Is Texas overvalued? – Part II

This newsletter is a follow up to last week’s post, “Is Texas housing overvalued?” Check out last week’s post on the Independence Title blog to get an understanding of why we don’t think it is overvalued or in a bubble.

People are asking if Texas is overvalued because Texas metros have received so much attention since the recession. Job growth, GDP growth, and population growth have been phenomenally strong compared to the rest of the nation. Values have improved, but not outrageously (not the 40+% annual appreciation of prerecession California, Arizona, Nevada and Florida). Some of our metros have seen double digit value appreciation in the low teens.

Additionally, the overvalued question stems from how much rents have escalated over the last 10 years, with Austin leading the pack at 65+% rent appreciation. Other Texas metros have not had as aggressive rent hikes but all have been above 35% over the last 10 years. Wages and salaries in Texas have definitively not kept pace in the same period.

Basic assumptions

Housing related decisions are among the most important financial decisions we have to make. For the majority of Americans, their home is their largest asset. And for many of us, shelter is the largest portion of our monthly and annual expenses.

That said, young people in the accumulation phase of their life need to plan their home purchase very carefully, as that home is likely to become a significant part of their overall worth long term. Baby Boomers planning for retirement have to decide whether they want to have their mortgage paid off before they retire or not. Retirees who have been in a home long-term may consider downsizing, taking some profit from their home and purchasing something less expensive.

No matter what your age is, decisions made regarding housing will have a huge impact on your finances. It’s worth your time to pay attention to the housing market and seek out expert advice when making these long term decisions.

For shelter costs (rent or mortgage payment) to be considered affordable, they are supposed to take up no more than 30% of a household’s income. In the past 50+ years the high leverage of America’s mortgage products allowed individuals to purchase large homes with minimal down payments, typically 3.5 to 5% down. The large cost of down payment of today’s post Dodd-Franks regulations is a non-issue for most current homeowners.

The Great Recession saw Americans’ net worth get clobbered by a declining stock market and falling home prices. Since then, both stocks and home prices have recovered. Both the Dow and the S&P 500 have hit record levels until the last two weeks, and home prices have also rebounded. Americans’ equity in their homes is up to over 50%, from a record low of 36.5% in early 2009.

One thing you can do to help make housing-related decisions is to educate yourself about the housing market. There are several economic reports you can monitor to gauge the health of housing in your area. Among them are existing home sales, new home sales, pending home sales, building permits, housing starts, and the home price indexes.

Remember all real estate is local. Values and appreciation are local. A sale or purchase in the suburbs has little to no impact on values in the interior of a city. Knowing where and what you want is important. In doing that it is important to not look at the last year or couple of years trends but the last 5 to 10 years. The average ownership term of homes has moved to 7+ years. The average rental term is one year, with annual turnover exceeding 61%. In a tight market this allows residential rental values to increase quickly.

People are concerned about housing values because we have seen double digit appreciation recently. But it is true demand that is driving the appreciation rather than speculation. As supply remains constrained we could see this trend persist for several more years. I would rather be paying a steady mortgage payment I can barely qualify for, rather than knowing that my rent payments will continually increase.

Recent national data has shown that the rapid rise in home prices that began in early 2012 has begun to subside. The S&P/Case-Shiller 20-city index rose just 0.6% in July and after seasonal adjustments showed a drop of 0.5%. Year-over-year prices have risen 6.7% nationally , and that is the slowest pace in the last two years. In most major cities, home prices are still below the peak that was seen during the housing bubble. Two exceptions are Dallas and Denver where prices have now risen higher.

First time buyers

Another issue driving housing appreciation concern is the lack of acceptable alternatives for first time home buyers. In Texas this would be any home below $250K. Traditionally first time home buyers have made up 30 to 35% of the market, presently it is less than 7%. A lack of first time home buyers is a problem, because such buyers are critical for the long term health of the housing market. There have been substantial job gains recently for people aged 25-34, who normally account for the majority of first time home purchases. But Millennials have a tendency to delay marriage and child-rearing and as a result they are also waiting longer for their first home purchase; they also are more inclined to stay in urban areas rather than move out to the suburbs.

Other issues

• It’s hard to get first time homebuyers qualified for loans even if they have a significant down payment, which most don’t. Plus, most of the new housing inventory is for properties priced in excess of $250,000. Starter homes are nearly non-existent in those locations desired, and builders have a hard time filling that channel due to land, labor, and construction price increases.

• Home owners who normally would sell are deciding to stay put — because there’s limited product for them to buy, and they’ve already refinanced their existing house at an interest rate that they can’t match or they don’t want to go through the hassles to qualify for a new mortgage under stricter underwriting.

• Municipalities, school districts, and other government entities are completely unprepared for the rapid pace of growth. All Texas metros are projected to double in size over the next 20 years according to the state demographer. Roadways, utilities, and other services are woefully under built or under staffed for the growth the state will experience over the next 20+ years. This is a “good problem” to have, but still a problem.

• Median home prices have been on an upswing but real wages aren’t keeping pace with inflation, much less real estate appreciation whether you or renting or buying. At the same time investors and equity with big bucks to spend are buying Texas property and potentially driving up prices. Improvement in wage growth will be good for a change in affordability. As rents continue to rise, there is still hope that the lending restrictions loosen to make purchasing a home more attainable. A recent drop in mortgage applications should reduce the amount of bidders and competition for available inventory. Jobs are moving back to healthy stages as unemployment levels reach a low since 2008.

• Mortgage rates, while likely remaining low for the next 9+ months, will probably increase in late 2015. This exasperates the affordability issue even more.

• Less obvious to the casual observer and consumer is the added regulations and costs most Texas municipalities are adding. Tougher zoning laws have shown to historically cause values to increase quicker. Look at California or closer to home, Austin where the cost to build is much higher than other Texas metros. The economic impact of affordable housing and other requirements are great in social responsibility, however they force values up quicker.

A nation of renters

Part of the reason for the heightened concern on values is the squeeze on renters, caused by simple demand — between 2007 and 2013 the United States added, on net, about 6.2 million tenants, compared with 200,000+ homeowners, according to the Census Bureau. Everywhere you look that is apparent with the number of new apartments being built. Here in Texas that is particularly apparent with record number being constructed for the last number of years with rental values not slowing.

That trend is continuing as young people and doubled-up families move out on their own and or move to Texas. But new households rarely plunge straight into homeownership, especially given that mortgages are much harder to obtain than they were before the financial crisis. The expectation is that when they strike out into their own units they’ll be moving into rental as opposed to the owner side

For many middle- and lower-income people, high rents choke spending on other goods and services, impeding the economic recovery. Low-income families that spend more than half their income on housing spend about a third less on food, 50 percent less on clothing, and 80 percent less on medical care compared with low-income families with affordable rents, according to a report by the National Low Income Housing Coalition. And renters amass less wealth, even non-housing wealth, than homeowners do.

The problem threatens to get worse before it gets better. Apartment builders have raced to build more units, creating a wave of supply that should have been at a ‘tipping point’ in the last 12 months in Austin, San Antonio and Dallas Fort Worth. But demand has shown no signs of slackening. And as long as there are plenty of upper-income renters looking for apartments, there is little incentive to build anything other than expensive units. As a result, there are in effect two separate rental markets that are so far apart in price that they have little impact on each other.

What economic impact does this have? Currently the state population is around 28 million with the conservative forecast predicting it will double in the next 20 years. Presently about 40 percent of all Texas are renters, so about 11,200,000. Now many of those will remain renters due to education fulfillment. The higher the education level the greater chance of home ownership.

Texans and Americans are spending the highest percentage of their income in 30 years on the rent check every month. Historically, the median household needed to spend a nationwide average of 24.5 percent (this includes utilities and additional costs) of their earnings to pay for rent at the median property level. Now, the share is 29.5 percent, a 19 percent jump from what it was between 1985 and 2000.

In most of the US, but particularly in Texas, there has never been a better time to buy. Barring a catastrophic event, real estate values in this state show little reason for decreasing. They will slow as supply builds, but the concerns of another bubble are not well founded in this state. As has been stated before, the apartment or home you look at today will not be there tomorrow.