHA for condominium projects, this sectorcould face more powerful headwinds…

dominium project, FHA analysts look at a range of fac-tors, including cash reserves held by theHOA (with theFHApreferring to see 10%of the budget earmarked forthe reserve fund), the ratio of leased units to owner-occupied units, the number of residents late on payingfees and assessments, and the need for ongoing main-tenance and repairs. In addition, FHA is limiting its ex-posure in individual projects, capping its percentageof loans at 30%. Finally, for urban buyers consideringone of the popular mixed-use projects, where retailspace and residential units are combined, the FHA haslimited the ratio of retail uses of an entire building onwhich they’ll lend to 20% of the total square footage.



The Apartment Rental Market

The one part of the housing market that had lookedrelatively solid through the end of 2008 was the apart-ment rentalmarket. Over the last 18months, however,this sector’s fundamentals have begun to weaken,with vacancy rates rising by 80 basis points—or17%—to 5.5%, or slightly above the 5.0% rate gener-ally considered to be market equilibrium. By the endof 2010, the vacancy rate could rise slightly to 5.6%and remain above 5% through the end of 2011. Mov-ing into the first part of 2012, vacancy rates are pro-jected first to fall below 5% and then to slip below4.0% a year later as pent-up demand is sated and asthe economic rebound gains traction. The good newsfor landlords is that by themiddle of 2013 through theend of 2014, vacancy rates could range from 3.7% to3.8%, thus prompting strong rental rate growth. Yetfor now, most apartment landlords are offering a va-riety of generous concessions to potential tenants, andin some cases even lowering existing rents in order tokeep those who complain.

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San Diego (MSA) Los Angeles (MD)Inland Empire (MSA) Orange County (MD)

*These data are seasonally adjusted and smoothedSource: Property & Portfolio Research

Q1-90 to Q1-10Apartment Vacancy Rate

Although rent growth in San Diego County had beenquite healthy, even as the for-sale housing market be-gan to tumble, by the last half of 2008 larger economicfactors began taking their toll, with rent growth turn-ing negative. Although quarterly rent growth is ex-pected to remain in negative territory from now

through the second quarter of 2011, after that periodit will stage a strong rebound, ranging mostly from0.6% to 0.8%.

After last peaking at $1,541 per month in the secondquarter of 2008, asking gross rents began to graduallydecline, falling by 5.3% to $1,459 by the first quarterof 2010. Rents are projected to continue falling to justunder $1,429 by the first quarter of 2011, after whichthey’ll begin to rise again slowly. With rents expected

The good news for landlords is that by themiddle of 2013 through the end of 2014,

vacancy rates could range from 3.7% to 3.8%,thus prompting strong rental rate growth.

to approach $1,590 by the end of 2014, they’ll be thehighest they’ve ever been. Still, one caveat to keepin mind is that these are asking rents—many land-lords are offering incentives (sometimes as much astwo free months in exchange for a long-term lease),so effective rents could be 10% to 15% lower.

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Q1-90 to Q1-10Apartment Cost of Rent

Net absorption levels, which were briefly negative inSan Diego County during the fourth quarter of 2008and the first quarter of 2009, have been in positive ter-ritory over the last several quarters. However, start-ing in the last half of 2010, absorption levels are ex-pected to dip again into negative territory for twoquarters before rebounding as we move into 2011. By



the end of 2011, pent-up demand will begin to pushquarterly absorption levels up sharply, with levelsranging well over 1.1 million square feet per quar-ter throughout 2012 and into mid-2013. Thereafter,absorption levels will likely decline a bit but still re-main strong, ranging predominantly from 600,000 to900,000 square feet per quarter.

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Q1-90 to Q1-10Apartment Net Absorption

Finally, cap rates for apartment investors—which fellbelow 4.70% in mid-2006 as prices were rising fasterthan rent rolls—have steadily rebounded back tonearly 7.20% as credit has dried up and as landlordswishing to sell have been forced to lower prices. Infact, between the first quarters of 2008 and 2010, caprates rose by nearly 37%, with close to half of that in-crease occurring since the first quarter of 2009. Look-ing ahead, cap rates are projected to peak at 7.28%during themiddle of 2011 through the end of the year,before beginning a slow yet gradual decline there-after. Nonetheless, by the end of 2014, cap rates willstill average close to 6.40%, which is just below wherethey were in the middle of 2009.

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Q1-90 to Q1-10Apartment Cap Rates

Given the size of the countywide market for apart-ments, it’s not surprising that the various submarketshave performed differently. For example, although

Given the size of the countywide market forapartments, it’s not surprising that thevarious submarkets have performed

differently.

San Diego County averaged ametro-wide vacancy rateof 6.3% during the first quarter of 2010, it was farhigher in the Central Business District (i.e., downtownSan Diego) at 10.0%, owing in large part to the area’scomplement of new condominiums and lofts, unitsthat were either originally added to the rental poolor converted when the for-sale housing market wentbust. Most of the other submarkets posted vacancyrates of about 5.0% to 6.0%, with the lowest rates seenin the I-5 corridor (4.6%) and the South County (4.8%).

While the Central Business District had the highest va-cancy rates, the highest asking rents were found inMissionValley/North Central ($1,697), and the I-5 cor-ridor ($1,660). The lowestmonthly asking rents duringthe first quarter of 2010 were found in the East County($1,275) and South County ($1,276).

Looking ahead into the forecast period, if the chil-dren of the baby boomers do indeed become an im-portant “echo boomer” cohort, San Diego could bene-



San Diego Apartment SubmarketsSnapshot: Q1-2010

Market Total Inventory Occupied Rental Vacancy Absorption(1,000s S.F.) (1,000s S.F.) Rate ($) Rate (%)CBD 54, 310 48, 879 1,437.00 10.0 −169East County 21, 250 20, 124 1,275.00 5.3 −13I-15 Corridor 31, 855 29, 880 1,532.00 6.2 −31I-5 Corridor 39, 954 38, 116 1,660.00 4.6 74Mission Valley/North Central 21, 616 20, 319 1,697.00 6.0 −47North County 23, 864 22, 408 1,547.00 6.1 −33South County 74, 085 70, 529 1,276.00 4.8 7Metrowide 266, 994 250, 173 1,456.00 6.3 −212

Source: Property & Portfolio Research

fit greatly. Between now and 2014, nearly 75,000 newresidents in their prime renting years will graduatefrom college and begin to enter the workforce, manyof whom will be attracted to the county’s weatherand high-tech job opportunities. By late 2012 andinto 2013, pent-up demand will greatly increase quar-terly absorption levels, thus paving the way for newconstruction by 2014 and 2015. Moreover, given SanDiego’s high cost of living relative to other cities, fu-ture households will opt to rent simply because that’sthe only option.

If there is any future risk to a rebound in the apart-ment market in the short to medium term, it’s that ofthe shadow supply in the downtown area. With more

If there is any future risk to a rebound in theapartment market in the short to mediumterm, it’s that of the shadow supply in the

downtown area.

than 8,000 condo units built between 2001 and 2008,hundreds of these units continue to compete with tra-ditional market-rate apartments. In addition, poten-tial renters whomight have chosen these market-rateapartments could be greatly tempted by luxury con-dos turned into rentals.

Foreclosures and Defaults

Over the last few years, the dominant story in theSan Diego County residential real estate market hasbeen the endless line of foreclosures, which at thepeak accounted for over half of all existing home sales.Although the well-intentioned $75 billion plan an-nounced by the Obama Administration was enactedto help up to 4 million borrowers at risk of foreclo-sure modify unaffordable mortgages, from its incep-tion through March of 2010 it has only helped about230,000 borrowers.

With up to 7 million borrowers late on their mort-gage payments, and with First American CoreLogic es-timating that 25% of borrowers nationally owe morethan their homes are worth, it’s not that surprisingthat 60% of loans modified through the federal pro-gram in late 2008 defaulted within a year, therebysimply delaying the day of reckoning. In March of2010, under pressure to do more about foreclosures,the Obama Administration announced an expansionof the original $75 billion plan to begin this fall, fi-nanced by money from the Troubled Asset Relief Pro-gram (TARP).

With the expanded plan, lenders will be encouragedto consider reducing loan balances, something bankshave been reluctant to grant since mortgage servicers



are contractually obligated to dowhatever is in the in-vestor’s best interest. Another component of the planis to temporarily reduce or suspend mortgage pay-ments—for up to sixmonths—for those employed bor-rowers who receive unemployment insurance bene-fits, afterwhich time the borrowerwould be evaluatedfor loan modifications. A third option is for borrow-ers current on their mortgages but living in underwa-ter homes to refinance into FHA loans worth 97.75% to115% of their home’s current value, depending on theexistence of any second liens.

In fact, the quarterly rate of seasonally adjusted fore-closures for single-family homes in San Diego Countyrose from just over 100 homes in the fourth quarterof 2005 to nearly 4,200 homes by the same quarter of2009. Although the rate of foreclosures did dip by 20%from the fourth quarter of 2009, to 3,338 units, therate could rise again as banks begin to bring more de-faulted homes to the market.

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Q1-94 Q1-96 Q1-98 Q1-00 Q1-02 Q1-04 Q1-06 Q1-08 Q1-10


Source: DataQuick

Q1-1994 to Q1-2010Foreclosures

With option ARM loans originating at the height of thehousing boom resetting to higher interest rates nowthrough early 2012, andwith lenders hinting at releas-ing REO properties that were caught up in previousmoratoriums, or sitting on their books as they rebuildtheir capital bases, we should expect to see elevatedforeclosure levels for some time. For now, investorsand buyerswith cash continue to hold the powerwhencompeting with more traditional buyers, not only for

REOs and short sales but also for homes of all typesand in all areas.

An early sign of future foreclosures are loan defaults,which did fall to 5,463 homes, representing declinesof 28% and 39% over the past 12 and 24 months, re-spectively. Nonetheless, quarterly default filings stillremain at levels exponentially higher than during thefirst half of the last decade.

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Q1-02 Q1-03 Q1-04 Q1-05 Q1-06 Q1-07 Q1-08 Q1-09 Q1-10


Source: DataQuick

Q1-2002 to Q1-2010Defaults

Residential Building Permits

The number of building permits issued can often beviewed as a forward-looking indicator for the relativehealth of the local housingmarket. But given the hugeplunge in demand for new housing units, permit is-suances fell by about 57% between 2007 and 2009. Thefollowing table summarizes building permits for SanDiego County, showing that just 1,862 single-familypermits were issued in 2009, for a decline of over 45%from 2007 and of 20% from 2008. For multi-familyunits, the decline from 2007 to 2009 was even morepronounced, at 67%. Multi-family permits also fell by59% between 2008 and 2009, as larger apartment andcondominiumprojects finished up just in time to greetan ailing housing market.

Looking ahead to the rest of 2010 and beyond, pro-prietary forecasts by Beacon Economics are showing a



Building Permits ($ Mill)San Diego County, 2007 to Q1-2010Year Single Family 2-Units 3-4 Units Five+ Units MF Units Total2007 3,418 141 273 3,219 3,640 7,1222008 2,323 71 101 2,759 2,938 5,1732009 1,862 47 78 1,085 1,216 3,093Q1-2009 402 7 20 311 337 758Q1-2010 637 16 69 180 257 883Q1-09 to Q1-10 (%) 58.6 125.8 242.2 -42.1 -23.7 16.42008 - 2009 (%) -19.8 -33.8 -22.8 -60.7 -58.6 -40.22007 - 2009 (%) -45.5 -66.7 -71.3 -66.3 -66.6 -56.6Source: CIRB

gradual increase in single-family permits, which hit aquarterly low of just 400 permits in the first quarter of2009. For the remainder of 2010, single-family permitsshould gradually rise, from just under 700 units in thefirst quarter of 2010, to 1,036 units by the fourth quar-ter of the year. Thereafter—and as the housing mar-ket begins to pull out of the doldrums—single-familyhousing permits will continue rising, exceeding 1,100units by the first quarter of 2011, 1,400 units by thefirst quarter of 2014, and 1,600 units by the end of2014.

Actual Forecast

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Q1-04 Q3-05 Q1-07 Q3-08 Q1-10 Q3-11 Q1-13Forecast by Beacon Economics

San Diego County, Q1-04 to Q4-13Single-Family Building Permit Forecast

For themulti-family sector, permits hit bottomduringthe third quarter of 2003, at just 280 units, but havesince rebounded slightly to 291 units. For this sector,the rebound in permitting will be slow, surpassing 300

units per quarter in the second quarter of 2010, 400units in the second quarter of 2011, and 700 units inthemiddle of 2013. By the third quarter of 2014,multi-family permits could cross the 1,000-unit level,match-ing what they were in the first quarter of 2007.

Actual Forecast

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Q1-04 Q3-05 Q1-07 Q3-08 Q1-10 Q3-11 Q1-13Forecast by Beacon Economics

San Diego County, Q1-04 to Q4-13Multi-Family Building Permit Forecast


the recovery: is it real? san diego economic conference, residential real estate section, may 2010

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