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Wednesday, Oct 5, 2022
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We Must Build for a Better Economy

In my postapocalyptic musing about recovery from our economic collapse, I have envisioned that the source of our resuscitation might be the much-vaunted technology sector, what with its growing importance as well as the competitive advantage it offers the U.S.

Knowing the construction and housing sector — which has brought us out of past modern recessions — to be particularly moribund, I was searching for a new catalyst to recovery. I no longer believe that technology can play a big enough role in economic recovery. The various technology sectors do not yet play a large enough role such that they could handle the task.

The regional manufacturing sector, which is now in full retreat with job levels down 25 percent since 2000, won’t be riding to the rescue either.

I again believe that the true economic recovery will be evidenced by growth in the construction sector. When we are building again, we will know that we have recovered.

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Recently, the Wall Street Journal published an article by Robert Bridges, “A Home Is A Lousy Investment,” in which he asks the question, “Why is there such rapt attention to the revival of the homebuilding industry and residential property markets?”

He does a side-by-side comparison of the investment in a home versus investing a similar amount over 30 years in the stock market and concludes that the stock market wins, big time.

Tearing Down the House

Bridges also provocatively asks the question: “Why then would anyone want to purchase a home? Why wouldn’t we just rent?” He calculates that home ownership in California from 1980 through 2010, when compared with a 30-year investment in the stock market, produces substantially inferior results.

Professor Bridges misses a concept fundamental to a reasonable comparison analysis: leverage. The concept of leverage is practically biblical in home buying, or, for that matter, in any real estate investment. You make a down payment, say 10 percent or 20 percent. When you do that, you must measure the return based on your actual leveraged expenditure. So while you have purchased an asset (your home) that appreciates at 3.6 percent annually, your net equity appreciates at a higher rate because it only represents 10 percent or 20 percent of the asset value.

We compared these two asset classes employing a different methodology, which I will dub a “same time frame” analysis. This approach compares the two asset classes — housing versus the stock market — over the same time frame but not at the same time.

This is because all asset classes have bottoms, middles and tops. Both markets have periods of relative low price points which ultimately bubble up. It makes more sense to test each asset class within their own bubble and bust periods.

Employing that test, our calculations are that the Dow Jones & Co. industrial average increased by 254 percent from 1990 through ’98. Where as the Standard & Poor’s Case-Shiller Price Index for San Diego rose 138 percent from 2000 through ’06. To give a down cycle example, the Dow Jones was down 11 percent from the beginning of 1999 through the end of 2002, and the Case-Shiller Price Index for San Diego was down 33 percent from the beginning of ’07 through the end of 2010.

While I cannot dispute that the overall results show the Dow performed better on average, these numbers still compare a full price investment in the Dow to a full price investment in a house. If you put a more typical 10 percent or 20 perecent down on the home, and then still realized the appreciation, the home investment would outperform the Dow average by an additional 15 percent per year in the up-cycle. However, the decline after the peak was much greater in real estate (a 33 percent drop) compared to the Dow (down 11 percent).

The point is that it is a wash. You can prosper or fail investing in both.

I recommend investing in both. Use your stock portfolio as your nest egg and ultimately as a source of retirement income or benefaction. And over a 30-year investment horizon, you will continuously rebalance your investment portfolio among the various asset classes, particularly to take advantage of buying low and selling high. And you would also try to time your housing “move ups” to take advantage of the sector’s lows and highs.

Enjoy your home. Go barbecue in the backyard. Sell it to “move up” or ultimately to retire at mostly tax-free capital gains.

A Foundation for Growth

And always keep in mind the compelling role the construction sector plays in both the local and state economies.

The economic “multiplier” of construction, is a huge two — for every construction worker employed, two jobs are also created — this is higher than the tech and manufacturing sectors, which are one-multipliers.

While perhaps transitory, these constructions jobs are not “temporary.” True, when a project is built and completed, the construction job is finished. But in a healthy economy, the construction worker simply moves to the next job. How is that any more temporary than most any other job? We all move to the next task.

The very inefficiency of the construction sector broadens its economic reach. As America has evolved its employment base, we have lost manufacturing jobs to other countries with lower labor costs. However, in the American construction sector, with the exception of some materials, most materials and most of the labor is American.

While San Diego building permits have hovered at the historic lows of below 6,000 units per year during the past 3 1/2 years, clearly the sector bears a huge load in taking down this economy. No other sector comes close, either locally or nationally in importance.

That’s why I believe that the housing sector, in particular, and the construction sector in general has to recover for the economy to truly recover.

This is actually a bad omen because the sector simply cannot recover quickly. In fact, for the foreseeable future, there is very little demand for any construction until the market clears. This means the present high vacancies in the commercial market have to come down. We must face up to the very real assault on “brick and mortar” retail by technology. The distressed residential assets have to emerge from the shadows and be dumped on the market.

The apartment sector will build at a healthy clip early. But for the remainder of the housing sector, it will be some years before new construction can be justified, except for occasional spot opportunities.

Yet, be very careful before you dis the construction sector. Few activities have such direct, intense and immediate positive economic impact as new construction. In California, construction employs more people than Apple, Google, Facebook and the some others — combined.

Housing creates construction jobs. The government wants us to own a home. Communities benefit from the care and maintenance homeowners put into their homes and their neighborhoods. And in supply-constrained regions such as San Diego, the investment gain through homeownership has exceeded the average by most reasonable calculations.

This is not what political scientists like to call a “zero-sum game.” The housing market is a key measurement of the overall economic prosperity of the region. Stripping the construction sector from the economic equation is like taking a big slice of pizza out of the overall pie.

You cannot deliver the pizza with a slice missing. To fuel a recovery, we need that “slice.”

Gary H. London is president of The London Group Realty Advisors, which provides real estate consulting and economic analysis. Check him out on the Web at londongroup.com.

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