Recovery or another real estate bubble?

There is a broad consensus that the housing market nationally, regionally and locally has bottomed, and is on its way to recovery. The hanging question is if this housing recovery is real, temporary, or if it could grow into a bubble.

Home ownership is down nationally

In April of this year, the US homeownership rate hit an 18-year low, signaling a shift away from homeownership towards rental housing. The homeownership rate in the United States fell during the first quarter 2013 to 65 percent, plunging to the lowest level since 1995, according to the US Census Bureau. The homeownership rate is now far below the 2005 boom peak of 69%. Homeownership was lowest in the West at 59 percent and highest in the Midwest at 70+ percent. Although Americans are still buying homes, tighter credit conditions and limited inventory are still holding back many homebuyers who are opting to rent. The Great Recession slowed down household formation, but it did not stop it. Remember, people are still graduating from college, getting married, having families, etc., so there still is a need for shelter. Here in Texas, the need for housing is great.

Many investors are seeing this as an opportunity. The consumers’ inability to buy for whatever reason has allowed cash investors to provide shelter. Over the past few years equity REITS such as Blackstone Equity and Colony Capital have invested an estimated $6.5+ billion (just these two groups), scooping up thousands of foreclosed and REO single family homes. The single family rental market was a large portion of the market, even before the housing crash, with 16+ million homes designated as rentals nationally in 2010, according to the US Census. Add on top of that at least five million plus foreclosures, many of which could become investor-owned rentals, and the potential scale is apparent.

These properties are traditionally in distressed markets where the ability to purchase at a significant discount is still available (often a 40+% discount to current construction costs). The opportunity provides a long-term income stream as well as the opportunity for appreciation — which may come slowly at first but will improve along with the greater housing market. Historically, buying in downturns has produced a strong return, from 10+% annually to much higher.

The key to their success will be effectively managing these properties, which are spread out over geographic areas rather than concentrated as they would be in an multifamily or commercial opportunity. These REIT’s are trying to get as close to the multi-family apartment model as possible. While there cannot be one landlord in one location, REIT employees are armed with tablets and laptops, helping communicate current information from the field. From the inspection and construction teams inspecting potential homes for purchase, to the project managers checking in on homes they are rehabilitating, to the agents showing homes to potential renters, to the handy-men answering renter complaints, all the information is transmitted back to the main office from wherever they are.

Other than DFW, the large REIT’s have not been as active in single family in Texas. The inability to buy large numbers of discounted properties due to the limited supply of homes has prevented the large equity groups from making significant plays in Texas. It doesn’t mean it couldn’t happen, this analyst just believes that that opportunity passed a couple of years ago in this state.

Low Inventory

Meanwhile, here in Texas, there is a shortage of existing homes and new homes for sale. Nationally, there were only 1.68 million previously owned properties on the market in March 2013, down from 1.93 million the prior year, according to the National Association of Realtors. That’s the fewest since March 2000. Here in Austin there is only a 2.7 month supply of resales available, 25 percent fewer than April 2012. In San Antonio housing inventory has held steady at 5.2 months since February. Houston is at a 3.4 month supply, a thirteen year low. And in DFW there is currently a 3.3 month supply of homes— the lowest inventory in almost 20 years. In a healthy balanced market, there’s roughly a six month supply. This March, nationally the number had fallen to a 4.7 month supply — a market favorable to sellers. Limited inventory pushes prices up. The median value of an existing home rose 11.8 per cent, the most since November 2005, to $184,300 last month from $164,800 in March 2012. Many listings are seeing multiple offers. Does this indicate a coming real estate bubble? Not quite.

The same, but different

One of the reasons we are hearing murmurs of a bubble are the stories of frenzy – homes in Austin are selling as fast as they are being listed, and those in desirable areas are receiving multiple offers, sometimes above list price. However, this isn’t a speculative bubble. It’s driven by the lowest inventory levels we’ve seen in years. As stated above, nationally, regionally and locally the inventories are low; home inventories are at 1.9+ million units, which is equivalent to about 4.7 months of supply, based on the current sales rates. And inventories keep dwindling on a year-over-year basis with little to limited replacement. Nationally inventories continue to decline, with 135 out of 146 markets tracked by NAR experiencing year-over-year inventory declines, with about 25% of the markets seeing declines of 20% or more. New home construction has been held on a tight leash, with limited speculative construction due to previous lower demand. Considering that, there’s no way we’re getting to six months worth of supply any time soon locally or nationally – not unless home construction activity picks up in a major way. New home construction remains over 65% below the peak, which also flies in the face of any bubble talk.

What about foreclosures?

Yes, they continue to happen, but they have slowed down dramatically from the top of the bust. Foreclosures fell 27% from where they were a year ago, to the lowest level since 2006. Yes, they continue to happen in Texas, but because of demand remain less than 1.5% of all sales. They are basically a non-factor in this region and they have slowed down dramatically nationally.

Values improving

As more buyers bid on fewer properties, prices are being forced up. Home prices are rising even as homeownership drops. Prices in the top twenty cities have risen 9.3 percent in the past year, according to the Case-Shiller Home Price Indices that track home prices in twenty major metropolitan markets.

Inventory will continue to be challenged as long as interest rates remain low. The tight supply isn’t the only factor slowing the housing market. Homebuyers are facing fierce competition because of record low rates. It is hard to argue with purchasing when rates are so low. Who could refuse the Federal Reserve’s cheap credit? So yes, the claim that the housing rebound is closely tied to the Fed’s campaign to lower interest rates is true. The Fed Rate which has pushed down mortgage interest rates to historic lows has made housing an attractive (and affordable) investment. The low interest rates have lured investors of all stripes to buy homes, a large factor in the diminished inventory we discussed.

So, when you couple this scarcity of listings – particularly high-quality ones – with historically low interest rates, what do you get? Competition for properties, of course. It’s the basic economic principles of supply and demand at work. But as we have stated before, we don’t have to fret about this situation leading to another bubble.

First, increasing record low mortgage rates will slowly erode record affordability. Borrowing costs for a 30-year fixed mortgage just hit 3.51%, the highest level in six weeks, yet are still tremendously affordable compared to the boom. As rates creep higher, it should help contain demand and slow purchases. Second, most mortgage applicants now boast FICO scores above 740, over a 100 points higher than during the boom. Yes, the industry wants to improve and increase lending. There is more capital available than ever before at the banks and equity groups, but they are still concerned about down payments and lending standards. Lending standards remain tight. Insisting on higher credit scores ensures that the real estate market doesn’t get (way) ahead of itself again.

To have a bubble of any type, you need speculation and financing. There may be some speculation happening locally, but it isn’t the short term house-flipping type speculation seen in the boom years in CA, FL, etc. Lenders and appraisals continue to be cautious, taking a lot of the wind out of potential bubble concerns. What we are seeing locally is genuine demand, driven by job creation and inmigration, and low supply due to the slowdown in home construction in the last five years. Increasing values are because of need, and not the speculation we saw in the boom. Any speculation is tempered by the large capital needed to be an investor, typically at least 25% down.

High Demand

Whether it is local, regional or national, we have had a record low number of home sales the last five years. Household buying slowed, while household formation did not. With little to no inventory being produced the last five years that demand is finally catching up to us. Austin needs 23,000 to 25,000 to meet demand, San Antonio 18,000 to 22,000. Another way to look at it, is for every two jobs, you historically have one housing start. That hasn’t happened in any of the Texas metros over the last five years. So, we are playing catch up as well as facing future demand, leading to a healthy local and regional markets for a while.

The continued strength of national, regional and local employment will continue to push the demand for housing, whether rental or purchase. There is always a need for ‘shelter’, both new and used.

The bottom line is that we don’t appear to be in another real estate bubble. Not yet, at least. Is the potential there? Always. But again there is a difference between demand and speculation, and what the Texas metros are experiencing is a strong demand, not speculation. So, forget talks of a bubble and continue to look for ways to profit from the current recovery.

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