Texas housing markets (still) aren’t overvalued

The Austin Board of Realtors reported that the March 2015 median price for single family homes was $255,000, a 10% year-over-year increase. This is a record high for Austin homes, so it isn’t surprising that some are saying our market is overvalued or in a bubble.

Still, you can’t just look at appreciation and say the market is overvalued without looking at the reasons for the rise in prices. In relation to the other desirable cities that are creating 30,000+ jobs annually, our values are on the inexpensive side.

Texas has never led the nation in real estate appreciation. For the last forty years our state has averaged just under 4% annual according to Texas A&M Real Estate Center. Last year we saw 7.12% annual appreciation in Texas, according to FHFA House Price Index (HPI). During the housing bubble, Texas was at the bottom of real estate appreciation of all states, as you can see on this interactive map.

We’ve had a couple of good years in Texas after recovering faster than the rest of the nation. Speculation is hard in Texas, because the annual returns are not as great as in other markets. The speculation that many investors look for is not available in Texas; namely, those investors betting on appreciation rather than the fundamentals of income producing properties and/or historical sales prices. As long as job growth remains strong, Texas’s housing market likely won’t tank. Folks betting on appreciation might get hurt, but others will be fine.

It’s all about jobs

Again, job creation is driving demand and home values. From March 2014 to March 2015, Texas total nonfarm employment increased by 327,500 jobs, or 2.8%. The Texas unemployment rate was 4.2% for March 2015, down from 5.3% in March 2014. The Texas unemployment rate has been at or below the national rate for 99 consecutive months. Over the same period, Dallas had 4% job growth, ranking 5th nationally. The other major Texas metros missed the top 10: San Antonio grew by 3.4% (14th), Houston grew by 2.9% (22nd), Fort Worth grew by 2.6% (28th), and Austin by 2.5% (29th).

Whether the stronger home price appreciation in some Texas markets will lead to a bubble will depend on whether the employment growth here is sustainable in the long term. Most analysts think so. A continued drop in oil prices, or even a tech bubble burst, could curb demand for housing in hot Texas markets, and take some of the air out of the steady increase in values. Texas was among the first states to emerge from the 2007-09 Great Recession, surpassing its pre-recession employment peak in late 2011. Since 2000, change in Texas employment is up 24.9%, while the rest of the country is up 4.7%. Since 2000, Texas has created 2 million jobs, while the rest of the country combined has produced 5 million. As a whole, 29% of all new jobs since 2000 were created in Texas.

Remember the financial meltdown in the US was caused in part by not following the fundamentals of real estate. For every three jobs there should be one home start. Texas and its metros continue to be right in line with that. Those states where appreciation was in the mid 40% annually were pure speculation. It was a strong run, but based on non-sustainable fundamentals. Texas continues to have the fundamentals in building and consuming the shelter available presently.

Richard W. Fisher, president of the Federal Reserve Bank of Dallas, emphasizes Texas’s comparatively rapid rate of job creation. Over the last twenty-three years, the number of jobs has increased twice as fast in Texas as it has in the rest of the country. Many people might imagine that most of those new jobs pay low wages, but that turns out not to be true. To be sure, Texas has more minimum-wage jobs than any other state, and only Mississippi exceeds it with the most minimum-wage workers per capita. However if you consider cost of living, the Texas wages are better than most.

According to the Dallas Fed, only 28 percent of the jobs created in or relocated to Texas since 2001 pay in the lowest quarter of the nation’s wage distribution. By comparison, jobs paying in the top half account for about 45 percent of the new jobs in Texas.

This means that Texas has been creating or attracting middle and high wage jobs at a far faster pace than the rest of the country taken as whole. For example, between 2001 and 2012, the number of Texas jobs in the upper-middle quarter of the nation’s wage distribution increased by 25.6 percent. This compares with a 4.1 percent decline in the number of such jobs outside of Texas. Though coming off a comparatively small base, Texas has also outperformed the rest of the country in its growth of high-paying jobs.

That’s a big deal. During the last decade, the country as a whole experienced zero net job creation, and the decline in middle-class jobs is arguably the largest single threat to the national economy’s viability. Only 65 counties out of just over 3,000 have fully recovered real estate values, employment, and GDP to prerecession numbers. Nationally the country continues to struggle. Much of these statistics come from an article from the Federal Reserve Bank of Dallas, 1Q14.

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Appreciation isn’t the only factor in determining if a market is overvalued. Here are some other metrics to watch:

  • Job creation vs. home starts (a ratio of three jobs to one home start is balanced)
  • Resale housing inventory: less than six months is considered a sellers’ market
  • Less than 24 months supply of new home starts
  • Less than 24 months supply of lot inventory
  • Rental occupancy residentially above 90% with no concessions
  • Double digit appreciation for more than three years

When there has been job creation but an absence of developing and building there will be a need for more inventory as the market plays catch up. That is where our Texas metros are; playing catch up, not overvalued or undervalued. With true demand from population and employment growth the metro markets have a ways to go to catch up.

Those of us who have been watching and analyzing Texas real estate will be the first to tell you that we don’t know the future. History has taught us differently. Even if Texas metros are a good market now doesn’t mean in 18 months or 5 years that it still will be a good market. But by reviewing past regional history against national metrics, we can say confidently that the regional market will be strong for at least the next three years based on jobs, population, affordability, and demographics.

The speculative building that we saw regionally in the 80’s here in Texas and the same in the sand states (California, Nevada, Arizona and Florida) in the early 2000’s is not present today. Double digit appreciation as a region is not present. Are these things that bear watching? Absolutely. Remember that although the headline of “x market is overvalued” gets attention, to most long term analysts and economists appreciation is just one of many statistics, and all the fundamentals need to be reviewed to make a true assessment.


Is Texas overvalued?

Last week, the media picked up an article by one of the major real estate media outlets on the ‘overvalued’ Texas metros real estate.

The real estate and financial collapse of the last decade — a once-in-a-century financial crisis and recession — is not something most folks are excited to see repeated. Many parameters since the crash have been put in place to discourage another bubble and crash. Mortgage lending is tremendously harsher than it was 10 years ago, potentially excluding 3 to 7% of the total market from qualifying for home mortgages.

The housing market nationally is at about 40 to 50% of production / sales of where it was pre-recession. The last couple of years have been healthier, with Texas real estate in 2012-13 really showing strength.

Yet, after the real estate bubble, when any ‘hard asset’ market shows strength, the naysayers seem to take delight in looking for the next bubble collapse, whether it is in gold, stocks, Bitcoin, real estate, etc. I am not well versed in many of these, but know well the history, demand, and forecast of the Texas economy, having watched and participated in it over the last fifty years.

After a number of years of declining or stagnating housing prices, the market turned around big time in 2012-13, making some analysts and naysayers worry that we’re seeing the beginnings of Housing Bubble 2.0. The concern for housing bubbles is real, wherever you live.

However, there is a long way to go before the regional market begins to show those signs. Here in Texas we are not seeing this based on economics 101 – supply and demand. Are we overvalued? No. I am sure that if you delve deep enough into all the regional properties available, there are some that are overvalued. But as an overall market this is not true.

For those who are not familiar with the Texas’s history during the recession, it came out fairly unscathed with real estate values and employment leading the nation. During the bubble years when the sand states (California, Nevada, Arizona, and Florida) were leading the nation in appreciation (40+% annual), Texas was near dead last in home price appreciation, with less than 3% annual appreciation for a number of years. Texas was 50th in appreciation for a couple of years. We may have climbed up to 47th or so, but the runaway real estate speculation of the bubble states was just not available here to those looking for a ‘quick buck’.


So to the point I am addressing, one of the major real estate media sources has named a number of our Texas region metros as ‘bubble markets’ to watch. Their basis is on tracking home prices across the country to see which markets are over and undervalued. In a forthcoming “Bubble Watch” report, they find that while most of the U.S. real estate market remains significantly undervalued, there are certain markets that feel are straying into bubble territory.

Realize that they are a media source, not a real estate broker. They are a very knowledgeable source but they make their money on advertising rather than real estate investment. We have a great deal of respect for the chief economist and his findings, but to call Austin and the other regional markets overvalued? Compared to what? You cannot compare to history, Texas and Austin appreciation has been one of the lowest in the country over the last 10 years. Check with the national sources such as OFHEO, FHFA, or Corelogic index.

Their methodology looks at whether home prices are overvalued or undervalued relative to their fundamental value by comparing prices today with historical prices, incomes, and rents. The more prices are overvalued relative to fundamentals, the closer they feel we are to a housing bubble – and the bigger the risk of a future price crash. By their own admission, ‘Recent price changes, by themselves, cannot tell us whether this is a housing bubble; neither can a simple comparison of nominal price levels today to where they were in the past.“

They then combine these various measures of value rather than relying on a single factor, because no one measure is perfect. In doing that markets in California, Orange county and Los Angeles are more than 10% overvalued. But where I argue is that they also showed the Austin, Texas market at 10% overvalued, while 7 other markets range from 4% to 7% overvalued. Those include:

• San Antonio, TX;
• Honolulu, HI;
• San Francisco, CA;
• Houston, TX;
• Riverside-San Bernandino, CA
• Oakland, CA

Unsurprisingly, these markets are where job creation has lead the nation, in Texas and California, which have also seen double digit home appreciation over the past year, with Orange County real estate appreciating a strong 23.4% since October of 2012.

So are we in danger of another housing bubble like we experienced last decade? Not quite yet, at least nationally. We cannot comment on those markets outside of Texas. According to their data, the national market remains roughly 4% undervalued overall. And in some markets, like Cleveland, Ohio and Palm Bay-Melborne-Titusville, Florida, home prices are still 20% below their fundamental value yet they do not have the employment growth or demand of the Texas region. Furthermore, even the most frothy markets are less overvalued than the national market was in 2004, when home prices were 24% overvalued nationally.

Starting with residential home values, Austin, San Antonio, D/FW and Houston metros are still challenged in inventory with all having less than 6 months inventory. Analysts at Texas A&M Real Estate Center will tell you that 6 months worth of inventory is equilibrium. Below that it becomes a seller’s market (a market where lack of inventory makes values improve). Above that mark of 6 months, supply dictates an easing of values, making it more of a buyer’s market. So based on demand and supply this market does not seem to be overvalued presently and with current absorption and employment projections, it will be 2 to 3 years at least before this could become an issue.

Looking at residential rental, the market demand currently has been outstripping demand for the last 2 to 3 years, even with near record supply of apartments being built in all Texas metros. Supply at some point should outstrip demand, right? It may happen soon in Austin, San Antonio or D/FW based on current construction. But demand has outstripped supply as shown by the lack of concessions or lower occupancy. Rental values over the last 10 years have appreciated over 50% with home values around 35%. Demand has kept values strong.

One of the things to keep in mind about current demand vs. prerecession is that the non-30 straight rate, 5% to 10% down programs that are prevalent now, were in the minority pre-recession when sales, values, appreciation, and speculation were stronger. The ability to have a bubble in real estate is more restrictive now.

Overvalue is overstated presently in the local regional markets. In other words, the real estate and financial world has changed. Younger families are unable to qualify. Young people have not gotten the economic traction since the recession. Even the ones who can aren’t getting mortgages because credit is much tighter than it was in the pre-bubble years, and recent price increases have been fueled by over-enthusiastic investors rather than true economy-wide demand for housing. Every real estate analyst is forced to used assumptions when forecasting the future prices of homes, and given the fact that home price appreciation in Texas has been healthy for a couple of years, may be going too far in arguing that certain Texas metro markets are overvalued bringing thoughts of another bubble.
Let’s look at appreciation from another source: Corelogic, an analytics company with lots of data. When you look at the following chart you can see that a number of states have had stronger appreciation than the Texas region.

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Another chart shows annual metro appreciation and supports the same conclusion of good appreciation, but not overvalued.

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Texas metros are not overvalued

In all Texas metros demand is outstripping supply and the entitlement and lending process have a way of governing development and building. Will Texas and it metros overdevelop and build in the future? Absolutely, the advantage of a free market is the ability to market real estate if you can get the financing. the market dictates whether the market is overbuilt or not. The market has a way of self correcting. All of our metros seem to be a few years away from slowing. Austin, which led the list of overvalued markets in Texas, has the longest entitlement process of approval, meaning supply will take a while to catch up to demand.

It’s still cheaper to buy than rent. If you live in a metropolitan area, it may make more financial sense to buy a home than rent a house, condo, or apartment. According to a to this same real estate media source study, buying a home is 44 percent cheaper than renting in the 100 largest metro areas in the United States. While this data was calculated based on last year’s lower mortgage rates, there is still a significant price difference in total monthly costs with today’s rates. And again income vs. home value is tremendously better in Texas than almost any other state that is creating jobs.

Comparatively, home prices are relatively low. Housing price trends vary significantly by location and even by neighborhood, but the average housing price trends across the country look promising for prospective homebuyers looking at Texas versus their current state. The S&P/Case-Shiller composite index of 20 metropolitan areas increased only 1 percent this past season, so 2014/15 could still be a great time to buy.

Because of the lack of dramatic appreciation, there is less competition from home flippers. Housing prices in some markets are increasing, making house flipping attractive. But in Texas it has historically been a lower appreciation value. This gives prospective homebuyers more inventory to choose from and the benefit of having less pressure to close a deal because of another pending offer. This could be the time to enjoy the freedom of shopping around for that perfect home and making an offer.

The majority of renters would like to avoid the cost of rising rent. A buyer’s market means it might be time to say goodbye to renting for good, but Texas is a seller’s market. That said, rent increases historically go up quicker than appreciation. So as you look at shrinking housing dollars at your current location or want to move but will experience a spike in rent, consider the benefits of buying a home instead. You may be able to secure a great rate with your credit history and end up paying the equivalent or less in monthly payments as you build equity in a home. Renting can be a more affordable option for the short term, but renters still have to face rising rental costs year after year.

Presently with Texas real estate being undervalued, there is not a more affordable time to buy. Buying a home gives you a chance to start building equity, and you are investing in your future. Even if you end up selling your home in five or ten years, you could profit from the sale and invest that money elsewhere. If you’ve been dealing with rising rent or the hassles of costly moves for the past few years, settling in to a home can stabilize your housing expenses – especially if you get a fixed-rate loan at a great rate. You won’t have to worry about your monthly housing expenses changing significantly for a few years, and you will pay for something that has more value than a rental property. Consider the benefits of making this type of contribution to your future month after month. Of all the regional markets, look what region has had consistent growth over the last 10 years. Not necessarily explosive appreciation, but affordable. Now is the time to buy in Texas!

One of the enduring lessons of the last real estate bubble is that while there are many reasons to buy a house — like the tax-deductibility of mortgage debt, the forced savings mechanism of paying a mortgage, and the pride of homeownership — expecting unrealistic significant appreciation in your home’s value shouldn’t be one of them. If you are looking at the value or your home / real estate it is more important to look at the last 5 to 10 years history to decide if it is overvalued. Looking at a snapshot, is just that; a partial picture of the total.

Why the national real estate recovery has slowed this year

Is real estate still a good investment, or has the U.S. housing market finally topped out after one year of recovery? Over the last few months, pending home sales have slowed down due to weather, a rise in mortgage rates, and a 12% rise in home prices from the same time last year. Many are wondering if the housing recovery is over.

We saw the biggest real estate and financial bubble with the longest recovery following it since the Great Depression. Housing and real estate prices, fueled by easy financing and speculation, topped out somewhere in 2006 or 2007. Then the market collapsed, taking global financial markets with it. It has taken six years for the recovery to take hold.

The mentality of potential buyers fundamentally changed. They saw homeowners lose over $8+ trillion in asset value. Many questioned the validity of owning real estate due to the devastating effects of this bubble. After seeing so many homeowners in upside down mortgages, many felt that renting was better than buying. It changed demographic habits across the country. Children moved back in after college. Household formation of couples moved back 5+ years. The housing market underwent a fundamental shift as home buyers became scarce and homebuilders scrambled just to stay afloat.

A few parts of the country didn’t see a housing boom, and some parts (such as Texas) didn’t really see a bust. That does not mean they went unscathed. In general, because of the real estate and financial meltdown, we saw a fundamental change in financing from acquisition and development through mortgage policies. Harsher lending guidelines were but in place. Government backing of the majority of the housing market was no longer desirable. All of this had a dampening effect on real estate that we still feel today, no matter where you live.

So why the concern about real estate slowing? Nationally, existing home sales were down 7.5% year-over-year in March 2014. In the same time period, however here in Texas there were 22,511 sales of existing single-family homes, 3% more than in March 2013. Values continued to improve regionally, the median sale price for an existing single-family home was $178,000 in March 2014, 8.1 percent higher than a year ago. In Austin, most realtors will tell you there biggest concern is lack of inventory.

New home starts face similar issues. Nationally, this March was down -5.9% from this time last year, another sign of the market possibly slowing or catching its breath. In Texas, we saw a total of 8,023 building permits for single-family homes were issued in March 2014, 7.4 percent more than in March 2013. In the 12 months ending in March 2014, a total of 87,931 permits were issued, 12 percent more than in the previous year.

Here in Austin, we have been about 5,000 home starts annually short for the last two years and this year looks the same. Remember for every two jobs there should be one home start. Austin has been averaging just over 30,000 new jobs the last couple of years. All the Texas metros have delivered less than demand. This is a good problem to have, particularly when compared to the rest of the country. New home sales are up significantly from the bottom, but are still historically very low. There really is nowhere to go but up. A growing population will require more new homes.

With this demand, values have increased, which has people wondering if we are entering another bubble. They point to the fact that the housing market is being propped up by low interest rates, a loose monetary policy by the Fed, and bank bailouts. While these things are certainly true and they do prop up real estate prices, I believe that true demand is what has caused values to surge.

Others believe that real estate prices will continue to go up, while maintaining that it is not a bubble yet. They point to the Federal Reserve’s focus on inflation. Whether there is high inflation or low inflation, most investors look for undervalued hard assets. You can’t get more of a hard asset than real estate. So if you expect inflation to continue to get worse, real estate is something to seriously consider, whether it is your first house or an investment piece of property.

As far as concern about a bubble locally and regionally, this analyst and others will tell you not to worry. Regionally housing prices bottomed somewhere around 2011, we have seen them climb quite significantly, though still not to the levels we saw in 2006 in most places. The supply side is the biggest constraint to housing and real estate growth in Texas and our metros. For a more in-depth discussion, check out the Independence Voice blog.

Worrying about the housing market has been common for the last few years. However, it is time for the media and the consumer to look at the reasons to buy into the housing and real estate market. The vast majority of markets in the nation as well as Texas do not have enough inventory for the demand. Housing and real estate is lagging because of the residual effects of the housing and financial crisis.

So why the slowdown nationally? Numerous reasons:

• Lack of foreclosures and short sales. Most of the distressed product has been acquired, and most values are no longer offering the large discounts that the investors are looking for.
• Rates increasing historically slows down sales for a couple of months, while the public decide whether they will see low rates again or not. As most of us over 40 know, rates are at a historical low. Why wait?

• Foreclosures have dramatically slowed as well as bank and mortgage company failure. The investor that was buying the last couple of years no longer has the opportunity he had the last 3+ years to get discount prices. With less distressed inventory, the investors as well as the consumer are scrambling for product. Supply has not met demand yet. Foreclosures were never much of a factor in Texas. Many of the consumers looking today realize that the ability to find a distressed ‘dream home’ is no longer possible. There is little to no residential, commercial, retail, etc. real estate available in Texas at a distressed value. After a couple of weekends shopping in our metros and cities, most consumers realize that trying to find that perfect deal or home at a discounted price is not possible.

If you live in Texas, waiting to buy a home or investment property will cost you.

• Rates are at historical lows, every time that rates increase you lose 12% buying power. Why wait?

• Whether renting or buying home and real estate values continue to improve. How much? High single digits in most metros in Texas. Yes there are those high demand areas that will be double digit, and those low demand areas that will be in the low single digit. However they are all moving in the same direction, up!

• Comparatively, in most of our metro markets, real estate is still pretty cheap in Texas. Throw in the cost of living compared to most metros outside Texas, it is a dramatic reduction in cost for most families.

• Whether nationally, regionally or locally, real estate historically has been a great long-term return. If you look back 30 years, real estate is still valued much higher than it was. And if you are looking at investment property, and if you have tenants paying your mortgage, it makes the investment that much more profitable. Most Texas metros have seen rent appreciation higher than actual real estate value. What does that mean? Austin has seen a 58+% increase in rents the last 10 years. Home value and real estate appreciation has been around 38+/-% in the same time.
So if you are buying a house (as opposed to renting) because you need a place to live, this might be a valid time. However, it’s important to remember that buying a house to live in is not really an investment, other than the fact that you need a place to live. The only sense it could be considered an investment is that it’s somewhat of a forced savings plan, as you pay down the principal balance on your mortgage each month.

Housing is a slow moving market – and the recovery will not be smooth or fast with all the residual problems. But overall housing is clearly improving and the outlook remains positive for the next few years. I know, I know – you’ve been hearing for years that it’s a great time to buy real estate. When the bubble burst a few years ago, and people were losing money on their houses, it made investing in real estate a scary proposition. But thanks to the same recession that caused the real estate mess, there are loads of opportunities for those with the financial resources and means to buy real estate.

(Note: I will be out on sabbatical, so the Voice will go on hiatus until June)

How would you grade the recovery?

The recession seemed to come on so quickly, and yet the recovery seems to be slow catching on. Why does it feel like we’re still in a recession?

Overall, GDP growth in 2013 was subpar with 2% growth. This is below the historical norm of 3%, and it’s been several years of under 3% growth. As you can see in the chart, last year GDP growth has not been anything to write home about.

voice gragh 1

The U.S. economy is expanding, the stock market is breaking records, the global economy is doing better, state economies in the region are doing better, and all that is expected to continue in 2014. So, why do most Americans still think we’re in a recession?

After all, the economy is technically growing — slowly, imperceptibly, like watching grass grow. As you question the recovery, what most are experiencing upon closer inspection is what many analysts call a “balance sheet recession.” That means that just about everybody in the Western World — households, corporations, and even governments – are focused on paying off our balance sheets (paying off debt) at the same time. That’s nice for our balance sheets. But it’s a horrible way to jumpstart a weak economy. The lack of confidence in our economy is apparent as you watch Congressional budget debates, and watch consumer and business spending slow or halt during those discussions. In any type of recovery, physical or economic, slow and steady is the recommended solution. Any exceptions to that tend cause concern, particularly when we are recovering from loss of over $7.8 trillion in net worth nationally. Businesses and consumers are not ready to jump in with both feet it appears.

Remember, between the technology bubble and the housing bubble that book-ended the 2000s, households and business borrowed lots of money, year after year. Then the recession hit, and our incomes fell, and we started savings and running surpluses by saving more of our money. The Baby Boomers were not near the savers their parents and grandparents were until the recession hit. When you are not sure or optimistic about the economic future, we have been taught to save.

Also remember nationally, after the tech bubble, the U.S. economy relied on Americans buying more houses — and more expensive houses — than ever before. Today, Americans are buying the fewest number of homes in 60 years, a fifth of homeowners are underwater, and savings rates have shot up. Deleveraging created a whopping 9-percent-of-GDP shift toward savings in the private sector. Meanwhile, the public sector’s borrowings offset only about two-thirds of that shift.

So what is slowing the recovery? One of the main factors is unemployment, long term and short term. This recovery just does not have the feeling of improvement, even though unemployment has been declining measurably – from 10% at its peak to 6.6%. But if you look at the employment rate – not the unemployment rate – you see how few in the adult population have jobs, and we have not made any progress since the recession began. We are only at 58% of the adult population working now, same as it was in the depth of the recession, and well below the historical trend of 63% nationally.

Unemployment until this last December has been above 7 percent for over 4 years, above pre-recession levels for over 5 years, and isn’t likely to return to those levels for a few more years. Wages are not keeping up with inflation or appreciation. A great example is Austin, where over the last 5 years rents have increased 58%, real estate residential appreciation 38%, while wages have been flat. Austin, as good as it seems to be doing, is a microcosm of the national economic picture. The ability to spend more is tapered by the inability to make more in many jobs.

The U.S. economy continues its slow walk back to pre-recession levels, with unemployment being among the slowest of indicators to return. Household median income has declined over 5 percent since the meltdown. While higher-wage occupations have generally recovered, mid-wage occupations have not. Instead, the growth has been in lower-wage occupations. This is forcing many Americans to lower expectations about lifestyle and living standards.

If you look at the chart below you see that this recovery has been slower and longer than previous economic slowdowns.

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Then there is the consumer spending piece of the puzzle. Consumer spending has been slow. Consumers and most business are still cautious and less confident about the economic recovery. There are plenty of conflicting indicators about what is happening in the U.S. economy, with booming sales of cars and houses seeming to be offset by sluggish spending in retail, stores and restaurants. The good news is that people are showing more confidence in making longer-term, big ticket purchases than they are in loosening up on their day-to-day spending over the last year. But there also is a need nationally for retail spending to pick up.

One of the many economic indicators that I watch personally is how women are spending. Since many women who are married also manage the budget (and even if they don’t), they spend money on themselves last in the family budget. A great example is the lipstick index, first suggested by Leonard Lauder, chairman of Estee Lauder. The index shows that women turn to lipstick instead of more expensive indulgences like handbags and shoes during hard times. You always have your exceptions to every rule, but in my 35+ years of following the economy, when women’s retail chains and stocks begin to pick up, it is a good sign. For most of last year we began to see that spending indicator. Unfortunately beginning with budget impasse, it has plateaued.

That can be seen in business spending, too. Historically business investment should follow profit, but that’s not happening. Profit is up but businesses aren’t spending. It implies that businesses are uncertain about the near future. That said, if you look at small business optimism index, 2014 shows optimism and potential growth (small business make up 80+% of our national GDP). But again, what we are seeing is the lack of confidence in long term economic growth presently.

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Despite the lack of confidence and the hollow unemployment rate improvement, most economists and analysts still expect growth through 2014 into 2015. Just not the robust growth everyone wants and remembers from pre-recession days. The good news is the economy is expanding. Most analysts expect 2.5% GDP growth this year. In the 4th quarter 2013, growth was solid but that was one quarter. We need that rate to be consistent for four quarters.

So, how do we grade out?

Nationwide – C+

The Federal Reserve lowered rates, and is planning to let rates increase as housing and job growth historically follow. When the rates are at zero, the Federal Reserve uses other means, such as quantitative easing (QE) to encourage growth. It has been by most measurements mildly effective. As the Fed reduces stimulus, then rates will rise, which in turn causes concerns on home affordability. Historically as rates rise, sales slow, then pick up as businesses and consumers realize that rates won’t go down much once they begin to rise.

Texas – B+

Supply and demand is in balance, and home/land value appreciation meets or beats inflation. Employment growth, lack of business regulation, and low tax burdens all have helped. The attention Texas has gotten from its economic performance compared to other states means it is being seen as the new ‘land of growth’.

Austin – A

So much has been written about the strength and success of this market. Job creation and housing formation as well as other real estate channel demand exceeds supply. Housing and real estate appreciation is stronger. Most of the area concerns are caused by the strength and demand of the market. After the tech bubble burst, local civic leaders got together to plant a broader economic base for growth. This blueprint has allowed tremendous ‘buzz’ and goodwill in attracting talent and jobs.

Houston – A

Like Austin, after the energy and tech busts, local leaders looked to improve and broaden their economic footprint. What has ensued is a city that has felt very little of the national recession. The housing formation as well as other real estate channel demand exceeds supply. Through 2014-15 housing and real estate appreciation will continue to gain strength.


Dallas / Fort Worth is much more dependent on the national economy, therefore the recession hit them harder than the other city their size in Texas. They just began to feel the recovery in the beginning of 2013, unlike the rest of the state. The good news is that demand has picked up, putting pressure on supply in most channels. Not quite as robust as Houston or Austin, but getting there.

San Antonio – B-

San Antonio had been doing better until last year, when the Congressional sequester and defense budget cuts hit. Over 90,000 civil defense jobs were lost in Texas. This hit El Paso, Killeen and San Antonio hard where there is such a large military presence. That said, they still had a net positive of 8,000 jobs in a market that remains tight in all residential channels. Economic recovery potential remains strong as most brokers see greater housing formation than inventory.

Key indicators are generally positive nationwide, again with the Oklahoma-Texas region leading. Regional GDP will grow, unemployment will continue to decline, business investment and consumer spending will grow, no matter what people are feeling.

Inflation and interest rates will see slight increases. Agricultural production and income will be down slightly in the region while the natural resource sector will likely see a steady rise. Regional wages will also likely be steady to up. Unemployment will continue its slow decline.

This continued level of uncertainty suggests the continued importance of risk management and longer term strategic planning. With 2014 as a mid-term election year, it is unlikely that the rhetoric of politics will be dialed down. Not just the economists and analysts, but all of us will need to be keen on interpreting the facts from spin, and how such information is likely to effect our economic realities.

No bubbles here: a look at the DFW real estate market

Last week, we took a close look Austin’s real estate economy. This week we are going to look at the growth in Dallas-Fort Worth. We also wanted to spend some time discussing why the strong appreciation we are seeing through out Texas is indicative of a healthy market and not a real estate bubble.

The Dallas-Fort Worth Metroplex has continued to grow even amidst a recession. It’s true that job growth slowed following the recession. That said, in the last ten years this metro has had some of the best growth in the country. Its location in the middle of the country makes it an easy plane ride from either coast, which is why many companies decide to put their headquarters there. Firms such as American Airlines, Lockheed Martin, Citigroup, and AT&T all have major operations in Dallas, which has helped insulate the city somewhat from the recession. Texas now has more Fortune 500 headquarters than any other state.

According to Census Bureau estimates the Metroplex population is over 6.7 million people. Since the 2010 census DFW’s growth has been even more impressive. The population has increased by 4.3 percent, or 274,781 people. With all this robust growth there is a need for shelter.


Population and job growth has driven strong home sales. For 26 months in a row, area home sales were higher than the same month of the previous year. Median home prices in October 2013 rose 13 percent from a year ago. Through the first 10 months of 2013, pre-owned home sales are 19 percent ahead of where they were in the same period last year. And median home prices are up 10 percent from the first 10 months of 2012. In October, there were 22,656 homes listed for sale with Realtors in the roughly 50 counties included in the monthly survey. That’s 13 percent fewer houses on the market at this time last year. Currently there is only a 3.1-month supply of houses for sale in North Texas — the lowest inventory in more than a decade. As supply decreases, and demand increase, values also increase. DFW suffers the same problem the other metros have and that is not enough developed lots in desirable areas due to the downturn in development during the recession. As the market has turned this has caused a lack of inventory.

The job and population growth of the last 18+ months has helped DFW apartment owners and should allow them another secure 2 to 3 quarters before new construction begins to dictate long term performance and values at existing properties. The continued strong job creation and population growth have kept values and rents strong, allowing the lowest level of vacancies in over a dozen years. The attraction of this market has a number of equity and management groups looking to develop more units in the coming year.

With single family sales doing so well, a lack of housing inventory and continued strong demand has allowed the apartment market to deliver over 13,500+/- units with little erosion of rents currently. Another 24,000 units are under construction, which normally would make equity and analysts nervous. However, last quarter 6,355 units were leased – more than the 4,992 new units delivered. Demand is outstripping supply, which is a sign of the strength of the local rental market.

DFW leads the nation on new apartment deliveries an annual basis. Looking forward, future job growth continues to be impressive with over 8,000 new jobs at State Farm in Richardson, 1000+/- jobs at Amazon’s two fulfillment centers, and a wide mix of white collar and blue collar positions this year, which will continue to generate strong demand over all tiers in the coming months, potentially years. According to the Bureau of Labor statistics local payrolls have exceeded prerecession employment by over 150,000+ jobs, a sign of the strength of the market and continued improvement.

DFW leads the nation in both net apartment leasing and construction, according to a report released by MPF Research. The strong third-quarter performance surprised many apartment analysts. They expected Dallas-Fort Worth to do well given the strength of the local economy, but no one thought the market would see occupancy move to a 12-year high and be able to continue to add that many new units without erosion to rental income.

Most of the construction is in central Dallas, with class ‘A’ units — uptown, downtown and the Oak Lawn area. In the suburbs, building is concentrated in Lewisville, Las Colinas, the Allen-McKinney area, Frisco, Plano, and Denton. Beginning in 2014, the large number of class ‘A’ apartment community deliveries may allow ‘B’ and ‘ C’ communities growth, both in rents and potential sales as investors begin to look for new opportunities.
Couple that with some of the tightest rental conditions since 2001 and its clear that all residential should see values rise and should continue to improve for the next couple of years, barring a catastrophic event. Even though housing is on the rebound, the bounce back is stronger in more affluent neighborhoods, like the inner loop areas. The spread between cap rates and interest rates remains favorable, and most local multifamily investment groups have been trading up.


The office market has experienced some of the strongest leasing activity in its history, and seems destined to tighten as job growth drives record expansions and relocations. New deliveries this year are more than double last year’s production (2.6 million square feet delivered this year compared to 1.2 million in 2012), but with strong absorption the impact on vacancy is forecast to be minimal in 2014.

The office market’s strong performance has been driven by demand from the professional services sector including insurance, IT, and financial services firms. Most analysts agree that Dallas employment growth accelerated in Q3 2013 due to the sharp increases in the financial and professional/business services sectors, which fueled the strongest quarterly office demand in over four years. As stated earlier, large corporate user activity, led by State Farm, has reduced available office space by 25%-to-30% over the past year in the Richardson/Plano and Las Colinas submarkets. North Dallas has become a draw for major office development and relocations due to the areas relatively affordable housing and quality rated schools.

Office sales improved dramatically because of the amount of developed unused contiguous space in the DFW area. Office sales improved 40+% compared to the previous 12 months, with smaller (50,000 square feet or less) accounting for approximately 50% of transactions in the markets. The large properties that have been purchased are being acquired for redevelopment or repositioning. A good example is the old Texas Instruments site, which is being considered for mixed-use residential (previously it was industrial).


As the other channels, retail has been spurred by all this economic growth, adding 2.6 million square feet of retail space, up 200,000 square feet from 2012. Vacancy has risen slightly but rent values have remained strong. Most existing strip centers over the last two years have seen improvement with large blocks of space being absorbed. Vacancy at area shopping centers peaked at near 15% in 2010 and have continued to improve through this quarter.

2014 should be stronger for retail, particularly with grocery retailers expanding with 5 percent sales growth in the metro area. The concern of overbuilding of retail in the DFW market in 2010 has given equity some great opportunities. Those opportunities will be a challenge to find through 2014.

As you can see, Texas metros continue to be the bright spot in the nation’s economy, but come with their challenges. Each metro continues to have challenged submarkets that may take years to fully recover, but all in all Texas real estate continues to improve and grow.

Most importantly, inmigration is not slowing down. We are seeing significant domestic migration, but international migration is right up there as well. We have people moving here from all over the country and all over the world. College graduates and job seekers are moving to areas with greater economic opportunities, and Texas is high on most lists. Part of that is employment, but you also have the economics of the low cost of living in Texas.

Being the center of the nation’s energy sector has helped, fueling growth across Texas and the nation. Most analysts and economists understand that we are in the midst of an energy boom unlike anything we’ve seen since the 1970s, and this time it is not just in Texas, Oklahoma, and the Southwest. It’s all over the country. Wherever there is drilling and production of oil and gas from shale plays, you are seeing significant population and job growth.

The continued strength of this market, along with the tax and financial advantages of Texas should continue to bode well for this area through 2014.

Are we in a new real estate bubble?

This week Trulia published Bubble Watch, a quarterly report that tracks whether home prices nationally and in the 100 largest metros are under or overvalued.

“Nationally, home prices were 4% undervalued, but home prices at the metro level are above their fundamental value in 17 of the 100 largest metros. Most of these overvalued metros are only slightly so: of the 17 overvalued metros, just two – Orange County and Los Angeles – look at least 10% overvalued. Meanwhile, home values are on the high end and are actually 10% overvalued in Austin.”

What is a bubble? Bubbles have characterized recent economic history, as institutional and other major investors have sought high-return, low-risk investments. These investments have turned into speculative manias that eventually come crashing down. The last decade alone has seen the telecom bubble, the nearly simultaneous dot-com bubble, the housing bubble, and most recently, the oil bubble. Of all of them, the housing bubble seems to be the most significant and far reaching.

Four things have to be available for a housing bubble: tight supply, demand, restrictive regulation, and easy financing. Statewide, only tight supply and demand are present; only in Austin does regulation come into play. Financing is still a challenge in today’s environment. When looking at local markets, it is good to look first to job creation, population growth, and lack of inventory available. These basics are not taken into account when looking at naming these ‘bubble markets’. No, the Texas markets are not bubble markets. The current appreciation is driven by demand, not speculation. Supply will take 2 to 3 years to catch up to demand, until then we will see higher values for real estate.

Where do I have concerns about real estate bubbles presently? Markets like Orange County and Phoenix have seen land escalate 30+% in the last year. I would think that level of appreciation would be bubble driven.

For a more complete discussion, I recommend checking out the March 29th edition of the Independence Voice on the Independence Title blog.

I think highly of Jed Kolko, the Trulia economist. However this is one of those releases that doesn’t fully understand the local markets and their trends.
The caveat with Zillow, Trulia, and other similar websites is that all information needs to be verified if you are serious about a property or community. Information on the website is not always 100% accurate. Estimates provided by Zillow as “Zestimates” are just that – estimations, not promises, and not verified. Rremember, Texas is a non-disclosure state. Your own valuation, with the help of a qualified Realtor through the MLS, will almost always arrive at different numbers that are vastly more valid and reliable.

These websites are amazingly useful tools for real estate investors, provided they are used with understanding of their pros and cons. These are great sites to begin to educate yourself on your local market. The level of information makes an investor’s job much faster and more efficient. But the information should not be relied on as gospel – these sites typically have a disclaimer that actual values can be 25% +/- the actual value. Check official records and verify the information you intend to rely on for your real estate investing decisions.

Should you or your customers have any questions, please let us know.


Meet Fannie & Freddie

Over the last few weeks, more attention has been put on dismantling Fannie Mae and Freddie Mac. Why? Because FNMA and FMAC have been singled out as one of the main causes of the national housing meltdown. Early on, during the early days of the financial crisis, the federal government had to step in and take control of these two mortgage financiers and set them up in a conservatorship. Starting with the bailout, the two companies required roughly $150 billion in taxpayer support to stay solvent, while the government was able to keep the housing market afloat by backing more than 95 percent of all home loans made in the United States.

The mortgage giant has now been turning a profit. This year it has had an $18.2 billion profit, its sixth-straight quarter with positive results. Fannie Mae has repaid the US Treasury nearly $95 billion—close to the $117 billion it originally drew. Freddie Mac has also been profitable. So, if they’re profitable, that means that they are near paying off their debt, because the profits go back to pay their bailout, correct?

It turns out they don’t. So where does it go? The chief beneficiary of Fannie’s profits, is the federal government—the same entity that bailed it out at the height of the financial panic nearly five years ago. The payback was not set up as a loan, with debt payments towards paying off the initial debt as most notes are done. Part of the agreement was that the government took senior preferred shares of the company. Fannie Mae now has to pay nearly all of its profits, save a small capital cushion, to the government in dividends. This doesn’t pay back the draw; it is just a dividend. In turn the federal government decides where the money should go. This does not necessarily go to paying off the original debt.

So, should we do away with them, because of the financial meltdown? Let’s start with a basic understanding of who they are and what they do.

What do Fannie Mae and Freddie Mac do?

Fannie MAE and Freddie MAC remain two of the largest financial institutions in the world, responsible for a combined $5 trillion in mortgage assets.

FNMA was founded in 1938 during the Great Depression as part of the New Deal, in response to mass bank failures. FMAC was created in the early 70’s to help create a secondary market to package mortgages to investors. Before the depression most mortgages were held by local and regional banks with little to no insurance or federal backing should the real estate market turn against them. FNMA is a government-sponsored enterprise (GSE), though it has been a publicly traded company since 1968. The primary function of Fannie Mae and Freddie Mac is to provide liquidity to the nation’s mortgage finance system. Fannie and Freddie purchase home and residential loans made by private firms (provided the loans meet strict size, credit, and underwriting standards), package those loans into mortgage-backed securities, and guarantee the timely payment of principal and interest on those securities to outside investors. Fannie and Freddie also hold some home loans and mortgage securities in their own investment portfolios.

The theory is, since the mortgage lenders (firms) don’t have to hold these loans on their balance sheets, they will have more capital available to make loans to other creditworthy borrowers, in turn stimulating the local, regional and national economy. These lenders, because of the implied backing of the federal government, also added incentives in the package of 30 years notes, a unique form of long term mortgages in the world of finance, unique primarily to the US. This ability to offer safe and sustainable products—namely long-term, fixed-rate mortgages – exists because lenders know Fannie and Freddie will likely purchase them. Since Fannie and Freddie guarantee payments in the event of a default – for a fee, of course – investors don’t have to worry about credit risk, which makes these mortgages a particularly attractive investment.

Outside the United States, fixed-rate mortgages are less popular, and in some countries, true fixed-rate mortgages are not available except for shorter-term loans. For example, in Canada the longest term for which a mortgage rate can be fixed is typically no more than ten years, while mortgage maturities (the length of the loan) are commonly 25 years. Britain and its mortgage industry has traditionally been dominated by building societies, whose mortgages require at least 50% deposits, so lenders prefer variable-rate mortgages to fixed-rate mortgages to reduce asset-liability mismatch due to interest rate risk. Lenders, in turn, influence consumer decisions which already prefer lower initial monthly payments, driven by higher down payments.

Under the current US finance system, mortgage credit was continuously and easily available well into the late-1990s under terms and at prices that put sustainable homeownership within reach for most American families. This philosophy was part of the ‘American Dream’: to own a portion of land with your own house, independent of a landlord. Housing became viewed as a ‘safe investment’, so Wall Street figured out how to purchase and securitize mortgages without needing Fannie and Freddie as intermediaries, leading to a fundamental shift in the U.S. mortgage market and causing other issues.

Did FNMA/FMAC play a major role in the housing bubble?

Contrary to most arguments, the answer is that their role contributed very little. During the bubble, loan originators backed by Wall Street capital began operating outside the FNMA / FMAC system that had been working for decades by packaging and selling large quantities of high-risk subprime mortgages with terms and features that drastically increased the chance of default. (Many financial institutions were trading these mortgage backed securities with little to no concern over the higher level of risk in these portfolios. Those people and institutions that invested in them did not always realize the higher risk). Many of those loans were predatory products such as hybrid adjustable-rate mortgages with balloon payments that required serial refinancing, or negative amortization, mortgages that increased the unpaid balance over time and the famous ‘liar loans’ (no stated income / no financial history loans, etc).

Wall Street investment banks in turn packaged these high-risk loans into securities, had the credit-rating agencies bless them (allowing higher risk than normal investments to go undetected), and then passed them along to investors, who were often unaware or misinformed of the underlying risks and failure rate of their portfolios. It was the poor performance of the loans in these “private-label” securities—those not owned or guaranteed by Fannie and Freddie—that led to the financial meltdown, according to the bipartisan Financial Crisis Inquiry Commission, among other independent researchers looking for the underlying reason for the financial meltdown of 2006.

What people fail to view is the facts: FNMA and FMAC lost market share as the bubble grew. The companies backed roughly 50% of all home-loan originations in 2002 but just 30% in 2005 and 2006. In an ill-fated effort to win back market share and with ill advised support and insistence of the legislative branch, FNMA and FMAC made strategic mistakes later in the underwriting. Starting in 2006 and 2007 (just as the housing bubble was reaching its peak) – FNMA/FMAC increased their exposure and began investing in certain subprime securities that credit agencies incorrectly deemed low-risk. There was also a lot of discussion and pressure from the legislative side to put more people in homes, people who might not have been able to qualify otherwise.

In taking this action, FNMA/FMAC also lowered their qualifying underwriting standards in their securitization business, purchasing and securitizing so-called Alt-A loans. While Alt-A loans typically went to borrowers with good credit and relatively high income, they required little or no income documentation, opening the door to fraud (which was often perpetrated by the mortgage broker rather than the homebuyer). When the market reversed, these decisions contributed to the companies’ massive losses, but all this happened far too late to be a primary cause of the housing crisis.

Then why did FNMA / FMAC require a bailout?

Fannie and Freddie failed in large part because of the above bad decisions in underwriting towards the end of the boom. Remember over fifty of the largest lenders consolidated into four, and over 580 small, regional and national lenders failed because they held insufficient capital and insurance to cover their losses. Also, unlike most private investment firms with a larger base of industries, Fannie and Freddie had only one line of business—residential mortgage finance—and thus did not have other sources of income to compensate when residential prices began to fall.

When the housing market did begin to fail in 2007, over 50% of the losses came from the Alt-A loans, despite those loans accounting for just 11% of the companies’ total business. But those losses were only the beginning: Between January 2008 and March 2012, Fannie and Freddie would lose a combined $265 billion, more than 60 percent of which was attributable to risky products purchased and underwritten in 2006 and 2007. By mid 2008—about a year after the start of the housing crisis—Wall Street firms had all but abandoned the US mortgage market, while pension funds and other major investors throughout the world continued to hold large amounts of Fannie and Freddie securities. If Fannie and Freddie were allowed to fail, experts agreed that the housing market would collapse even further, paralyzing the entire financial system. The Bush administration in September 2008 responded by placing Fannie Mae and Freddie Mac into government conservatorship, where they remain today.

Have FNMA / FMAC improved?

Yes! As stated earlier their profits have improved dramatically. Fannie Mae has made $95 billion of its $117 billion debt, and Freddie Mac has paid $30 billion of its $72 billion debt. So the short answer is about $65 billion is left on their debt. This potentially could be repaid in less than a couple of years. However in the interim the U.S. Treasury Department has changed the terms of the government bailout. Under the previous agreement, Fannie and Freddie drew money from the Treasury Department as needed to bolster its capital reserves. In exchange, the companies issued preferred stock to the government on which they paid a mandatory 10 percent dividend. Under the new rules, Treasury will simply claim all of Fannie and Freddie’s profits at the end of each quarter and provide capital when necessary in the event of a quarterly loss. All this uncertainty has led many key staff to leave and has caused underinvestment in necessary infrastructure and systems, in essence making a weaker business.

What should we do with Fannie and Freddie?

The federal government is currently backing nearly every home loan (90 to 95%) made in the country today. That is not a sign of a healthy mortgage market. The federal government is underwriting the housing recovery, rather than private equity or the banks. Economists, analysts, and politicians agree that the current level of government support is unsustainable in the long run, and private equity will eventually have to assume more risk in the mortgage market. That leaves two critical questions before policymakers today: what sort of presence should the federal government have in the future housing market, and what do we need to do to transition responsibly to a new system of housing finance and backing.

Understand this: private equity cannot compete with the artificial ‘low’ rates of the government. Also when suggested proposals of written off mortgages by the government are suggested, equity does not want to underwrite those standards either. No one wants to lose money!

FNMA / FMAC has billions of dollars of mortgages at record low lending rates. Who wants to buy those investments when they know that rates will be better in the future? Again, another roadblock into convincing private industry to lend.

Most agree that the private equity needs to take more responsibility. History is a helpful teacher here. Prior to the introduction of the government guarantee on residential mortgages in the 1930s, mortgages typically had 50 percent down-payment requirements, short durations, and higher interest rates—putting homeownership out of reach for many families. Prior to government backing, the housing finance system was subject to frequent panics during which depositors demanded cash from their banks, leaving lenders insolvent. That volatility is one reason why every other developed economy in the world has deep levels of government support for residential mortgage finance.

All are in agreement that removing government support would almost certainly mean the end of the 30-year fixed-rate mortgage, now a pillar of the U.S. housing market. Upward mobility for decades has depended on the security and affordability of this product, which allows borrowers to fix their housing costs and better plan for their futures. Most experts agree that this highly beneficial product would largely disappear without a government guarantee.

So ultimately how does this affect me?

Currently rates are increasing, and by taking government backing out, private industry would in all likelihood have interest rates ¾ to a point higher than the government backed loans. However with the government artificially holding rates down it is hard to say how much rates would go up and when. But rates and down payment will be more.

Thirty year mortgages and low down payments in all likelihood would go away without government backing. Shorter terms and higher down payments would become the norm. The belief is that people would still buy, it just would require a larger down payment. This is a large stumbling block for most. Over the last fifty years, the US consumer has shown a dramatic change in their savings habits; going from 30% of income being saved by our grandparents 50+ years ago, to currently less than 3% of our total income. The US is very much a consumer economy, showing a reluctance to save. Whether it is a home, car or college education, most are looking for the ability to put as little cash down up front as possible. Look at the financial predicament the nation has had on housing, the car industry, and student debt if you don’t agree.

One of the beliefs of most economists is that construction (housing being a large portion of that) is a major pillar of economic recovery. If consumers can’t qualify, then construction slows, in turn slowing down industry and ultimately the recovery.

The slow recovery has allowed housing affordability to stay around longer than most thought. Because of lack of supply today and in the near future, prices are going to rise. Presently FNMA /FMAC mortgage backing allows lower down payments and rates. They have to go up!

The conclusion is that there has never been a more affordable time to buy.

The federal government must continue to play a key role in the housing market, whether it is through the current system or a new agency. The previous system worked for years, because of safe basic underwriting. It was when pressured by the legislative arm to be more aggressive in their lending that they got in trouble. Allow the agency to be run separate from any government pressure. Only then will private industry have comfort in getting back in the game. Again all this leads to higher lending rates, down payments, and stricter guidelines.

We will say it again, there has never been a more affordable time to buy.

Real housing demand or speculation?

Home prices have increased more than 10% year over year nationwide. In many markets, including ours, buyers are engaging in bidding wars and submitting offers greater than list value.

Headlines and talking heads are beginning to describe this positive development as a housing bubble. Just mentioning the words “housing bubble” in a headline generates buzz and viewers. In reality, this is no bubble, but rather genuine demand for shelter paired with a low inventory of desirable homes.

Many may not understand the difference. All this buzz begs the question of what is the difference between housing demand and speculation? Let’s review some basic parameters for projecting housing growth. For starters, job growth is paramount. For every two jobs, you can count on needing one additional housing start. Apartment developers like to say for every 2.5 to 3 jobs, one new apartment. If you don’t have job growth, there is no need for additional housing.

Let’s look at the four basic laws of supply and demand: demand and the price of a commodity (real estate) have an inverse relationship.

1. If demand increases and supply remains unchanged, a shortage occurs, leading to a higher equilibrium price.
2. If demand decreases and supply remains unchanged, a surplus occurs, leading to a lower equilibrium price.
3. If demand remains unchanged and supply increases, a surplus occurs, leading to a lower equilibrium price.
4. If demand remains unchanged and supply decreases, a shortage occurs, leading to a higher equilibrium price

Speculation is known as the practice of engaging in risky financial transactions in an attempt to profit from short or medium term fluctuations in the market value of a tradable good such as real estate. In real estate the common term is ‘flipping’. I liken speculation to gambling, both are risky and usually involve participants that don’t fully understand the business and the risks.

A good example of a speculative market was Las Vegas in the boom years. In 2005, Vegas had 58,000 jobs created and 39,000 home starts, a ratio of 1.5 homes to 1 job. Now that extra 10,000 starts might not seem much, but when you compare it against actual demand the market gets out of whack quickly. Most of the homes starts were speculative, with little thought of who or when somebody was going to move in. Builders were building just to sell as quickly as possible.

Once you start building for a speculative market, it is hard to stop quickly. It takes a while to understand where the demand is. In the aforementioned example they were building speculatively for a speculative demand. As non-construction employment did not keep up with supply, the market was soon overbuilt, which in turn caused values to decrease.

It is also important to know the lag times in completing new product. In Austin it is 2.5 to 3 years from inception to actual completion of development and housing.

Using Austin as an example, we have 60,000+ people immigrating to Austin on an annual basis.

Not all units available are desirable (cost vs. value, geography, schools, etc). Because of this, and because there has been a limited number of units delivered to the ‘home’ market, the market is playing catch up from the last five years. Presently that places demand stronger than supply, creating a seller’s market.

• 142,669 total rental units Austin SMSA
• 95% occupancy = 7,133 units available

• 10,260 units under construction to be completed 2013

Total of 17,393 rental units available in the next 12 months

• 7,800 to 9,000 home starts this year
• 5,200 listings presently
Total shelter 31,593 units available

When you have demand that is greater than supply it forces prices to price. In Silicon Valley, demand is being driven by a flood of new (Facebook, Google) tech money. This has resulted in employees that have a tremendous amount of new money, but all are chasing after a shrinking supply of homes. Transactions are still below boom levels over the last 25 years and half the level seen at the peak in the mid-2000s. Prices would have to skyrocket, as we’ll see below, to get back to peak levels, so presently although some areas are experiencing record values from the depressed values of the last five years they do have a way to go.’

During the housing bust, the anchor slowing the economy was lack of construction, which in turn was a drag on the economy due to large mortgages and lower home values. Where are values now?

First, prices as measured by Case-Shiller, are still down 27 percent from their peak seven years ago. Case-Shiller calculates nominal prices, not real values. And the (inflation) is up 15 percent since 2006. So real house prices are about 37 percent below 2006 levels and are just now returning to where they were 13 years ago. Bill McBride of Calculated Risk has a great chart showing real house prices going back a few decades:

first chart

And here’s a tip for the math-challenged out there: It takes a larger percentage increase to offset a percentage decline. Take a $100,000 house at the peak. If it fell the real national average 42% percent in the bust, it would have been worth $58,000 at the bottom early last year. But to get back to $100,000, it would take a 72.4% percent increase from the trough. Even now, after the sharp bump off the bottom, prices would have to jump 60 percent to get back to their bubble-era peak.

It’s not just the national market, either. The bubble stories have focused on markets like Los Angeles, San Francisco, and even Austin. But these markets, for instance, are just now getting back to early 2000 to 2003 prices and have a ways to get to boom pricing in 2005. To get back to 2005/06 levels, San Francisco’s home prices would have to jump 60+%, by my calculations (using Case-Shiller data). LA would have to jump 65+%, Phoenix 100%, and Miami 105%. Las Vegas home prices would have to skyrocket 149% to reach ‘boom/bubble’ levels.

second chart

Here in the Texas region, even with our limited exposure to ‘bubble pricing’, Texas values still have not caught up to the long-term appreciation experienced by California and Arizona. People and realtors have a hard time understanding that. Remember, these markets experienced 45+% annual appreciation for a number of years. So even with a 60% drop in value since the peak, they are worth more than when they started. In that same time period Texas and the surrounding region did not experience the highs or lows of the housing bubble.

The continued diversity in price performance at the local level will be a function of job creation. Demand will follow jobs, which in turn will increase values. That is the main reason for the strength of the market in Austin, Houston and San Antonio over the D/FW area presently. The same can be said for the San José and San Francisco areas. There simply is not enough housing.

So again, what is the difference between speculation and true demand? Presently the multiple offers are caused by true demand in Austin, Houston, San Francisco, etc. There is not enough housing with respect to the jobs being created. This does present a small opportunity for house “flippers”, however present financing conditions demand larger down payments, slowing the speculative demand the nation experienced during the boom. Here in Texas, ‘flipping’ was tempered by the lack of tremendous appreciation (40+% annual in California and other ‘boom states). Texas and local homeowners experienced less than 3% annual appreciation at the height of the housing boom. They may be seeing a bit better presently. But you have to look at the whole metro market. There are still challenged submarkets. So just because Tarrytown is experiencing 15+% annual appreciation, does not mean you can expect similar appreciation in Round Rock, Georgetown, or Lago Vista. Real estate is local, and your appreciation is going to be somewhere below or above that. An experienced real estate professional will be able to help you find the ‘true value’ of your neighborhood and home.

Should you decide that you want to get into real estate speculation, just because you did well on your last home investment, does not equate to doing well with real estate speculation. Get with a professional, not only in the real estate channel you want to participate in, but in the submarkets you decide on. All real estate is local, as are real estate experts. I would suggest getting opinions from two or three of the local experts before making a decision.

Is now the time? That is a personal decision you need to make with your family and financial planners. But from this analysts view point, two years ago would have been the best time, now is a good time and the next three to five years should remain strong for real estate investment in our region. Remember I am not a broker, financial planner, or lawyer. I’m just an analyst with over 35+ years in this market, and right now I’m seeing one of the better markets of my career.

Now really is the time to buy!

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.

Is there a danger of a housing bubble in Texas?

First, four things have to be available for a housing bubble: tight supply, demand, regulation, and easy financial terms. Statewide, only tight supply and demand are present; only in Austin does regulation come into play. Financing is still a challenge in today’s environment.

What is a bubble? Bubbles have characterized recent economic history, as institutional and other major investors have sought high-return, low-risk investments. These investments have turned into speculative manias that eventually come crashing down. The last decade alone has seen the telecom bubble, the nearly simultaneous dot-com bubble, the housing bubble, and most recently, the oil bubble. Of all of them, the housing bubble seems to be the most significant and far reaching.

On one hand, consumer spending (remember 70%+ of our annual GDP is consumer spending driven) fed by people borrowing against the temporarily increased equity in their homes kept the world economy going after the high-tech and telecom bubbles burst in 2001 through 2006. On the other hand, the eventual deflation of the housing bubble caused far more severe economic problems than the deflation of the telecom and high-tech bubbles would have caused if the housing and financial bubble had not disguised them. A bubble has been defined as ‘trade in high volumes at prices that are considerably at variance with intrinsic values.’ Bubbles are essentially irrational, so they are difficult to describe with a rational economic model. However, the housing bubble can be explained using simple supply-and-demand curves.

Charles Kindleberger’s wrote a classic book called Manias, Panics, and Crashes which describes six stages of a typical bubble. First, a displacement or outside shock to the economy leads to a change in the value of some good. Second, new credit instruments (zero down or non-qualifying loans come to mind) are developed to allow investors to take advantage of that change. This leads to the third stage, a period of euphoria, in which investors come to believe that prices will never fall. This often results in a period of fraud, the fourth stage, in which increasing numbers of people try to take advantage of apparently ever-rising prices. Soon, however, prices do fall, and, in the fifth stage, the market crashes. In the sixth and final stage, government officials try to impose new regulation to prevent such bubbles from taking place in the future.

All of these stages were apparent in the recent housing bubble and ensuing global recession. The key point is that because of easy credit and high speculative demand, consumers were able to speculate with not only their own homes but were driven to speculate on other local real estate, because annual returns were so high (during the boom years, annual state wide appreciation was 40+% or better in the sand states of California, Arizona, Nevada, Florida plus Georgia). The result was an immense price bubble in those states, home to over a quarter of the nations population.

New housing allows accommodation of population growth and replaces both worn out older housing and housing in areas that are being converted to other uses. The price of used housing is set by the cost of new housing. If the price of new housing rises, sellers of existing homes will respond by adjusting their asking prices. Thus, to understand the price of housing, we must focus on the supply and demand curves for new housing. The steepness of those curves—which economists call elasticity—describes the sensitivity of prices to changes in demand or supply. A flat or elastic supply curve, for example means that large changes in demand will lead to only small changes in price. But a steep or inelastic curve means small changes in demand can lead to large changes in price, as we saw in those states that had high real estate speculation.

The demand for housing is inelastic; few Americans are willing to live without a home. The vast majority of Americans, moreover, prefer a single-family home with a yard. The same is true for Californians, Texans, New Yorkers, Canadians, etc. and, likely, the people of most other nations. While people are willing to live in multifamily housing, most Americans see such housing as only temporary until they can afford a single-family home. This suggests that the demand for single-family housing may be even more inelastic than for housing in general. Inelastic demand curves mean that a small change in the supply of new homes can lead to large changes in price. While demand for housing is inelastic, supply can be either elastic or inelastic. The main determinants of the cost of new housing are land, materials, labor, and the time required to construct a house. Although many love to remind people that the supply of land is fixed, it is actually fixed at a high portion of the total equity level.

Supply and demand charts only go so far in explaining bubbles. The housing bubble was exacerbated by money fleeing the post–dotcom bubble stock market and by loose credit. Investors looking for safe places to put their money quickly noted that housing prices were increasing at double- digit rates in California, Florida, Nevada, Arizona and Georgia. At this point, most home sales were driven by speculation rather than the primary need of shelter.

For example, because of the dot-com crash, San Jose lost 17 percent of its jobs between 2001 and 2004. In the same period, office vacancy rates increased from 3 to 30 percent. Yet, between the beginning of 2001 and the end of 2004, home prices increased by more than 20 percent. The rise in prices in the face of declining demand can be attributed to speculation— that is, people buying homes as sources of income rather than for shelter. Exacerbating this was the ease of credit. Not only did this allow many to borrow against the quick appreciation of their homes (sometimes refinancing twice in a year to pull equity out), but even those who were buying for shelter paid more for a house than its fundamental value (as measured by rents). So the sharp rises in price caused people to see housing as a speculative investment and they had the ability to fund that investment easily.

As we discuss speculation, I am reminded of the Warren Buffet quote, “I define a speculator as someone that seeks to buy and sell in order to take advantage of market price fluctuations and doesn’t really understand them. An investor is someone who holds on to securities that provide a good income or capital gain by virtue of them being based on something of real and increasing value. Risk (speculation) comes from not knowing what you’re doing. Consumers did not really understand the dynamics of housing supply and demand. Housing supply should be driven by job growth, not speculation and the ability to see double digit returns.”

Remember this from economics 101, even with a good handle on supply and demand it is hard to predict hard asset price trajectory (more students would go into economics if there was a true science of predicting returns on assets). Moreover, the last seven years should make everyone wary about predicting gold, silver or housing price changes. The housing price volatility of the last six years has been so extreme that it confounds conventional economic explanations. Certainly, those price increases cannot be explained by increases in average income. Income growth was quite modest from 2002 to 2006. Nor can the boom be explained by a dearth of new housing supply. Construction rose dramatically during the boom.

While low interest rates, on their own, cannot influence the real estate bubble, perhaps the increased availability of credit to subprime borrowers has more explanatory power. The correlation between housing price growth and subprime lending across markets is likely to indicate that lenders took more risks in booming markets as that those risks caused markets to boom. The most plausible explanations of the housing bubble require levels of irrationality that are difficult for economists and analysts either to accept or explain.

I don’t think people actually believed that housing prices would never, ever go down before the housing bust. What they thought is that housing prices would go up in real terms, on average, over time – that housing was/is a good long-run investment. They knew there would be variation around that trend, but they expected the variation to be relatively mild, they didn’t expect the severe variation in prices and associated problems that actually occurred. Even those who had been through late 80’s housing bust in Texas and California didn’t expect values to decrease much.

But this still leaves the original question unanswered. Is there any reason to worry about a local or regional ‘housing bubble’?

First, the true need for shelter in all four metros is there. All Texas metros like the rest of the country cut back dramatically on producing housing and any type of real estate investment. Secondly, in the last five years if any of us would have approached lenders or equity about housing, office, or most real estate development they would have kicked us out of their office based on how volatile the market has been. However, the continuing job creation in Texas will fuel demand and continue to put pressure on supply. The challenges of the financial markets (mortgages, banking, Dodd Franks legislation, Enforcement of Basel 3, etc.) will slow the ability to speculate on real estate that we saw in the last few bubbles.

Most Texas metros have seen a healthy appreciation of rents over the last couple of years. This has put more pressure on the consumer feeling the need to buy. The relationship between rent and housing prices depends heavily on borrowing / interest rates – both the real portion and expected inflation. A house is like a utility company. Instead of providing power services, it provides shelter services and keeps you from having to pay rent.

Most financial folk are familiar with the rule-of-thumb that utilities tend to trade like bonds. Higher interest rates lead to lower bond and utility stock prices. Lower interest rates lead to higher bond and utility stock prices. This is because – like a house – you are receiving a fixed stream of services over a long period of time. When the market is balanced the monthly mortgage payment should be slightly higher than the rental payment because 1) Mortgages get a tax break and 2) Traditional rate mortgages offer you the stability of a fixed payment. So most consumers moving to Texas have displayed a great need to buy rather than rent if able. This has caused increased demand regionally.

Job growth has been one of the primary factors for real estate values improving regionally, much more so than in the rest of the country.

If housing price growth merely stabilized into a sustainable equilibrium with rents then the future probably wouldn’t be too dramatic. We would see a shoot-up in home prices, followed by a long period of little to no price growth as the Fed raised interest rates. Rents would still be going up and monthly mortgage payments would rise with them to maintain equilibrium. However, mortgages payments would be rising because interest rates were rising, not because home prices were rising.

Eventually, the Fed will stop raising rates and home prices would start to drift higher and eventually home price growth would converge to rent growth. However, the Fed is holding rates steady. Should that cause concern about a ‘bubble’? In the near future – the next three to five years – no. Lending is not getting looser. The potential for a local housing bubble will be greater if that happens.

Sometime in the future it is very likely that credit standards for homebuyers will fall. This will allow homebuyers to make larger offers and it will allow young people to buy a home even when they lack a down payment. This rapid increase in the number of buyers and their purchasing power will likely drive home prices into a bubble – likely not as large as in 2005, but it’s not out of the question that the potential for a bubble is there eventually.

We might think – “Didn’t lenders learn their lesson?” Or perhaps, “See, this is what happens when we create a moral hazard.” Neither of these are really correct. A perfectly competitive market in lending could not help but go into a bubble. To the extent our lenders avoid it, it is because regulations and/or tacit collusion among major players prevents the competitive equilibrium from being reached. As standards go down, buyers rush in with more buying power and we enter a new bubble phase. To my knowledge of history neither the government, the lending industry, nor we as a society have done anything that promises to prevent this.

But back to the question, are we in a housing bubble in our region? With current demand, job growth, and more demanding lending standards the potential is there, but not near as much as the run up in 2004 through 2006. Supply and demand will continue to be your governing factors and presently they seem to show favorable strength of the Texas regional market for a while – not parameters for a bubble currently.

This has been the fourth major recession I’ve experienced, and the harshest. I am not one known for optimism. With that in mind, believe me when I say our metro markets look good for a while. Whether you decide to participate or not is you and your financial advisor’s decision. If not now, when?