Where are we in the cycle?

Economic markets are cyclical, and real estate is no exception. Typically, we see a period of expansion, followed by a contraction, followed then by stabilization and recovery, and again into expansion.

For those of you that have been through more than one real estate boom and contraction, you may be asking, “Where are we in the cycle?”. Let’s look at this great graph from Citibank Investment Services.


Policymakers work on reducing the impact of an unstable economy, and try to move to the path of recovery. Some techniques used by policymakers include creating new job opportunities, controlling inflation, and stabilizing the currency exchange rate. Financing should remain flowing for business start ups and growth plans as a way of injecting money back into the economy. Inflation must be controlled because high inflation discourages investors to purchase products or securities, since they are more expensive than before. The overall goal should be to create consumer confidence, encourage investment, and stimulate business growth.

This is an increase in business activity after the lowest point of the depression has been reached. Entrepreneurs begin to feel that the economic situation was after all not so bad. This leads to improvement in business activity and greater confidence in the economy. This in turn leads to stronger industrial production, which picks up slowly and gradually. The volume of employment also steadily increases. The analysts and economists are able to track by watching for a slow rise in prices accompanied by a small rise in profits. Wages also rise. New investments take place in capital goods industries, which in turn increases GDP and return on investment. The banks also expand credit. Pessimism is gradually replaced by an atmosphere of all round cautious hope. There seems to be greater demand than supply.

This stage is characterized by increased production, high capital investment in basic industries, and expansion of bank credit, high prices, high profits and full employment. There is a general feeling of optimism among businessmen and industrialists. Production increases to supply demand, sometimes leading to the emergence of boom. In this stage of rapid expansion we see high stocks and commodity prices, high profits, over supply and overfill employment. There is undue optimism among businessmen and industrialists who make additional investments in the various branches of the economy. The number of jobs exceeds the number of workers available in the market. Such a situation is known as overfill employment. Profits touch a new height. Businessmen further increase their investments. Runaway inflation raises its head in all its ugliness. Prices risk sky-high. The tempo of boom reaches new heights. There is an atmosphere of over-optimism all around. This oversupply carries with it seeds of self-destruction. Bottlenecks begin to appear in various sectors of the economy.

Contraction phase
Over-optimism is replaced now by over-pessimism characterized by fear and hesitation on the part of equity and business leaders. The failure of some businesses creates panic among businessmen. The banks begin to withdraw loans from business enterprises. With the downturn of demand and lending, more business enterprises fail. Prices collapse and confidence is shaken. Building construction slow down and unemployment appears in basic, capital goods industries which gradually spread to other industries as well. As more unemployment happens it leads to fall in income, expenditure, prices and profits. Recession has a cumulative effect. Once a recession starts, it goes on gathering momentum and finally assumes the shape of depression. It is a protracted period in which business activity in the country is far below the normal. It is characterized by a sharp reduction of production, mass unemployment, low employment, falling prices, falling profit, low wages, contraction of credit, a high rate of business failures and an atmosphere of all round pessimism and despair. All construction activities come to a more or less complete standstill during a depression.

So after that charming and uplifting lesson, where is the nation, Texas and our local metros in the cycle?

US – Stabilization
The Federal Reserve lowers rates, then gradually allows increase, as housing and job growth historically follow. When the rates are at zero, the Federal Reserve uses other stimulus, such as quantitative easing (QE) to encourage growth. This has been mildly effective. As the Fed reduces stimulus, rates will rise.

Texas – Recovery / Expansion
Supply and demand is in balance, and home/land value appreciation meets or beats inflation.

Austin – Expansion
Economic housing formation as well as other real estate channel demand exceeds supply. Housing and real estate appreciation stronger. Austin is about 2+ years from the bottom of the market; we have seen healthy demand and now are seeing banks, developers, and builders trying to fill the void left by no activity the last 6+ years. Austin has a ways to go in this cycle hopefully. The one governing factor in Austin is the length of entitlement, which is about 2 ½ years for development. This has been helpful in preventing quick development and sometimes over development to meet the immediate need.

Houston – Expansion
Economic housing formation as well as other real estate channel demand exceeds supply. Housing and real estate appreciation stronger.

San Antonio – Recovery
Demand has picked up, putting pressure on supply.

Dallas/Fort Worth – Recovery
Demand has picked up, putting pressure on supply.

Why is Texas so different from the rest of the United States? Two words: job creation. Since 2009, 43% of all jobs created in the US were created in Texas.

Over the last six months, nearly every facet of the U.S. economy has shown improvement, and the real estate market is no exception. Below are some examples of the improvement we are seeing.

Housing Starts
Nationally housing starts have improved to an annual rate of 891,000, which includes multifamily and single family. That’s up 14.7% from the 608,800 starts in 2011… up 18.9% from the 586,900 starts in 2010… and up 25.9% from the record-low 554,000 starts in 2009. Even after the uptick, we’re nowhere close to the high-water mark of 2.07 million starts hit in 2005. Regionally, we have seen an aggressive increase. July 2013 saw a total of 83,579 permits were issued, a 20% increase from the previous year. Austin, San Antonio and Houston could all have more starts, if they had the finished lots. Presently we are at about 50% of the prerecession numbers for housing starts for all Texas metros. Demand is very much ahead of supply in Texas.

Dwindling supply
Nationally, regionally and locally builders, developer and lenders have been reluctant to add supply to a ‘questionable market’. Therefore when the market did turn, they are playing catch up for over 6+ years of slow development. Expect even more building on the horizon. Why? Because new home inventories plunged to their lowest levels on record in January of this year at 150,000 units. Since then we have begun to see supply improve, but we still have a ways to go. Regionally, we are just beginning to see development go through the process to address the shortage. In San Antonio, Houston, and Dallas they have 3+ years of potential strong sales as the markets try to catch up. In Austin, we have a little longer due to the longer entitlement process, around a 3-5 year run of playing catch up.

Including existing homes in the mix, the total number of homes listed for sale has dropped – on a year-over-year basis – for 12 consecutive months. Now there are 2.43 million homes listed for sale, which is down 19.3% in the last year and down 39.8% from the record inventory of 4.04 million homes in July 2007. With job creation so strong in this state and the metros, resale is a third to half of where it needs to be, allowing a strong sellers market.

Bidding Wars
The lack of inventory has created a competitive bidding environment. Most well priced homes and investment properties are seeing multiple offers, sometimes before the property is available to the general market. Most competitive markets, where demand outstrips supply, will see this. The bigger economic question is how much annual appreciation we feel is healthy. A single digit appreciation is good. When you get into double digits over a number of years, it is usually the signs of a ‘bubble’.

We have passed bottom in new home and resales. Nationally, regionally, and locally we can see the bottom of the curve. With household formation and the lack of supply we may slow in demand but I feel that even the most pessimistic of analysts and economists feels that we are past the bottom of the market. Last year, nationally new home sales fell to 302,000 units – the worst reading on record. Comparatively, in 2005, 1.28 million new homes were sold. The market has likely bottomed out. New home sales in February checked-in at an annual rate of 313,000 units, which is 11.4% higher than last February’s rate. All metros and rural have improved dramatically, with a minimum of 15% increased demand over last year.

As I’ve written before, prices will be the last sign of a recovery. They’re a lagging indicator, like unemployment. That being said, signs of a price rebound are evident, particularly in Texas. The ability to get a ‘deal’ is long gone. The impact of foreclosures is minimal, with less than 1.5% of the market. Nationally, even in hard hit markets such as Miami, Phoenix and Las Vegas – arguably three of the hardest-hit real estate markets – were up in this year by over 15+%. The good news is that this positive value has maintained since the first of the year.

Rising Confidence
If insiders know best, they’re certainly sending bullish signals. The National Association of Realtors/Wells Fargo Index of Builder Confidence, lenders all have seen their business rise for the last 12 months. They are at their highest levels since 2007. Builders and developers aren’t hiding their optimism, either. Their aggressive need for lots is evident across the nation. In Texas metros, developers and builders cannot keep up with the demand. Most are concerned about having inventory for 2015-16 due to the lack of volume in the pipelines. All the empirical data points that are today confirming that the market is showing real signs of stability

Historic Affordability
If you have not heard, lending rates coupled with values have allowed historic affordability, unlike anything we have seen in the last 60+ years. Nationally we have see prices down an average of 35+% from the peak (in some markets as much as 60%). In fact, the National Association of Realtors Housing Affordability Index hit a record high of 206.1 in January 2013. A value of 100 means a family earning the national median income can afford a median-priced property at current mortgage rates. Most major metros have seen the bottom of the value spectrum.

Unemployment is less and less of a headline
Economics 101 shows that job creation is needed for a strong economy. Two jobs created is one housing start. With jobs comes demand as Texas and our economy have shown. With one out of two jobs created in the nation being created in our Texas metros, it has forced values, rents, and wages higher. It’s hard to buy a house if you don’t have a job. No one can deny that the labor market is improving. In the last year, the unemployment rate is down almost one full percentage point from a year ago nationally. And regionally we have lead the nation for over 88 months in our unemployment rate.

Lack of ‘A’ opportunities
It’s all relative in a supply and demand marketplace. But most ‘A’ opportunities that were available a couple of years ago are no longer there, and the possibility of their supply being replaced is slim in the current markets. Over the last few years, real estate has been the most undervalued hard asset. The ‘smart money’ on Wall Street realized this. We have seen the large equity players such as SAC Capital, Blackstone, Caxton Associates, Cerberus, Canyon Partners, and others making a strong play in undervalued markets. The good news is that as a region we saw very little of this.

Even the most pessimistic of us realize that we are in a recovering market. And for some of us, an expansion mode. Don’t wait, the recession of the past number of years hopefully is a ‘once in a lifetime’ event. Most of us, particularly those who have bought will not see an opportunity like this again…why wait?