California/San Diego Outlook: No Recession but Tepid Growth; Continuing Real Estate Weakness

By Alton Gary Simpson

The UCLA Anderson Forecast, a report from the UCLA Anderson School of Management on the state of California's economy, reveals that California has weathered the beginning of the real estate slowdown better than originally believed. San Diego County remained healthy last year despite the slowdown. Real estate-related sectors saw significant declines in job formation in 2006, but the rest of the economy has so far managed to pick up most of the slack.

Senior economist Ryan Ratcliff paid particular attention to revised employment figures, noting that in the group's last report they were concerned with a construction sector that was bleeding jobs at the same time the service sector was losing momentum. New estimates released in March 2007 reveal a much brighter 2006, with job growth up 52,000 and job creation rates up to 1.8% from 1.1%.

"We still expect to see the pattern of deepening real estate (job) losses combined with a slowdown in the rest of the economy," said Mr. Ratcliff. "Now it's just the first half of 2007 instead of the second half of 2006."

Looking at San Diego County, the "San Diego Outlook for 2007-08" stated that the county's economy remained relatively healthy through 2006, with low unemployment and job growth only slightly slower than the California average.

Mr. Ratcliff noted that the San Diego economy has presented somewhat of a paradox, while sales and home prices were falling in 2006, the overall economy barely noticed, it's only now that sales and home prices have leveled off that weakness in construction and mortgage finance have begun exerting some drag on the county's economy. He argued that part of the explanation lies with the leisure and hospitality sector. As real estate-related employment slowed in 2006, job growth in the leisure and hospitality sector accelerated, keeping overall job growth only slightly slower. In 2007, this offset to real estate weakness has started to disappear as the boom in leisure and hospitality slackens.

Mr. Ratcliff also acknowledged the impact of the subprime meltdown on the state. He said the collapse of the subprime mortgage market has implications ranging from the soundness of international financial institutions, to job creation in the Southern California. He addresses several key questions on this topic, including whether the tightening of lending standards will further depress home sales and whether or not a wave of foreclosures will bring down home prices as bank sellers generate substantial pressure on prices. "… the historical record suggests that a spike in defaults does not automatically imply a surge in foreclosure sales," wrote Mr. Ratcliff. While it is too early to tell, he suggested that the current combination of financial excess in an otherwise relatively healthy economy may resemble the 1980s, when many households experienced delinquencies but avoided foreclosure.

The California forecast calls for job growth in the state to slow below 1% through the middle of 2008 while real taxable sales slow to 2% through this period. "If the professional/business services sector can sustain its momentum longer in 2007," notes Mr. Ratcliff, "we might see a more mild slowdown, but if the carnage in the subprime markets turns out worse than we expect, job losses in Southern California could make things a bit worse. But the essential logic of the no recession forecast remains. While there's some wiggle room on how weak real estate will be and how much other sectors will offset this weakness, there is still no other sector that looks poised to combine with real estate to generate enough job loss to cause a recession."

According to Mr. Ratcliff, the combination of slower population growth, a subprime credit crunch for first-time homebuyers and a continuing level of record foreclosures makes the forecast for the San Diego housing market less building, weak sales volume and flat-to-slightly-falling home prices with some improvement seen by mid-2008.