One of the most common concerns for those moving to Texas is the lack of inventory in all real estate channels. Strong demand is the main reason there has been little to no increase in inventory in the last few years. There has been a great deal of discussion regarding the consistently low housing inventory levels throughout the nation, not just in Texas. Very little, however, has been written about the reasons why inventory levels are staying so low.
Understanding the “whys” can be helpful in predicting how these factors might influence longer-term supply levels and future appreciation potential. This knowledge might also shed light on why inventory might remain constrained over the long term in our region.
In the second half of 2011 we began to see an acceleration in the decline of inventory levels nationally and in our Texas metros, as Texas began recovery sooner than the rest of the country. Since that time housing inventory has remained historically low. There are numerous conditions that have contributed to this, and bundled together have created an inventory supply dynamic that, as prices rise, only serves to limit the number of homes available for sale.
Home prices are rising, even hitting record levels in most of our Texas metros. Even with the rise in values, Texas is not an overvalued market, due to demand and the lower annual appreciation we have experienced historically. These numbers come from the Federal Housing Finance Agency. Home prices in Texas increased in 33 of the past 38 years.
- The highest rate of appreciation was 17.8 percent in 1981, which is extremely high for Texas.
- House prices increased by more than 10 percent in five of those years
- Texas home prices declined in six of the past 38 years.
- Four years of decline occurred in the 1980s when the oil market collapsed.
- Two years of decline were during the Great Recession in 2009 and 2010.
- The largest decline was in 1987, when prices fell 9.6 percent.
- The average rate of house price appreciation over the past 38 years has only been about 4 percent.
Gains of around 5 percent are seen as stable, sustainable growth. Those states that have averaged over double digit appreciation (California, Nevada, etc.) have shown that that type of hyper appreciation is not sustainable. Our market is not built on speculation, but rather true demand and employment growth. I get nervous anytime I see double digit appreciation over a couple of years.
Most of our regional metros have less than three months supply (a six month supply is considered equilibrium, with supply and demand balanced). Based on current economic factors, regionally we will continue to see a sellers’ market for 3 or 4 years while the markets play catch up. Employment growth also plays into this with the number of people moving to the Texas region looking for jobs and lower cost of living.
Mortgage rates are still low for now. At less than 3.7 percent, mortgage rates haven’t been this low since 2013. Even though rates are expected to rise as the year progresses, for now these rates are at very low levels. The average over the last 50 years has been 8.8%. With the economy improving, the potential of higher interest rates this fall is great.
Most Baby Boomers, especially older boomers born before 1955, own their own home. They’ve been paying a mortgage, faithfully and relentlessly, for most of their adult lives. For these people, a primary goal is to finally pay off the mortgage and own their home free and clear. For many, paying off the mortgage is an important threshold – a crucial step they feel they need to take before they can even consider retirement.
For many Boomers, the equity they’ve built up in their home is the largest asset they have. According to a recent FNMA survey of 6,000 adults, on average, home equity among homeowners age 65 and older is more than $200,000. Many boomers look forward to freeing up some of their equity to pay for travel, medical expenses, home renovations or other expenses they know they’ll face at some point in the years ahead. Many think of moving down but are unsure of the ability to afford something else or the ability to match the great mortgage rates they have had access to. There isn’t a great deal of motivation for them to move at this point.
Prior to May 7, 1997, the only way you could avoid paying taxes on your home sale gain was to use the funds to buy another, equal or more expensive house within two years. I recall my parents being motivated by a “move up” mentality. Every few years, they would sell our existing home for a bigger, more expensive property. They would explain to us that they were using tax-free money to leverage into a bigger home that only “someday” they would owe capital gains on, and hopefully something they would not have to deal with, but their heirs. By leveraging those gains, they contributed to the health of the local real estate market. This dynamic created a steady supply and demand equilibrium not only in local markets, but in markets throughout the country.
When they turned 55, another option became available. They could take a once-in-a-lifetime tax exemption of up to $125,000 in capital gains. However, when the Taxpayer Relief Act of 1997 became law, the rollover or once-in-a-lifetime options were replaced with the current per-sale exclusion amounts. The Taxpayer Relief Act allows homeowners to take a $250,000 (for singles) or a $500,000 (for married couples) capital gains/appreciation exclusion, which could be used under certain conditions every two years. While the Taxpayer Relief Act eased the home-sale tax burden for millions of homeowners, higher-priced real estate markets experienced an unintended outcome: fewer move-up buyers because their gains on their existing home exceeded the $250K/$500K maximum, thereby creating an unwanted tax expense associated with moving.
This frozen segment of the real estate pipeline has upset the flow of buying and selling activity. The typical move-up buyer has caused a bottleneck by remaining in place thereby reducing available supply to new entrants. The current law does not create the compelling motivation for individuals to continually move up into “bigger and better” higher-priced properties.
In Texas our average values have continued to improve as the rest of the country deteriorated. Our average price in Texas currently according to Texas A&M Real Estate Center is $238,500. In many of our metros, it is not uncommon for homeowners to exceed the $250K/$500K exclusion amounts if they have owned their primary residence for a period of time. Once a homeowner passes this threshold, their motivation to sell in order to move up diminishes as the possibility of a financial tax consequence looms. Many move up buyers have begun their research only to discover they would be subject to capital gains tax on a portion of their gain — another sacrifice they are not willing to make in order to buy that bigger, better property.
Additionally, there is the current mentality among some homeowners that home values will continue to rise. Very similar to the mindset of people holding on to a stock because they expect it to rise, people believe their properties will increase over time. Right or wrong, this mindset has become another factor in the tightening of inventory. What typically happens is that once homeowners realize the up cycle has turned, they electively decide or are forced to sell due to job loss or other negative economic pressures. This would result in a significant inventory increase, which we have not seen in this region. Based on current employment growth projections for the region, values should continue to appreciate.
Those wanting to move find that values have continued to appreciate beyond their means. Consumers do not expect values and demand to be as strong as they are in this region. The shock of values after the recession in this regional market have caused many sellers to pull back and hunker down. The aforementioned forces feed on each other and further exacerbate the move up problem. Lower inventory begets lower inventory; a downward pressure cycle continues. If one cannot find properties to move up to, they will not sell their current homes.
This same dilemma plagues retirees finding limited or no options for retirement communities in their local area. Retirees in this region have had little to nothing to chose from. Texas was not historically a retirement state. In the last few years, the low cost of living, sunny weather, and low tax burden have captured the national retirement developers’ eye, but it will take some time for the development cycle to catch up. Because of this, housing supply is limited on the top end of the market since seniors are not motivated to sell unless they know exactly where they are going.
Over the past seven years there has been an unparalleled low level of new housing starts and development. Equity and lenders were recovering from the recession and housing bubble. No one was interested or positioned to start new developments. This prolonged decrease in new home development dramatically multiplied the low-inventory gap. To further the dilemma, the start-to-finish build cycle in many areas has become more cumbersome due to new restrictions, labor, administration, and costs, often requiring multiple years to plan, approve, build and market, which slows market momentum. Until the new housing development engine gets moving at an accelerated pace, inventory will continue to lag.
Be aware that these major factors have created this extraordinary low-inventory environment we are currently experiencing. Given the factors above, inventory will remain low for an extended period of time.