2008 Forecast: Some Post-Bubble Optimism

Business

San Diego’s economic outlook for 2008 includes many positive factors that outweigh the troubled mortgage/housing market

IF THE SAN DIEGO ECONOMY over the past three years were a play, we’d be heading into Act Three, in which the Forces of Darkness unleash their last furious attack before the Forces of Good mount a countercharge.

At least we won’t have to revisit Act One, the Real Estate Bubble, and its partner in crime, Bubble Denial. In ’07——Act Two——the bubble burst, but it had nothing to do with double-digit appreciation on homes where mortgages were paid up. It was all about selling mortgages to unqualified borrowers on so-called entry-level homes, which in San Diego run north of $400,000. As real estate prices dropped, adjustable rates on mortgages kicked in, meaning that homeowners——some of whom got in with no money down——owed more on their homes than they were worth. The resulting defaults and foreclosures not only sapped juice from real estate sales but spilled over into job losses in housing-related industries such as construction and financial services.

What’s surprising is that other components of the San Diego economy——tourism, high-tech and international trade——are taking up the slack, seemingly unaffected by the housing crunch. Act Three for the local economy is also dependent on factors beyond our control, such as a national recession that would hurt tourism, and the value of the dollar, since a weaker dollar makes San Diego more desirable for international visitors and investors.

Add it all up, and you have what UCLA’s Anderson Forecast calls “a near-recessionary environment” for Southern California, which experts say can also be applied to the local economy. For example, the University of San Diego’s Index of Leading Economic Indicators has declined in 18 of the past 19 months, seven in a row through October. USD Professor of Economics Alan Gin, who publishes the index, says he expects a slow go in ’08, with the economy adding roughly 10,000 new jobs, the same as in ’07.

“What’s interesting is that if you take job losses through real estate out, we’d be back where we were in 2006,” Gin says. “We have well-performing sectors in leisure and hospitality, a lot of job growth in hotels and restaurants, though the worry there is these are low-paying jobs. But healthcare is up, government employment is up, and professional and technical services——lawyers, architects, engineers——are also up.”

Kelly Cunningham, economist at the San Diego Institute for Policy Research, says though growth of the gross metropolitan product in ’08 will probably not exceed 2.5 percent in a $163 billion regional economy, San Diego has an advantage of having felt the impact of the mortgage meltdown early on.

“We seem to be ahead of the curve since 2000,” he says. “We didn’t have quite the fallout experienced elsewhere from the dot-com bust, and in this instance, we were the first to see housing prices level off and start to decline. Our economy is about a year ahead of what is happening in the rest of the state, so it should start to pick up by the end of ’08, and ’09 should be even better.”

What happens in the local housing market could be affected by a so-called rate freeze being discussed in Washington that, in theory, would prevent homeowners in shaky circumstances from having their rates adjusted and subsequently losing their homes. There is a long list of questions about the rate freeze, but two main sticking points are: 1) Who would qualify? Everyone whose mortgage adjusted? Only those who can prove hardship to the bank? Would one actually have to be in default? 2) Who would lose out if mortgages were less profitable due to the rate freeze?

“I’m not sure if they can freeze interest rates, and it’s not clear who’s left holding the bag,” says James Hamilton, professor of economics at UCSD. “If it can prevent widespread defaults, then that could be a win-win situation. But the mortgage-associated problems are bigger than you could fix with a rate freeze.”

ASSUMING HOUSING continues to lag and shaves another 5-plus percent from home values in ’08, other sectors will demonstrate the buoyancy of the San Diego economy.

“The commercial real estate sector is pretty strong,” says Gary London, of London Group Realty Advisors. “A lot of footage is being added, so there will be some slippage in lease rates and occupancy, but I’m not worried about commercial unless we go into a major recessionary situation. It’s more a function of supply being added rather than lower demand.”

Biotech also continues as a source of relatively high-paying jobs. The trade group San Diego Biocom says biotech employs more than 36,000; the industry generates about $8.5 billion among 500 or so companies. San Diego biotechs will be showcased when the national Biotechnology Industry Organization holds its annual conference here in June. Venture capital into the region exceeded $1.5 billion in 2007, with funding to biotech companies the largest component.

“The industry here is about 20 years old, and it takes 12 to 15 years for companies to get through the [product] development phase to approval of their products,” says San Diego Biocom CEO Joe Panetta. “We have a good critical mass of companies that have moved down that path, and we’re beginning to see approvals by the Food & Drug Administration.”

Tourism continues to add jobs that offset losses in construction and financial services. Marney Cox, chief economist at the San Diego Association of Governments (SANDAG), says the visitor industry has shown remarkable growth in adding about 12,000 jobs to the economy over the past year. According to the San Diego Convention & Visitors Bureau, total visitor spending through September increased 2.6 percent to $6.2 billion. Although room nights were flat at about 11 million, room rates at hotels and motels in the county increased by 6.5 percent to about $142.

Another possible job generator is international trade, which Cox says has grown 450 percent from 1990 to 2005——nine times faster than the gross regional product, which grew 50 percent over the same period.

Cox has another theory about what’s contributing to the decline in housing values. “If you look at dollars per square foot, you get a different picture,” he explains. “San Diego housing was worth $320 per square foot two years ago, and it’s still worth that today. The square footage of the average house being built has declined. When we see predictions of doom and gloom, we need to make sure we’re talking about the same kinds of units.”

Some experts say there’s reason to be optimistic where we least expect it. “There are some great deals out there,” says Alan Nevin, director of research for Market-Pointe Realty Advisors. “And you can get a 30-year fixed rate mortgage for 5.5 percent.”

As it turns out, the potential saviors of the local economy are the usual suspects. On to Act Three.

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Measuring San Diego

ANYONE WHO ATTENDS business conferences has heard the San Diego economy compared to a three-legged stool, the implication being that the area’s economy is diversified enough to withstand the current real estate slump, just as it was in deflecting the dotcom bust of 2001. But what are the three legs, and is the analogy valid anymore?

Historically, the legs have been manufacturing, the military and tourism, but USD’s Alan Gin would replace manufacturing with a technology category that ranges from telecom to biotech.

Kelly Cunningham says there are actually four legs to our economy——we now have a chair. “The economy was always thought of as defense, manufacturing and tourism, but in the last 20 years, technology-based services, research and high-tech have become a separate leg,” he says. “Qualcomm, for example, went from being a manufacturer of phones to a service provider for manufacturers.” He expects the trend to continue in the high-tech sector.

For his part, SANDAG’s Marney Cox has heard enough about stools and chairs. “I’ve never been a big believer in the three-legged stool,” he says. “Our diversified economy has many industries that need to be separately identified, like biotech, software, defense and telecom. Over time, you can’t wrap all those into manufacturing; they don’t fit well into the old categories. For example, with defense, we should separate uniformed military from defense contracts.”

Sounds more like a sofa——even if there won’t be much chance to recline this year.

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