The Recovery: Is it Real? San Diego Economic Conference, Residential Real Estate Section, May 2010

The
RECOVERY:
Is It Real?
2010 SAN DIEGO
Economic Forecast
Conference

BEACON ECONOMICS

BEACON ECONOMICS

Residential Real Estate
by Patrick S. Duffy
MetroIntelligence Real Estate Advisors

Contents
Key Chapter Findings 72
Overview 72
New Home Sales 74
Existing Single-Family Home Sales 76
Existing Condominium Sales 77
The Apartment Rental Market 79
Foreclosures and Defaults 81
Residential 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% of
households able to buy the median-priced home at current interest rates, up exponentially from the mid
single 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, those
rises could be short-lived as interest rates rise and support by the federal government in the form of tax
credits expire.

A combination of state tax credits favoring new homes as well as cost cutting by home builders has helped
new home sales rebound by 11% since the trough in the first quarter of 2009. Although prices here took
longer to crest during the boom versus the overall state, they did hit bottom during the fourth quarter of
2009 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 about
35% are foreclosures - rose by 48% during the same time period. However, since the fourth quarter of 2009
sales 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% during
the same time period. However, since the fourth quarter of 2009 condo sales dipped by nearly 9% as prices
continued to rise by 1.2% to $224,833.

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

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

Overview closures and—more recently—short sales. However,
the correction in home prices has occurred faster and
Although San Diego County didn’t see the signifi- more steeply than witnessed in previous downturns,
cant overbuilding of new homes that characterized which should help bring prices back into balance with
other regions, such as the Inland Empire and the
Central Valley, its housing market was still ground …at current household incomes, 48% of the
zero for the type of rapid pricing escalations that county’s households can afford the
were so disconnected from the basic economic fun- median-priced home at prevailing
damentals that the incredible boom had no choice interest rates.
but to devolve into a crushing bust. In the wake of
the steepest decline in prices since the Great Depres- household incomes and potential rental rates sooner
sion, the new-home industry remains in tatters, with rather than later, thereby setting the stage for slow
most of the demand sated by deeply discounted fore- but steady growth.

72 2010 San Diego Economic Forecast Conference

Beacon Economics Residential Real Estate

S&P/Case-Shiller Tiered Price Index, San Diego Metropolitan Area
February 2010 (Percent Changes, Seasonally-Adjusted)
Comparison Low Tier Middle Tier High Tier Aggregate
Period (Under $312,655) ($312,655 - $466,339) (Over $466,339) (Overall Market)
Feb-09 to Feb-10 9.4 4.9 3.4 7.6
Feb-08 to Feb-10 −20.8 −13.9 −16.1 −17.0
Feb-07 to Feb-10 −42.6 −31.5 −26.6 −33.0
Aug-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 measured to gain momentum, with the index falling by 25% be-
by the NAHB/Wells Fargo Housing Opportunity Index, tween the fourth quarters of 2007 and 2008. It wasn’t
reached 48% during the first quarter of 2010. While until the second quarter of 2009 that San Diego home
that’s a bit lower than the recent peak of nearly 59% prices finally hit bottom, falling by 42% since the peak
during the first quarter of 2009, it’s still exponentially and landing at levels not seen since early 2003.
higher than the mid single digits seen from the last
Although prices in the county did rise again between
half of 2004 through the end of 2006. This means that
the second and third quarters of 2009, the size of the
at current household incomes, 48% of the county’s
increase—an anemic 3.1%—demonstrates the fragility
households can afford the median-priced home at pre-
of the housing rebound. During the same time period,
vailing interest rates.
the index rose by only 3.4% throughout California and
From an historical perspective, the earlier increase in by a mere 1.8% for the entire United States.
home values throughout the county, state, and nation
reduced home affordability to levels never seen be- From an historical perspective, the earlier
fore. After last bottoming out during the fourth quar- increase in home values throughout the
ter of 1995, the S&P/Case-Shiller Index for San Diego county, state, and nation reduced home
County—which compares the sales prices of the same affordability to levels never seen before.
homes over time—began to consistently rise by the
first half of 1998. At first the rise was gradual, but by
the early years of the new century, it became exponen- Moreover, mid- and high-priced homes could con-
tial. Between the first quarter of 1998 and the second tinue to face pricing declines because, according to
quarter of 2003, the index doubled; it tripled by the the index, these homes did not see the declines expe-
second quarter of 2005 and eventually peaked in the rienced by homes in the entry-level sector. Between
first quarter of 2006, after rising by about 210% over February of 2007 and February of 2010, prices for
an eight-year period. entry-level homes priced under $312,655 in San Diego
County fell by 43%, compared to a decline of just 32%
When the pricing bubble in the county finally did pop for mid-level homes (those priced from $312,655 to
during the first quarter of 2006, the decline in the in- $466,339) and 27% for the higher-priced homes (those
dex was initially contained, because home prices tend priced over $466,339). Between the pricing peak in
to be sticky. It fell by less than 9% over the next year. April of 2006 and February of 2010, the pricing index
However, by the end of 2007 the pricing decline began for 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-priced Case-Shiller Index
homes. 250
Single-Family Home Prices, Q1-88 to Q4-09

Eventually, homes in the mid- and high-priced
tiers—especially those originally reliant on jumbo 200

Index (Q1-2000 = 100, SA)
or option adjustable-rate mortgages—could see the
150
same types of price declines already noted for the
entry-level tier. Because the housing market typi- 100
cally provides a financial ladder for most homebuy-
ers—that is, starter condo to townhome to small 50

single-family home to larger single-family home to Q1-88 Q3-91 Q1-95 Q3-98 Q1-02 Q3-05 Q1-09

San Diego (MSA) California United States
luxury condo—without sufficient equity to purchase Source: 1010Data

mid-level homes, entry-level buyers who can afford
their mortgages often have little choice but to remain
in place. Consequently, in order to sell their homes,
New Home Sales
Between the pricing peak in April of 2006
As one of the major real estate markets in Califor-
and February of 2010, the pricing index for
nia, San Diego County might be expected to reflect
entry-level homes fell by 84%, compared to
statewide patterns, but the county slightly preceded
55% for mid-level homes and just 42% for
overall statewide trends during the recent boom-
higher-priced homes.
and-bust cycle, with total new home sales (includ-
ing those not part of major subdivisions) reaching a
owners of mid-level units may eventually have to ca- peak of nearly 4,300 units in the second quarter of
pitulate on price. Similar trends could also affect the 2005—about three quarters before the peak reported
highest pricing tier, although that segment also cap- by Los Angeles County. However, seasonally adjusted
tures buyers with greater resources who bring in eq- new home sales subsequently fell much faster than
uity based not just on previous home sales but also on most experts had anticipated, bottoming out at 643
prior gains from stocks, bonds and other investments. units by the first quarter of 2009 for a peak-to-trough
However, for now the specter of further price declines decline of 85%. Since then, due in large part to gener-
has been avoided, as the S&P/Case-Shiller Index for ous incentives provided by both the federal and state
San Diego County rose 7.6% between February of 2009 governments for buyers of new homes, new home
and 2010 (ranging from 3.4% to 9.4% for each pric- sales have rebounded by about 11%. Nonetheless, new
ing tier). Moreover, the entry-level tier has enjoyed home sales in the county have been generally bounc-
the strongest rebound, rising by 9.4% over the past ing around between 650 and 900 units since the third
year. The rise in the index is likely owing to the bar- quarter of 2008. While sales did rise by 13% between
gain hunters who have taken advantage of sharply the first quarters of 2009 and 2010, they fell by 18%
lower prices and have thus provided a floor to housing between the traditionally slow fourth quarter of 2009
prices, a floor that could prove to be temporary if the and the first quarter of 2010.
recent wave of foreclosures continues.



New Home Sales they track are also on the rebound. Between the
Q1-90 to Q1-10 first quarters of 2009 and 2010, median minimum
200
asking prices rose by 8.2%, to $531,945. Still, var-
150
ious sectors of new homes performed differently,
Index (Q1-2000 = 100)

with asking prices for single-family homes—often lo-
100 cated in outlying submarkets—falling by over 10%,
to $589,740, whereas those for condominiums fell by
50
8%, to $437,667. At the same time, prices for town-
homes/plexes rose by 27%, to $466,990. Of course ask-
0
Q1-90 Q2-93 Q3-96 Q4-99 Q1-03 Q2-06 Q3-09 ing prices do not include incentives, which can sub-
San Diego County California stantially lower the effective sales price of a new
Source: DataQuick
home.

While new home sales peaked earlier in San Diego During the same time period, new home sales tracked
County than in California, new home prices in San by Hanley Wood—sales helped to a large degree by
Diego actually peaked a bit later than they did federal and state tax credits—rose by 21%, to 673
statewide. Whereas the statewide peak in home prices homes. Sales of new single-family homes rose by an
occurred in late 2005, here prices peaked in the first even sharper 45%, to 424 units, while sales of town-
quarter of 2008, at $522,468. After this peak, according homes/plexes fell by 21%, to just 85 homes.
to DataQuick, new home prices ranged mostly from
$430,000 to $480,000 for several quarters before dip- By the first quarter of 2010, prices did rise
ping to a new trough of $378,160 in the fourth quarter again by just over 14%, to $432,603, but they
of 2009—about the same level noted in the first quar- are still down by 3.6% from the same quarter
ter of 2002. By the first quarter of 2010, prices did rise of 2009 and down by 17% from the same
again by just over 14%, to $432,603, but they are still quarter of 2008.
down by 3.6% from the same quarter of 2009 and down
by 17% from the same quarter of 2008.
Fortunately, cancellation rates are down sharply, av-
New Home Median Prices eraging 8.6% during the first quarter of 2010, or nearly
Q1-90 to Q3-09
200
9 percentage points lower than the average noted a
year ago. In fact, cancellation rates for all new hous-
ing sectors tracked by Hanley Wood were either rela-
Index (Q1-2000 = 100)

150
tively flat or fell sharply between the first quarters of
2009 and 2010, ranging from 6.3% for condominiums
100 to 9.4% for single-family units.
Accompanying the sharp rise in new home sales was
50
a 71% bump in the absorption of new homes—the
Q1-90 Q2-93 Q3-96 Q4-99 Q1-03 Q2-06 Q3-09

San Diego County California
rate at which new home communities sell their in-
Source: DataQuick ventory—to 1.67 sales per month per project. Notably,
the absorption rate was strongest for new condomini-
According to new home data provider Hanley Wood ums (1.74 sales per month) versus single-family homes
Market Intelligence, new home prices for the homes (1.66 sales per month).



San Diego County New Home Summary However, there are also an additional 4,024 units
Jan. 2010 - Mar. 2010
planned for development in the future phases of ex-
2010 2009 % Changed
Net Sales
isting projects which, at current net sales rates, would
SF 424 292 45.2 take nearly 18 months to sell. Nonetheless, given the
TH/Duplex/Plex 85 107 -20.6 relatively low levels of sales in the current environ-
Condos 164 156 5.1
Total 673 555 21.3 ment, it’s likely that these units in future phases will
Monthly Sales/Project be absorbed more quickly as sales eventually rebound.
SF 1.656 0.896 84.9
TH/Duplex/Plex 1.604 1.551 3.4 The accompanying list summarizes active new home
Condos 1.745 0.907 92.4 projects in San Diego County by city and sector as
Total 1.670 0.979 70.6
tracked by Hanley Wood Market Intelligence during
Median Minimum Sales Price
SF 589,740 657,191 -10.3 the first quarter of 2010.
TH/Duplex/Plex 466,990 367,400 27.1
Condos 437,667 475,900 -8.0
Total 531,945 491,495 8.2
Existing Single-Family Home Sales
Median Price Per S.F.
SF 215.05 205.26 4.8
TH/Duplex/Plex 251.88 210.16 19.9
Condos 396.71 384.10 3.3
After last peaking at nearly 10,000 units during the
Total 236.52 227.42 4.0 third quarter of 2003, seasonally adjusted sales of ex-
Cancellation Rate (%) isting single-family homes in San Diego County began
SF 9.4 14.1 Down a constant slide that bottomed out at under 3,600 units
TH/Duplex/Plex 8.6 7.0 Up
Condos 6.3 27.4 Down by the end of 2007. Due to continuing pricing declines
Total 8.6 17.2 Down as well as to tax credit programs, sales rebounded to
Source: Hanley Wood Market Intelligence
6,699 units during the fourth quarter of 2009—a rise of
88%—before falling by 12% during the first quarter of
Due to differences in product type and construction 2010, to 5,883 homes. Over the past several quarters,
status, new home inventory can vary greatly from
quarter to quarter. It’s often common for larger con- …there were just 161 new homes of all types
dominium projects—because they are usually built in under construction by the end of March
one or two phases—to offer more finished units for 2010, which at current net sales rates would
sale. At the end of March 2010, there were just 440 be sold out within about three weeks.
total new homes completed but unsold, represent-
ing a decline of 69% over the same period of 2009.
sales have predominantly ranged between 5,800 and
In fact, declines in standing inventory were seen in
6,700 units per quarter. Although rising by 48% since
all housing categories, ranging from 37% for single-
the first quarter of 2008, sales are down by 4.4% since
family homes to 57% for townhomes/plexes. At cur-
the same quarter of 2009.
rent net sales rates, these unsold completed homes
would sell in just under two months overall, compared According to Zillow.com, during February of 2010, 35%
to just over 2.5 weeks for single-family homes and over of these sales countywide were for homes that had
six months for condominiums. In addition, there were been in foreclosure, which makes it very difficult for
just 161 new homes of all types under construction by both homebuilders and sellers of market-rate existing
the end of March 2010, which at current net sales rates homes not at risk of foreclosure to compete. In addi-
would be sold out within about three weeks. tion, according to DataQuick for March of 2010, with



27% of buyers of homes throughout Southern Califor- first quarter of 2009, for a decline of 43%. Nonetheless,
nia paying cash, another 39% taking on FHA-insured prices have since rebounded by over 14%, to nearly
loans, and 21% buying second homes or homes for in- $371,401, although they’re still down by 17% since the
vestment purposes, today’s buyers continue to look first quarter of 2008.
for lower-priced bargains rather than move-up hous-
Existing Single-Family Median Home Prices
ing. Q1-90 to Q1-10

250
Existing Single-Family Sales
Q1-90 to Q1-10

Index (Q1-2000 = 100)
200
120

150
Index (Q1-2000 = 100)

100

100
80

50
60
Q1-90 Q2-93 Q3-96 Q4-99 Q1-03 Q2-06 Q3-09

40 Source: DataQuick
Q1-90 Q2-93 Q3-96 Q4-99 Q1-03 Q2-06 Q3-09

Source: DataQuick Again, according to proprietary forecasts by Bea-
con Economics, single-family home prices, after their
According to proprietary forecasts by Beacon Eco- rapid fall in San Diego, are expected to continue ris-
nomics, single-family home sales in the county are ing from now through the end of the forecast pe-
expected to continue rising to approach 7,200 units riod (the end of 2015). After stalling from the end of
per quarter in the second quarter of 2010 but will 2010 through the end of 2011, prices should push past
then stage a slight retreat to a range of 6,300 to the $400,000 level by the first quarter of 2012, reach
6,800 units from the end of 2010 through the mid- $425,000 by the beginning of 2014, and end 2015 at
dle of 2012 as the popular tax credit programs ex- nearly $460,000.
pire and as long-term mortgage rates start to rise. Yet
by the tail end of 2012—and as the economy regains …single-family home sales in the county are
strength—quarterly sales are expected to continue expected to continue rising to approach
rising again through the end of the forecast period 7,200 units per quarter in the second quarter
(the fourth quarter of 2015). From mid-2013 through of 2010 but will then stage a slight retreat to
the end of 2015, pent-up demand and a stronger job a range of 6,300 to 6,800 units from the end of
base could push quarterly sales of existing single- 2010 through the middle of 2012…
family homes to nearly 7,500 units per quarter—a
faster pace than even the boom years of 2006 and 2007.
Not surprisingly, there remains a strong correlation
between this rebound in sales and the continuing de- Existing Condominium Sales
clines in median prices. After last peaking at nearly
$572,000 during the first quarter of 2006, the median Given their generally affordable prices, condomini-
price for an existing single-family home in San Diego ums can be a popular investment for first-time buyers
County finally reached a trough of $324,210 by the and investors when there is a housing boom. Yet when



a housing boom turns to bust, their sales can ebb and Existing Condominium Median Home Prices
flow even more wildly than sales in the single-family Q1-90 to Q1-10
250
home market.
In San Diego, the condominium boom in the down- 200

Index (Q1-2000 = 100)
town core and elsewhere helped boost sales by 167%
150
between 1995 and 1999 before taking a breather in
2000 and 2001. Thereafter, the housing boom that oc- 100
curred after the September 11, 2001, attacks helped
to reinvigorate the condominium market, with sea- 50
Q1-90 Q2-93 Q3-96 Q4-99 Q1-03 Q2-06 Q3-09
sonally adjusted sales peaking in late 2003 at over
4,600 units. However, between this peak and the most Source: DataQuick

recent trough in the fourth quarter of 2007, condo-
minium sales fell to 1,738 units, for a decline of 62%. However, given tighter lending guidelines by the FHA
Although condominium sales have since recovered for condominium projects, this sector could face more
nicely to nearly 3,100 sales—rising by 65% between the powerful headwinds if buyers are unable to locate ap-
first quarters of 2008 and 2010, and by 11.5% from the propriate financing. In past years, individual loans
first quarter of 2009—over the last quarter alone they were approved without regard to a condominium
have fallen by 8.6% as prices have begun to rebound. project’s status. Today, entire developments must
first be approved by the FHA. When approving a con-
Existing Condominium Sales
Q1-90 to Q1-10
120
…given tighter lending guidelines by the
100 FHA for condominium projects, this sector
Index (Q1-2000 = 100)

could face more powerful headwinds…
80

60 dominium project, FHA analysts look at a range of fac-
tors, including cash reserves held by the HOA (with the
40
FHA preferring to see 10% of the budget earmarked for
Q1-90 Q2-93 Q3-96 Q4-99 Q1-03 Q2-06 Q3-09
the reserve fund), the ratio of leased units to owner-
Source: DataQuick occupied units, the number of residents late on paying
fees and assessments, and the need for ongoing main-
Of course, like the sales of single-family homes, con- tenance and repairs. In addition, FHA is limiting its ex-
dominium sales rose because prices began a steep de- posure in individual projects, capping its percentage
cline, falling by 51% to the latest trough of $197,809 of loans at 30%. Finally, for urban buyers considering
by the middle of 2009, after last peaking at nearly one of the popular mixed-use projects, where retail
$401,561 during the fourth quarter of 2005. Follow- space and residential units are combined, the FHA has
ing the second quarter of 2007, however, condo prices limited the ratio of retail uses of an entire building on
have been on the mend, rising by nearly 14% by the which they’ll lend to 20% of the total square footage.
first 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.



The Apartment Rental Market through the second quarter of 2011, after that period
it will stage a strong rebound, ranging mostly from
The one part of the housing market that had looked 0.6% to 0.8%.
relatively solid through the end of 2008 was the apart- After last peaking at $1,541 per month in the second
ment rental market. Over the last 18 months, however, quarter of 2008, asking gross rents began to gradually
this sector’s fundamentals have begun to weaken, decline, falling by 5.3% to $1,459 by the first quarter
with vacancy rates rising by 80 basis points—or of 2010. Rents are projected to continue falling to just
17%—to 5.5%, or slightly above the 5.0% rate gener- under $1,429 by the first quarter of 2011, after which
ally considered to be market equilibrium. By the end they’ll begin to rise again slowly. With rents expected
of 2010, the vacancy rate could rise slightly to 5.6%
and remain above 5% through the end of 2011. Mov-
The good news for landlords is that by the
ing into the first part of 2012, vacancy rates are pro-
jected first to fall below 5% and then to slip below
middle of 2013 through the end of 2014,
4.0% a year later as pent-up demand is sated and as
vacancy rates could range from 3.7% to 3.8%,
the economic rebound gains traction. The good news
thus prompting strong rental rate growth.
for landlords is that by the middle of 2013 through the
end of 2014, vacancy rates could range from 3.7% to to approach $1,590 by the end of 2014, they’ll be the
3.8%, thus prompting strong rental rate growth. Yet highest they’ve ever been. Still, one caveat to keep
for now, most apartment landlords are offering a va- in mind is that these are asking rents—many land-
riety of generous concessions to potential tenants, and lords are offering incentives (sometimes as much as
in some cases even lowering existing rents in order to two free months in exchange for a long-term lease),
keep those who complain. so effective rents could be 10% to 15% lower.

Apartment Vacancy Rate Apartment Cost of Rent
Q1-90 to Q1-10 Q1-90 to Q1-10
2,000
12

10
1,500
Percentage

8

6 1,000

4

2 500

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

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

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

Although rent growth in San Diego County had been Net absorption levels, which were briefly negative in
quite healthy, even as the for-sale housing market be- San Diego County during the fourth quarter of 2008
gan to tumble, by the last half of 2008 larger economic and the first quarter of 2009, have been in positive ter-
factors began taking their toll, with rent growth turn- ritory over the last several quarters. However, start-
ing negative. Although quarterly rent growth is ex- ing in the last half of 2010, absorption levels are ex-
pected to remain in negative territory from now pected to dip again into negative territory for two
quarters before rebounding as we move into 2011. By



the end of 2011, pent-up demand will begin to push Apartment Cap Rates
quarterly absorption levels up sharply, with levels Q1-90 to Q1-10
9
ranging well over 1.1 million square feet per quar-
ter throughout 2012 and into mid-2013. Thereafter, 8

Percentage
absorption levels will likely decline a bit but still re- 7

main strong, ranging predominantly from 600,000 to
6
900,000 square feet per quarter.
5
Apartment Net Absorption
Q1-90 Q2-93 Q3-96 Q4-99 Q1-03 Q2-06 Q3-09
Q1-90 to Q1-10
San Diego (MSA) Los Angeles (MD)
4,000 Inland Empire (MSA) Orange County (MD)
*These data are seasonally adjusted and smoothed
Thousands of Units

2,000 Source: Property & Portfolio Research

0
Given the size of the countywide market for apart-
-2,000
ments, it’s not surprising that the various submarkets
-4,000 have performed differently. For example, although
Q1-90 Q2-93 Q3-96 Q4-99 Q1-03 Q2-06 Q3-09

San Diego (MSA) Los Angeles (MD)
Inland Empire (MSA) Orange County (MD) Given the size of the countywide market for
*These data are seasonally adjusted and smoothed
Source: Property & Portfolio Research apartments, it’s not surprising that the
various submarkets have performed
Finally, cap rates for apartment investors—which fell differently.
below 4.70% in mid-2006 as prices were rising faster
than rent rolls—have steadily rebounded back to San Diego County averaged a metro-wide vacancy rate
nearly 7.20% as credit has dried up and as landlords of 6.3% during the first quarter of 2010, it was far
wishing to sell have been forced to lower prices. In higher in the Central Business District (i.e., downtown
fact, between the first quarters of 2008 and 2010, cap San Diego) at 10.0%, owing in large part to the area’s
rates rose by nearly 37%, with close to half of that in- complement of new condominiums and lofts, units
crease occurring since the first quarter of 2009. Look- that were either originally added to the rental pool
ing ahead, cap rates are projected to peak at 7.28% or converted when the for-sale housing market went
during the middle of 2011 through the end of the year, bust. Most of the other submarkets posted vacancy
before beginning a slow yet gradual decline there- rates of about 5.0% to 6.0%, with the lowest rates seen
after. Nonetheless, by the end of 2014, cap rates will in the I-5 corridor (4.6%) and the South County (4.8%).
still average close to 6.40%, which is just below where
they were in the middle of 2009. While the Central Business District had the highest va-
cancy rates, the highest asking rents were found in
Mission Valley/North Central ($1,697), and the I-5 cor-
ridor ($1,660). The lowest monthly asking rents during
the 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 Submarkets
Snapshot: Q1-2010
Total Inventory Occupied Rental Vacancy
Market Absorption
(1,000s S.F.) (1,000s S.F.) Rate ($) Rate (%)
CBD 54, 310 48, 879 1,437.00 10.0 −169
East County 21, 250 20, 124 1,275.00 5.3 −13
I-15 Corridor 31, 855 29, 880 1,532.00 6.2 −31
I-5 Corridor 39, 954 38, 116 1,660.00 4.6 74
Mission Valley/North Central 21, 616 20, 319 1,697.00 6.0 −47
North County 23, 864 22, 408 1,547.00 6.1 −33
South County 74, 085 70, 529 1,276.00 4.8 7
Metrowide 266, 994 250, 173 1,456.00 6.3 −212
Source: Property & Portfolio Research

fit greatly. Between now and 2014, nearly 75,000 new Foreclosures and Defaults
residents in their prime renting years will graduate
from college and begin to enter the workforce, many Over the last few years, the dominant story in the
of whom will be attracted to the county’s weather San Diego County residential real estate market has
and high-tech job opportunities. By late 2012 and been the endless line of foreclosures, which at the
into 2013, pent-up demand will greatly increase quar- peak accounted for over half of all existing home sales.
terly absorption levels, thus paving the way for new Although the well-intentioned $75 billion plan an-
construction by 2014 and 2015. Moreover, given San nounced by the Obama Administration was enacted
Diego’s high cost of living relative to other cities, fu- to help up to 4 million borrowers at risk of foreclo-
ture households will opt to rent simply because that’s sure modify unaffordable mortgages, from its incep-
the only option. tion through March of 2010 it has only helped about
If there is any future risk to a rebound in the apart- 230,000 borrowers.
ment market in the short to medium term, it’s that of With up to 7 million borrowers late on their mort-
the shadow supply in the downtown area. With more gage payments, and with First American CoreLogic es-
timating that 25% of borrowers nationally owe more
If there is any future risk to a rebound in the than their homes are worth, it’s not that surprising
apartment market in the short to medium that 60% of loans modified through the federal pro-
term, it’s that of the shadow supply in the gram in late 2008 defaulted within a year, thereby
downtown area. simply delaying the day of reckoning. In March of
2010, under pressure to do more about foreclosures,
than 8,000 condo units built between 2001 and 2008, the Obama Administration announced an expansion
hundreds of these units continue to compete with tra- of the original $75 billion plan to begin this fall, fi-
ditional market-rate apartments. In addition, poten- nanced by money from the Troubled Asset Relief Pro-
tial renters who might have chosen these market-rate gram (TARP).
apartments could be greatly tempted by luxury con- With the expanded plan, lenders will be encouraged
dos turned into rentals. to consider reducing loan balances, something banks
have been reluctant to grant since mortgage servicers



are contractually obligated to do whatever is in the in- REOs and short sales but also for homes of all types
vestor’s best interest. Another component of the plan and in all areas.
is to temporarily reduce or suspend mortgage pay-
An early sign of future foreclosures are loan defaults,
ments—for up to six months—for those employed bor-
which did fall to 5,463 homes, representing declines
rowers who receive unemployment insurance bene-
of 28% and 39% over the past 12 and 24 months, re-
fits, after which time the borrower would be evaluated
spectively. Nonetheless, quarterly default filings still
for loan modifications. A third option is for borrow-
remain at levels exponentially higher than during the
ers current on their mortgages but living in underwa-
first half of the last decade.
ter homes to refinance into FHA loans worth 97.75% to
115% of their home’s current value, depending on the Defaults
Q1-2002 to Q1-2010
existence of any second liens.
1,500

Index (Q1-2002 = 100, SA and smoothed)
In fact, the quarterly rate of seasonally adjusted fore-
closures for single-family homes in San Diego County 1,000

rose from just over 100 homes in the fourth quarter
of 2005 to nearly 4,200 homes by the same quarter of
500
2009. Although the rate of foreclosures did dip by 20%
from the fourth quarter of 2009, to 3,338 units, the
0
rate could rise again as banks begin to bring more de- Q1-02 Q1-03 Q1-04 Q1-05 Q1-06 Q1-07 Q1-08 Q1-09 Q1-10
faulted homes to the market. San Diego County California
Source: DataQuick

Foreclosures
Q1-1994 to Q1-2010
2,000
Index (Q1-2000 = 100, SA and smoothed)

1,500 Residential Building Permits

1,000
The number of building permits issued can often be
500
viewed as a forward-looking indicator for the relative
health of the local housing market. But given the huge
0 plunge in demand for new housing units, permit is-
Q1-94 Q1-96 Q1-98 Q1-00 Q1-02 Q1-04 Q1-06 Q1-08 Q1-10
suances fell by about 57% between 2007 and 2009. The
Source: DataQuick
following table summarizes building permits for San
Diego County, showing that just 1,862 single-family
With option ARM loans originating at the height of the permits were issued in 2009, for a decline of over 45%
housing boom resetting to higher interest rates now from 2007 and of 20% from 2008. For multi-family
through early 2012, and with lenders hinting at releas- units, the decline from 2007 to 2009 was even more
ing REO properties that were caught up in previous pronounced, at 67%. Multi-family permits also fell by
moratoriums, or sitting on their books as they rebuild 59% between 2008 and 2009, as larger apartment and
their capital bases, we should expect to see elevated condominium projects finished up just in time to greet
foreclosure levels for some time. For now, investors an ailing housing market.
and buyers with cash continue to hold the power when Looking ahead to the rest of 2010 and beyond, pro-
competing with more traditional buyers, not only for prietary forecasts by Beacon Economics are showing a



Building Permits ($ Mill)
San Diego County, 2007 to Q1-2010
Year Single Family 2-Units 3-4 Units Five+ Units MF Units Total
2007 3,418 141 273 3,219 3,640 7,122
2008 2,323 71 101 2,759 2,938 5,173
2009 1,862 47 78 1,085 1,216 3,093
Q1-2009 402 7 20 311 337 758
Q1-2010 637 16 69 180 257 883
Q1-09 to Q1-10 (%) 58.6 125.8 242.2 -42.1 -23.7 16.4
2008 - 2009 (%) -19.8 -33.8 -22.8 -60.7 -58.6 -40.2
2007 - 2009 (%) -45.5 -66.7 -71.3 -66.3 -66.6 -56.6
Source: CIRB

gradual increase in single-family permits, which hit a units per quarter in the second quarter of 2010, 400
quarterly low of just 400 permits in the first quarter of units in the second quarter of 2011, and 700 units in
2009. For the remainder of 2010, single-family permits the middle of 2013. By the third quarter of 2014, multi-
should gradually rise, from just under 700 units in the family permits could cross the 1,000-unit level, match-
first quarter of 2010, to 1,036 units by the fourth quar- ing what they were in the first quarter of 2007.
ter of the year. Thereafter—and as the housing mar-
Multi-Family Building Permit Forecast
ket begins to pull out of the doldrums—single-family San Diego County, Q1-04 to Q4-13
housing permits will continue rising, exceeding 1,100 2.5
Actual Forecast
units by the first quarter of 2011, 1,400 units by the
2.0
first quarter of 2014, and 1,600 units by the end of
Thousands of Units

2014. 1.5

Single-Family Building Permit Forecast 1.0
San Diego County, Q1-04 to Q4-13
2.5
0.5
Actual Forecast

2.0 0.0
Thousands of Units

Q1-04 Q3-05 Q1-07 Q3-08 Q1-10 Q3-11 Q1-13
Forecast by Beacon Economics
1.5

1.0

0.5

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

For the multi-family sector, permits hit bottom during
the third quarter of 2003, at just 280 units, but have
since rebounded slightly to 291 units. For this sector,
the rebound in permitting will be slow, surpassing 300


The Recovery: Is it Real? San Diego Economic Conference, Residential Real Estate Section, May 2010

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