2013: Rebuilding confidence

We will remember 2013 as the year we “felt” the economy improve. After enduring the previous five years, this was the year that consumers began to look at spending again. Market trends in housing and car sales show definite signs of Improvement. After a number of years of post-financial crisis struggle, the national real estate picture for the United States has brightened and our regional metro markets have continued to improve. The housing market (single-family homes, townhouses, and condominiums), the multifamily real estate market (apartment buildings, new and used) office, retail, and the lending industry all appear to have turned the page.

Fear gripped the USA five years ago. As Americans awoke on Monday, September 15, 2008, they learned that Lehman Bros had collapsed in bankruptcy. This inflicted billions of dollars of new losses on a financial system that was already reeling from a cratering worldwide housing and real estate market and a tightening credit crunch. Aftershocks of the worst financial crisis since the Great Depression still reverberate in today’s fragile recovery memory. Look at all the new banking laws and requirements. The national psyche remains uneasy, worrying if it could happen again.

Even the most cynical of analysts agree that unemployment improved this year. The latest figures along with upward revisions for August and September released by the Bureau of Labor statistics show over 200,000+ jobs created over the last three months. Should the strength of job creation continue through the latter part of 2013 into 2014, the Federal Reserve will feel comfortable enough to ease on the stimulus efforts to improve the economy, although probably not as soon as the December 18th meeting of the board. The point is that all this new data shows a strengthening economy. It is growing, maybe not as fast as policy makers, politicians and the rest of us would like, but it has shown strength this last year that it has not shown the previous 5+ years.


Banking is back
This was the year we saw the financial industry make a strong recovery. Yes, the Treasury Department and the Federal Reserve are still writing checks (ultimately something that you and I will pay for). But the finance and insurance industries have grown to 8.5% of the US economy, exceeding the peak of 8.4% in 2006.
That coupled with the extended period of record-low interest rates fueled by the Federal Reserve’s monetary policy has been a leading driver of the value gains in the housing and real estate market as well as other credit markets. While credit and lending standards from banks remain somewhat tight compared to their historical standards, buyers who qualify for mortgages have rushed to the market in order to lock in basement-level debt payments available on borrowed funds. Texas has seen commercial real estate bank loans become more readily available.

Rates crept up a bit this year and will continue to rise with the improving economy. Many consumers are concerned they will be priced out by rising rates. Historically they will hesitate as rates escalate, then get back into the market as they realize rates are going to keep increasing.

The good news of 2013 is that banks are once again profitable and able to lend. The bad news is the recession led to the closure or consolidation of many banks. Presently, there are 6,891 banks, the lowest number of banking institutions nationally we have seen since the government began keeping records in 1934. The biggest portion of the lending market lost was the community banks, which in turn affects the accessibility of small business and small commercial real estate loans. These combined factors will slow development for inventory challenged markets with fewer choices of banks to borrow from.

Texas began to recover economically in March of 2010, and the rest of the US in early 2012. However 2013 was the year home prices and real estate saw their largest increase since their high seven years ago, at the peak of the housing bubble. Home values rose by about 8% year-on-year or more in most markets nationally. At the start of this year, bidding wars erupted on desirable properties nationally as well as locally. In light of the slow economic growth of the period, the speed of the recovery has taken many by surprise.

No inventory
Nationally, but particularly in Texas, one of the leading drivers of the real estate rebound is the lack of inventory (new as well as resale), which bodes well for most homebuilders or developers who secured land positions regionally. Regional surveys show that the biggest concern for developers over then next three years is the lack of developed lots. The existing supply of resale homes only amounts to five months worth of sales in November 2013. While construction virtually stopped in 2008 and after, the U.S. population has kept growing, while homebuyers repaired their personal balance sheets in order to purchase again. In addition, after over 4.5 million foreclosure cases, banks have sold the majority of the distressed properties they owned, even though they are still facing legal liabilities. Cash-paying investors came in aggressively and crowded out the marketplace in many bubble states. Texas metros seemed to miss the majority of the large investor trusts just due to the lack of inventory and lack of discounting during the last five years. Most noticeably, single-family homes became an institutional asset class for the first time, with large investors such as Blackstone and Colony Capital purchasing thousands of residences at once. The stock market is currently witnessing the first IPOs of such companies. However, this class activity seems to have slowed in the last 90 days. Whether it was lack of inventory, lack of aggressive discounting and financing, or other factors has yet to be determined.

2013 was the first year since the recession that foreclosures have become less of a factor. As we have said previously, they have been a non-factor in Texas, and with the housing market improving nationally they will become less and less of a factor nationwide. There are still 5 million houses with negative equity in the United States, but the good news is that banks are experiencing their lowest mortgage delinquency rate since the financial crisis. Lenders are now subject to more regulation and capital level requirements than before, but lending standards are slowly being relaxed. The government policy makers are making a push to that end, and wishes to redirect much of the loan issuance activity of quasi-public Freddie Mac (FMC) and Fannie Mae (FNMA) to the private sector. What happens there remains to be seen. Remember both of those agencies were profitable till legislative powers pressured them to underwrite subprime loans (that 15% of their portfolio caused over 50% of their losses).

We are seeing a renewed interest in US real estate from global equity, in particular the Texas region as evidenced by the number of new commercial, retail, industrial and residential developments happening in our metros and beyond. Most of this activity was not here a year ago. The global economy is channeling capital into North America. European growth is sluggish at best, so the United States seems a very attractive place to park funds for those seeking to invest in one of the still undervalued hard assets, real estate.

Rents for residential and office space were driven by demand and supply side factors. Demand for new space drove rents from the demand side, and a lack of construction from the recession meant there is very little new supply. Rents are still rising in 2013 across the country aggressively, and particularly in Texas. The multifamily sector leads the recovery among all commercial real estate asset classes: office, retail or industrial buildings. Specifically, the demand from growing technology start-up companies has upwardly influenced office building prices (especially in downtown areas of cities with highly educated workforces here in Texas).

While one can certainly question the speed of the housing rebound, fears of a new bubble are unfounded. Chances of a real estate crash of the magnitude of the recent one are very low. Indeed, the price increases will slow when interest rates rise, yet the economy is still growing. While the new supply of homes, apartments, office space, etc. is on its way, the strong demographics of the U.S. will prevent prices from dropping. In addition, first-time homebuyers will step into the marketplace as they have been sidelined by aggressive bidding from deeper pockets. Threats to the recovery do exist, such as a negative reaction to the Federal Reserve’s ‘taper’ of quantitative easing, nonetheless, escalating prices might endure a few years longer.

The rate of U.S. economic growth in the coming months will largely be determined by the pace of gains in the labor market. This may depend on increases in consumer spending, which in turn could be influenced by workers’ perceptions of their job security and consumers’ broader confidence in the economy.

2013 has been a year of rebuilding confidence. Consumers are still fragile from the recent recession, and any significant economic setback — such as with unemployment, the stock market, or further gridlock in Washington — could cause another rapid reversal in confidence and spending, crippling the economy. However, barring that, most economic metrics appear poised to finally make a significant break from their post-recession lows. The good news is that Texas continues to fire on all economic cylinders, and should continue to see growth through 2014. Only time will tell.