Tierra Grande - April 2012 by Texas Real Estate Research Center

APRIL 2012

JOURNAL OF THE REAL ESTATE CENTER AT TEXAS A&M UNIVERSITY

The oil and gas reviews are in! $

Colossal!

*Amount of oil and natural gas drilling in Texas.

Immense!

**Amount of knowledge landowners need to negotiate an oil and gas lease.

Monumental!***

***Amount of oil and gas leasing information available on the Centerâ&#x20AC;&#x2122;s website.

See related article, p. 22.

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Visit us online at

recenter.tamu.edu

APRIL 2012

VOLUME 19, NUMBER 2

TIERRA GRANDE JOURNAL OF THE REAL ESTATE CENTER AT TEXAS A&M UNIVERSITY

18 Land of the Setting Sun

Japan’s 1989 stock market crash and subsequent real estate bubble blowout hold valuable lessons for those who influence our nation’s economy. Have our key economic players learned from them, or will we be repeating history?

Director, GARY W. MALER Chief Economist, MARK G. DOTZOUR Senior Editor, DAVID S. JONES Managing Editor, NANCY MCQUISTION

BY MARK G. DOTZOUR

Associate Editor, BRYAN POPE Assistant Editor, KAMMY BAUMANN Art Director, ROBERT P. BEALS II Graphic Specialist/Photographer, JP BEATO III Circulation Manager, MARK BAUMANN Lithography, MOTHERAL PRINTING, FORT WORTH

ADVISORY COMMITTEE: Joe Bob McCartt, Amarillo, chairman; Mario A. Arriaga, Spring, vice chairman; James Michael Boyd, Houston; Russell Cain, Port Lavaca; Jacquelyn K. Hawkins, Austin; Kathleen McKenzie Owen, Pipe Creek; Kimberly Shambley, Dallas; Ronald C. Wakefield, San Antonio; and Avis Wukasch, Georgetown, ex-officio repre senting the Texas Real Estate Commission. TIERRA GRANDE (ISSN 1070-0234) is published quarterly by the Real Estate Center at Texas A&M University, College Station, Texas 77843-2115. Telephone: 979-845-2031. SUBSCRIPTIONS free to Texas real estate licen sees. Other subscribers, $20 per year. Subscribe online at http://recenter.tamu.edu/store VIEWS EXPRESSED are those of the authors and do not imply endorsement by the Real Estate Center, Mays Business School or Texas A&M University. The Texas A&M University System serves people of all ages, regardless of socioeconomic level, race, color, sex, religion, disability or national origin. PHOTOGRAPHY/ILLUSTRATIONS: Real Estate Center files, pp. 1, 6–9, 16, 18–19; Michael Christopher Brown, pp. 2–3; Courtesy of Victoria Economic Development Corp., pp. 4–5; Courtesy of Kansas City Southern, p. 6; Robert Beals II, pp. 10, 16, 20, 23, 25, 26–27; JP Beato III, pp. 14–15, 16; Harold Hunt, pp. 22, 24. © 2012, Real Estate Center. All rights reserved.

2 China’s Crisis, America’s Hope? 14 Cropland in Demand The gargantuan economic engine that is China is downshifting as labor costs rise, property prices fall and capital flows out. In the meantime, U.S. manufacturers are rediscovering the joys of producing stuff right here at home.

BY GERALD KLASSEN

But Large Tract Sales Wither

In spite of the drought, farmers are buying up cropland. Rangeland isn’t selling because buyers and sellers are digging in their heels, trying to wait each other out. And big tracts aren’t moving at all. BY CHARLES E. GILLILAND, GERALD KLASSEN AND GABRIEL GARCIA

7 AMT

Not Just for the Wealthy Anymore Don’t look now, but many middle-class citizens may have no alternative to paying the Alternative Minimum Tax. It wasn’t supposed to be that way, but Congress didn’t plan for inflation. BY JOHN KRAJICEK AND ELIJAH ERICKSON

22 Shale of the Century

Small Towns Dazed by Eagle Ford Influx Invasion of the oil and gas people. Traffic at the stoplight (seriously). Crowds at the Dairy Queen. Not enough housing for workers. Welcome to the Eagle Ford Shale. BY HAROLD D. HUNT

10 Home Groan ON THE COVER Texas bluebonnets in Burleson County

PHOTOGRAPHER Robert Beals II

Texas’ housing market is recovering s-l-o-w-l-y. So save yourself some disappointment and frustration — think in terms of tortoise rather than hare. BY JAMES P. GAINES

26 Income Factor

Center research reveals that family income determines Texas home prices more than credit costs and local market conditions. Barring drastic income reductions, home prices shouldn’t take a major tumble. BY ALI ANARI

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International Economy

ecent signs of an economic slowdown in China have American investors concerned. The predominant hope has been that growth in Chinese consumer demand could lift developing world economies in this time of crisis. But what if the Chinese economy is cooling? Could a â&#x20AC;&#x153;hard landingâ&#x20AC;? in China erase potential for export job growth in the United States? How would a bursting Chinese real estate bubble affect the U.S. economy?

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China holds significant sway over stock investor sentiment. Three days prior to the March 2009 U.S. stock market lows, China announced a massive four trillion yuan ($586 billion; 8.4 percent of China’s 2009 GDP) fiscal stimulus package to spur economic growth. It also expanded bank lending by nine trillion yuan in 2009, representing a 30 percent increase in total banking system loans. The U.S. stock market immediately rallied with a meteoric bull run spurred by hopes that emerging economies would grow and increase demand for goods and services from U.S. companies. In his January 2010 State of the Union address, President Obama set a goal of creating two million jobs by doubling U.S. export growth over the next five APRIL 2012

years. He did not lay out a detailed plan to accomplish this, but he started the National Export Initiative to help farmers and small businesses increase their exports. No doubt he was eyeing China as a major source of demand.

China’s Economic Problems

AN ENTIRE NEIGHBORHOOD of new homes stands vacant in the so-called “ghost town” of Ordos, China. In another city, people who paid full price for condos went on a rampage when the developer lowered the price and refused to give refunds. The real estate agents in the city of Shenzhen have closed shop.

lthough there are significant differences between the Chinese and U.S. economies, China’s recent economic downturn has much in common with the U.S. downturn of 2007–08. China’s economic growth has slowed for three straight quarters, and economists expect growth to drop below 9 percent for the first time since 2001. While that is strong growth by developed world standards, the Chinese believe the

AT ITS NEW PLANT in Victoria, Texas, Caterpillar will manufacture excavators previously imported from Japan. The cost advantage of manufacturing in Asia is rapidly shrinking, causing manufacturers to expand production in the United States.

minimum GDP growth rate required to create sufficient jobs to prevent civil unrest is 8 percent. Rapid growth in Chinese cities, whether by private or public investment, is necessary to create new jobs for workers migrating from rural areas. Slower growth, they believe, will leave many migrant workers out of work and inclined to disorderly conduct. The coming year could test that theory. he Chinese manufacturing sector is on the edge of contraction. The official purchasing-managers index fell to 49 in November 2011, matching the lowest reading since February 2009. China’s stock market is down 30 percent since May 2011 and 60 percent from four years ago. The Chinese National Social Security Fund (NSSF) has announced plans to spend ten billion yuan ($1.58 billion) to support stock market prices by purchasing local stocks. Average property prices in China declined for the second straight month in November 2011. Prices of newly built homes in 49 of 70 mediumsized Chinese cities fell that month on a sequential basis, up from 34 cities in October. Prices of new homes in major cities were down slightly compared with October 2011. As late as 2010, average home prices rose 12.8 percent year-over-year. The government is now working to support property prices. Roughly 25 percent of China’s GDP comes from housing and related industries. Wang Tao, China economist at UBS, estimates new housing starts fell 2.2 percent year-on-year in October including housing starts by the government.

Falling property prices are causing wealth to fall in Chinese households. Approximately half of China’s household wealth is tied up in property. In the town of Ordos, a symbol of China’s property boom, most households own two or three properties, and many have seven or eight. Transaction volume in Ordos has plummeted, and prices have started to fall. Across China, growth in new housing starts is close to zero, and one developer plans to slash

went on a rampage, breaking windows and smashing showrooms. According to property agency Homelink, new home prices in Beijing dropped 35 percent in November alone. Another property agency estimates that Beijing developers have 22 months of unsold inventory and Shanghai has 21 months. Half of the real estate agents in the city of Shenzhen have closed shop. More than 100 local government land auctions failed last month, and Beijing land sale revenue was down 15 percent in 2011. Chinese investors have been largely responsible for the recent run-up in real estate prices. Estimates of investor-owned vacant homes range from ten million to 65 million units. A significant portion of the 2009 bank-lending stimulus was used to develop new housing units. Developers in many cities have stopped purchasing land at local government auctions. In the first nine months of 2011, land sale revenue in 17 of the top 30 cities declined, and in three cities, the fall topped 35 percent. Local governments depend on land sales to raise money for building the roads, schools, hospitals and other projects Beijing has directed them to construct. Falling land

Wage inflation is reducing China’s manufacturing cost advantage. Many manufacturers can no longer absorb wage increases, so they are passing them along to buyers.

starts by 40 to 50 percent in 2012. Nationwide, 3.6 billion square meters of property were under construction at the end of October 2011 compared with sales of 709 million square meters in the first ten months of the year.

Developers Feeling Crunch Chinese developers are in distress. The Council on Foreign Relations reports that Shanghai developers recently slashed prices on their luxury condos by as much as one-third. Crowds of people who had bought apartments at full price converged on sales offices throughout the city, demanding refunds. Some of them

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revenue will cause many local governments to default on loans they took out during the massive 2009 bank-lending stimulus. Credit Suisse estimates that loan losses at Chinese banks may be equivalent to 60 percent of equity capital if real estate companies and local governments fail to repay debts. apital is now flowing out of China as the prospect for the rising yuan relative to the U.S. dollar diminishes. The rush of capital into China contributed to real estate development and economic growth. The flow of capital out of China is placing a strain on property prices and reducing credit availability. The yuan recently declined against the U.S. dollar as the People’s Bank of China allowed it to trade at the low end of its currency exchange rate band.

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The fixed investment that has fueled economic growth is unsustainable. Fixed investment in China is forecast to reach 60 percent of GDP in 2011, up from 50 percent in 2010. No country has ever had more than nine years at 33 percent yet China is in its 12th consecutive year above this level. The Chinese export engine may have reached its peak. China is the world’s largest exporter and accounted for 10 percent of global exports in 2009, up from 3 percent in 1999. From 1998 to 2008, China’s exports grew at an annual average of 23 percent in dollar terms, more than twice as fast as world trade. If it continues to expand at this pace, it could grab one quarter of world exports (and many more jobs from other countries) within ten years. That would beat America’s 18 percent share in the early 1950s, a figure that has dropped to 8 percent since. As a comparison, the “miracle” economy of Japan (see “Land of the Setting Sun,” p. 18) peaked with a 10 percent share of global exports in 1986. Wage inflation is reducing China’s manufacturing cost advantage. In November 2010, Dallas Federal Reserve President Richard Fisher made a speech in which he commented that the Chinese government was encouraging

manufacturers to grant wage increases of 15 to 20 percent to “goose up” domestic spending. He also noted that Chinese manufacturers of low-tech products sought price increases of 30 percent over current levels to supply goods to U.S. importers for fall of 2011. uring the 2011 shopping season, U.S. consumers paid higher prices for Chinese-made goods. Retailers are having to push through higher costs for their imported goods to maintain profit margins. For example, 80 percent of U.S. shoe imports come from China. The Labor Department reported that imported-footwear prices were up 6.1 percent year-over-year in November. China accounts for 60 percent of imported furniture, and those prices were also up 6.1 percent. Eighty percent of imported luggage comes from China. Prices of imported luggage rose 8.3 percent year over year in November. Higher prices for Chinese imports have contributed to rising consumer prices in the United States. In the past, Chinese manufacturers have been able to absorb wage inflation by accepting lower profits to keep export prices down. Many are reaching a point at which they can no longer absorb wage increases, so they are passing them along to buyers. China’s population is aging rapidly, and the reserve of future workers is declining. Those younger than 14 now make up 16.6 percent of the population compared with 23 percent ten years ago. Those older than 60 now account for 13.3 percent of the population compared with 10.3 percent in 2000. An energetic, young workforce is necessary to keep wages low and power economic growth. The Chinese government’s one-child policy is a threat to future economic growth. Japan exemplifies the challenges an export-led

LOGISTICS PLAYED an important role in Caterpillar selecting Victoria, Texas, for its new facility. Having an advanced, integrated supply chain like those found in Asia will be key to attracting manufacturers to Texas. Rail providers like Kansas City Southern and Union Pacific will play important roles.

economy faces when the workforce is aging rapidly, and social policy prevents needed population growth.

History Repeating Itself

hina’s economic path over the past ten years and its impact on the United States share many similarities with the Japanese experience of the 1970s and 1980s but on a larger scale. For example: • A long run of rapid growth in the export-led manufacturing sector preceded a property bubble in China as it did in Japan. • Americans feared the rise of China’s economic might just as they feared Japan’s economic rise. • U.S. manufacturing workers suffered most as their jobs were outsourced first to Japan and then to China. • U.S. investors in emerging economies benefited the most from skyrocketing stock and real estate prices in Japan and then China. • Rising wealth in Japan spilled over into acquisitions of U.S. real estate just prior to the bursting of the Japanese property bubble. Wealthy Chinese similarly have acquired significant amounts of U.S. real estate in the past few years. U.S. politicians, gross domestic product and mortgage borrowers have all benefited from deficit spending as first the Japanese and then the Chinese used their profits from U.S. exports to purchase U.S. Treasuries and mortgagebacked securities.

Brighter Days for U.S. Commercial Real Estate The imbalances that have existed during the rise of Japan and then China appear to be reaching their endgame. The widespread cost advantages from low wages and cheap currency have eroded on a large scale as reflected in rising U.S. import prices. There doesn’t appear to be another large emerging market capable of the economic expansion achieved in both countries. So what happens next? A clue to the answer exists in the relatively strong performance of the U.S. manufacturing sector during this recovery. While not earth shattering, U.S. manufacturing indices have performed well in the past two years. Importers are beginning to seek sourcing alternatives to China because the “Chinese price” is reaching parity with U.S.-sourced goods in some sectors. And U.S.-sourced orders mean shorter lead times, common business practices and better customer relationship management. The bottom line is that economic activity that was previously outsourced to Japan and China could be coming back to the United States. This is great news for the U.S. commercial real estate community. As capital exits emerging markets and returns to the United States, it will be available to fund new factories, warehouses and transportation infrastructure needed to support a renaissance in U.S. manufacturing. As importers source more of their goods domestically, manufacturing

workers may see an increase in employment opportunities. Reversing the imbalance could also present a challenge to the U.S. economy via decreased funding for U.S. deficits. What happens if China needs to use 50 percent of its foreign currency reserves to recapitalize its banking system after the property bubble bursts? What happens when the flow of U.S. dollars to China and Japan slows as manufacturing moves to the United States and other countries? Who will purchase the U.S. Treasuries and mortgage-backed securities used to fund American consumerism? he hope that President Obama and investors have placed on China fueling export-led U.S. job growth may be misplaced. Chinese wage inflation and the bursting of the Chinese property bubble may be the start of global rebalancing that produces domestically fueled job growth in the United States. And that would give Americans real hope.

Klassen (gklassen@tamu.edu) is a research analyst with the Real Estate Center at Texas A&M University.

THE TAKEAWAY Some view the economic slowdown in China as a threat to the U.S. economic recovery. But it could be an opportunity for job growth in U.S. manufacturing and expansion in U.S. commercial real estate. TIERRA GRANDE

Income Taxes

Not Just for the Wealthy Anymore By John Krajicek and Elijah Erickson

he year 1969 is usually remembered as the year Neil Armstrong walked on the moon, Richard Nixon became president, and the music festival Woodstock took place on a farm in New York. According to U.S. Commerce Department reports, the average U.S. household income in 1969 was $9,430, and the average cost of a new home was $24,000. That year, Congress passed new tax legislation known as the Alternative Minimum Tax (AMT). The AMT was designed as a new alternative to the regular income tax calculation. Applicable only to individuals earning over $200,000 (well over $1 million in today’s inflationadjusted dollars), it was essentially implemented to catch a small percentage of wealthy taxpayers who were exploiting tax loopholes to minimize or even avoid federal income tax

APRIL 2012

altogether. The AMT required these high-income earners to pay at least a minimum threshold of taxes. However, because subsequent Congresses have not indexed the AMT for inflation (unlike the regular tax system, which is inflation indexed), an alarmingly larger percentage of taxpayers become subject to this tax every year. hances are that many people reading this may already be impacted by the AMT, whether they are wealthy by today’s standards or not. A surprising number of people don’t even realize they are paying AMT. Taxpayers should be aware of the unintended but so far uncorrected negative consequences of not indexing the AMT for inflation. But before we weigh these matters further, let’s back up for a brief historical review.

Historical Perspective

In the 40-plus years since the AMT was signed into law, it he AMT was originally created by the Tax Reform Act has continued to cast an ever-widening net. According to a of 1969. It was designed to operate as a parallel tax recent Congressional Budget Office brief, less than 1 percent calculation to prevent high-income individuals from of taxpayers were affected by AMT in all of the 31 years leadusing federal income loopholes, preference items and excessive ing up to the year 2000. Shockingly, most estimates say that deductions to avoid federal income taxes. one-third of all taxpayers will be subject to the AMT in 2012. Fast forward to the 1980s. In the Tax Equity and Fiscal And without inflation indexing, this number will only grow. Responsibility Act of 1982 and the Tax Reform Act of 1986, Houston, we have a problem! the AMT evolved into its present form. The AMT rate was ABCs of AMT set at 26 percent for taxable income up to $175,000 and 28 So how does this tax work? percent for income above this threshold. This percentage is We’ve all heard about people cheating the IRS by keeping lower than the corresponding regular federal income tax rate, “two sets of books.” The AMT in essence requires taxpayers to so at first glance the AMT does not appear onerous. But these keep two sets of books, and operates as a mandatory “parallel” rates are deceptive because they apply to a broader base of tax system. income, which in turn eliminates a number of exemptions The first set of books and deductions. is the federal income Comparison of Standard and AMT Calculations The biggest flaw with tax, which is calcufor Houston Police Officer and Nurse these tax reform acts lated using Form 1040. was that they did not 2011 2012 To determine income index the AMT exempMarried Filing Jointly Standard AMT AMT tax liability, taxpayers tion to inflation. In Gross Income $130,000 $130,000 $130,000 begin with their annual 1986, an annual income Personal Exemptions $18,500 $ – $ – gross income and of $130,000 was a lot of AMT Exemption $– $74,450 $40,000 subtract the approprimoney. But today, accordItemized Deductions ate exemptions and ing to salary.com, it Primary Home Mortgage Interest $15,000 $15,000 $15,000 deductions. This results represents approximately State Taxes $8,000 $– $– in taxable income. The Gifts to Charity $12,000 $12,000 $12,000 the annual income of a Other Miscellaneous Deductions $3,000 $– $– applicable tax rates Houston police officer $73,500 $28,550 $63,000 are then applied to married to a nurse. That’s Taxable Income Effective Tax Rate 14.45% 26% 26% determine income tax not the type of people the Tax 10,619 7,423 16,380 liability. tax was intended for. Yet, Child Tax Credit 1,000 – – The alternative set today, this couple may be Total Tax Liability $9,619 $7,423 $16,380 of books begins where required to pay the AMT Source: Tax scenarios based on salary information from www.salary.com and tax the first one ends. To (see table). information from www.irs.gov. calculate AMT liabilSubsequent Congresses ity, federal taxable income is modified to derive Alternative have revisited the AMT exemption amounts over the last 26 Minimum Taxable Income (AMTI), by adding back personal years, but the results have mostly been cosmetic changes. and dependent exemptions and a potentially large number of Between 1990 and 2009, Congress passed a series of “patches” that acted as temporary inflation indexes for the AMT. The lat- deductions. The AMT exemption is then applied, which in est AMT adjustment was made in 2009 as part of the American the case of a married couple filing jointly, is $74,450 in 2011. Finally, the AMT rates are applied to AMTI to come up with Recovery and Reinvestment Act. However, this patch expired the AMTI liability. on Jan. 1, 2012.

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Once both sets of books have been calculated and both potential tax liabilities identified, the two amounts are compared. The tax liability is whichever amount is greater. The AMT system differs from the regular tax system in that it disallows all personal exemptions and many deductions. In fact, it looks a little like a flat tax. Two of the lost deductions are property taxes and home equity mortgage interest. State and local taxes are also disallowed, as are miscellaneous itemized deductions, a portion of otherwise deductible medical expenses, and certain business expenses. In addition, the AMT calculation negatively affects depreciation rates. The AMT simplifies the calculation of taxable income (again, somewhat like the flat tax proposals) but increases the base of income that is taxed. It also employs a simplified rate structure. Unlike the many tax “brackets” in place for the regular tax, the AMT has only two rates — 26 percent on the first $175,000 of AMTI and 28 percent on any excess. sing the middle-class Houston police officer and nurse as an example, the table walks us through a simplified regular income tax AMT calculation. In this case, which assumes the couple has three children, the tax liability under the regular tax system is $9,619. Under the mandatory alternative system, it is $7,423. This couple is liable for the greater of the two, or $9,619. However, in 2012, based on the same income and deductions, the AMT exemption drops and the tax bill under AMT increases by 70 percent to $16,380.

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New Alternative

It’s income tax time again, Americans: time to gather up those receipts, get out those tax forms, sharpen up that pencil, and stab yourself in the aorta. ~Dave Barry

ecause of the lack of indexing, the AMT net is expanding and will soon “catch” the middle class. We venture a guess that over half of those who read this publication will pay AMT in the 2012 tax year unless Congress acts. So, the question for 2012 is whether Congress even has the political will to debate adjusting the tax for inflation. Given the economy’s precarious state and the large government deficit, Congress may allow the AMT exemption to drop back to the $40,000 level set in the 1980s. The effect would be to eliminate inflation-indexing and impose this “wealth tax” on average taxpayers. If that happens, the tax will no longer be an alternative tax. In fact, the AMT seems destined to supplant the regular tax system. Krajicek (jkrajicek@mays.tamu.edu) is a CPA and executive professor and assistant director of business communication studies with the MBA Program of Mays Business School at Texas A&M University. Erickson, CISA, CRISC (Elijah.erickson@ tamu.edu) is an MBA candidate with Mays Business School.

THE TAKEAWAY The Alternative Minimum Tax (AMT) was created in 1969 to ensure that high-income taxpayers (those making over $200,000) would not avoid paying taxes by exploiting tax loopholes. But because the AMT was not indexed for inflation, people who are not wealthy by today’s standards are now subject to the tax.

Residential Markets

By James P. Gaines

espite massive Federal efforts to stimulate the housing market, including prolonged, historically low interest rates, direct tax incentives to selected buyers, and mortgage modification and refinance programs, the national housing market remains stalled. Home sales and new home construction may have bottomed in 2011 but still are significantly lower than their long-term averages. Home prices nationally may decline further, although at a slower rate than the last three years. But overall performance will stay close to current levels as excess inventory and an increased number of foreclosures forestall the overall recovery. Real estate markets are local, so the rocky road to recovery will differ significantly from area to area. Since 2008, Texas, the second largest housing market in the country, fared much better than most other states. During the

next couple of years, the stateâ&#x20AC;&#x2122;s housing markets should record a slow upturn. Significant uncertainties, including national, state and local elections, federal government policies and actions and the European debt workout, are a cloud on the U.S. economy. Fueled primarily by strength in the oil and gas industries, professional and business services, trade, and health care, Texas continues to lead the country in new job creation. But another national or global recession or a falloff in the energy sector could seriously affect Texasâ&#x20AC;&#x2122; economic climate and the housing market.

Home Sales Volume Annual home sales in Texas fell 30 percent from 2006 through 2011, less than the 37.4 percent that U.S. total sales declined TIERRA GRANDE

Table 1. Texas Home Sales, Average and Median Prices

Year

Sales

Average Price

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012p

100,047 99,619 107,107 116,604 122,134 121,823 138,123 146,395 170,638 184,056 188,738 196,401 201,528 216,147 241,020 266,842 292,805 275,584 232,381 213,334 203,610 208,000 215,000

87,300 89,300 93,400 99,300 102,400 104,400 110,800 117,900 124,700 132,200 146,100 150,100 155,600 159,400 164,300 174,400 183,800 192,600 191,600 185,400 192,300 196,100 $200,000

Median Price 68,100 71,200 75,200 78,200 80,000 81,600 86,400 90,700 96,200 100,900 112,100 119,400 124,500 127,700 130,100 136,800 142,900 147,300 146,900 145,800 147,600 148,800 $152,000

Year-Over-Year Percent Change Average Median Sales Price Price 7.5 8.9 4.7 –0.3 13.4 6.0 16.6 7.9 2.5 4.1 2.6 7.3 11.5 10.7 9.7 –5.9 –15.7 –8.2 –4.6 2.2 3.4

4.6 6.3 3.1 2.0 6.1 6.4 5.8 6.0 10.5 2.7 3.7 2.4 3.1 6.1 5.4 4.8 –0.5 –3.2 3.7 2.0 2.0

–0.4 5.6 4.0 2.3 2.0 5.9 5.0 6.1 4.9 11.1 6.5 4.3 2.6 1.9 5.1 4.5 3.1 –0.3 –0.7 1.2 0.8 2.2

Source: Real Estate Center at Texas A&M University

Figure 1. Annual Texas Home Sales

310 290

Sales Average Price Median Price

270 250 230

Thousands

210 190 170

150

3 00

ine

L nd

Tre

–2

130 110 90 70 50 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 Source: Real Estate Center at Texas A&M University

Percent Change Since Peak Average Median Sales Price Price 2.3

The substantial sales decline that started in 2007 was modestly interrupted by the tax credit inducement programs roughly between June 2009 and June 2010. The downward trend of home sales, however, appears to have reversed dur100.0 94.1 100.0 100.0 ing spring 2011. A gradual 79.4 99.5 99.7 improvement in monthly 72.9 96.3 99.0 sales moving toward the 69.5 99.8 100.2 long-term norm (as estimated 71.0 101.8 101.0 by the 1991–2003 trend line) 73.4 103.8 103.2 is expected to continue into 2013. Texas home sales are projected to grow to plus-or-minus 212,000 units in 2012, an increase of 3 to 3.5 percent for 2012. he projected 2012 level of sales is consistent with the historical rate of statewide sales per 1,000 households. The three-year trend in the rate of sales since 2010 reflects a reversion to the 1997–98 pace of sales, indicating a significant shift toward a more “normal” and sustainable market (Figure 3). The housing market remains somewhat precarious and could change, perhaps dramatically, as a result of small macroeconomic factors. Europe’s financial markets continue to be unstable, with no plan to fix the debt glut. A European recession could well trigger a U.S. retrenchment or outright recession. The credit squeeze makes new mortgages difficult to obtain, and appraisals often fail to support contract prices for new or existing home purchases. These two factors have caused contract cancellations to accelerate. Historically low mortgage interest rates have done little to attract buyers. Many buyers are postponing home purchases because of lack of confidence in the market and concern that prices may not have bottomed.

from their 2005 peak. Texas sales fell by 4.5 percent in 2010, despite the federal tax credit incentive during the first half of the year, but rebounded by a very modest 0.7 percent in 2011 (Figure 1, Table 1). arring any unforeseen economic or market shocks, U.S. home sales are expected to record around 4.4 million units of total existing home sales and 325,000 units of new home sales for the next couple of years. The general pattern of home sales is indicated by the 12-month moving average, which smooths reported 8,183 Sales monthly sales for seasonal variations (Figure 2). Texas January 1991 home sales experienced a sharp sales “bubble” from 2004 through 2006 that proved unsustainable into 2007 and 2008.

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4.6

Figure 2. Texas Home Sales 12-Month Moving Average Texas Sales “Bubble”

–20

1 199

nd Tre

16,939 Sales October 2011

Lin

Sources: U.S. Census Bureau and Real Estate Center at Texas A&M University

Texas Home Prices

Figure 3. Texas Home Sales per 1,000 Households

The good news for sellers so far is that home prices continue to appreciate. The National Association of Realtors (NAR) reported that the U.S. median home price fell a cumulative 22.4 percent from 2007 through 2009, increased less than 1 percent in 2010, and fell another 4 percent in 2011. The 2007–09 declines were the first losses since the 1960s, when NAR began tracking the data. 18.4 Sales 1980 Texas’ median home price dropped less than 1 percent in both 2008 and 2009, increased by 1.2 percent in 2010 and then by 0.7 percent in 2011. Despite the small rate of improvement, the 2011 median price of $148,700 established a record high. Texas home prices remain attractive relative to

MLS Area

2011 Median Price

Abilene Amarillo Arlington Austin Bay Area Beaumont Brazoria County Brownsville Bryan-College Station Collin County Corpus Christi Dallas Denton County El Paso Fort Bend Fort Worth Galveston Garland Harlingen Houston Irving Kerrville Killeen-Fort Hood Laredo Longview-Marshall Lubbock Lufkin McAllen Midland Montgomery County Nacogdoches Northeast Tarrant County Odessa Palestine Paris Port Arthur San Angelo San Antonio San Marcos Sherman-Denison South Padre Island Temple-Belton Texarkana Tyler Victoria Waco Wichita Falls Texas

$118,000 $128,000 $125,400 $191,200 $154,400 $128,900 $122,300 $93,300 $150,600 $209,300 $135,000 $158,500 $159,400 $131,300 $198,200 $110,500 $171,000 $91,200 $88,000 $153,200 $132,800 $154,400 $122,300 $123,300 $131,100 $117,000 $105,800 $104,400 $183,600 $184,200 $130,000 $167,200 $140,700 $90,300 $88,000 $106,300 $122,100 $151,000 $150,000 $87,300 $173,600 $129,600 $104,000 $137,200 $128,100 $120,700 $94,400 $148,600

Source: Real Estate Center at Texas A&M University

Year-Over-Year Percent Change 6 2 –4 1 –1 0 –2 –2 –1 1 –1 0 –2 –1 0 –3 4 –8 7 1 –4 –7 1 6 3 2 –13 2 5 3 2 –1 10 6 –9 2 4 1 10 –1 –10 6 –5 1 5 4 –4 1

21.0 Sales 1997 1980–97 Average Sales 16.7

23.3 Sales 2011 23.6 Sales Projected for 2012

Sources: U.S. Census Bureau and Real Estate Center at Texas A&M University

the national median, but the gap between the two has narrowed significantly as the national median price has fallen (Figure 4). MaintainFigure 4. United States and Texas ing home Median Home Prices values $221,900 throughout The gap between the U.S. and 2006 Texas median price widened to the state has 38%, but has narrowed to an been critical estimated 10% by 2011. $166,000 in lowering 2011 ice r P $142,900 the impact e 2006 o of mortgage an H edi e c i r M P . $148,700 loan defaults $95,200 me U. S Ho 2011 n and foreclo- 1989 a i Med s a x sures. NAR Te reports that $68,500 nationally, 1989 foreclosurem

Table 2. Median Price Change in Texas Metropolitan Areas

1980–2011 Average Sales 21.5

Sources: NAR and Real Estate Center at Texas A&M University

distressed sales account for as much as 33 percent of total sales. Texas’ distressed sales run 10 to 20 percent of total sales volume, much lower in some communities. Texas borrowers who experience difficulties have some chance of refinancing or selling prior to being foreclosed Figure 5. Texas Median Home Prices $151,500 rather than 2012 their mortgage (predicted) being “upside down” or having “negative $147,300 2007 equity.” Texas’ state$112,100 wide median 2000 $68,500 home price 1989 demonstrated relatively Source: Real Estate Center at Texas A&M University stable growth between 1989 and 2007 (Figure 5). The median price increased an average of 4.4 percent annually between 1990 and 2007, then stayed relatively flat during the housing bust. As there was no statewide price bubble during the boom, there was no statewide price bust. For 2012, the statewide median price is expected to increase 1 to 2 percent to between $150,000 and $152,000, less than half the historical average rate of appreciation. Texas’ four major metropolitan areas’ home prices have held steady (Figure 6). Dallas’ and Houston’s median home prices were flat while Austin’s and San Antonio’s median prices have shown some upward movement. TIERRA GRANDE

Figure 6. Texas Metropolitan Home Prices

Thousands of Dollars

Dallas

200 180 160 140 120 100 80 60 1996 2000 2004 2008 2012

Austin

200 180 160 140 120 100 80 60 1996 2000 2004 2008 2012

Houston

200 180 160 140 120 100 80 60 1996 2000 2004 2008 2012

San Antonio

200 180 160 140 120 100 80 60 1996 2000 2004 2008 2012

Source: Real Estate Center at Texas A&M University

New Home Construction

exas single-family home permitting dropped about 60 percent between 2005 and 2011. Statistically, the current decline closely replicates the 1984–88 collapse in construction, and the pattern of recovery could also mirror the subsequent decade. Despite the drop, Texas leads the nation in new home permits, and the Houston and Dallas metro areas rank one and two nationally in single-family home building activity in the United States. In 2011, Texas issued the fewest residential unit permits since 1992. While single-family permits in 2009 and 2010 were virtually constant, 2011 permits declined by 2 percent. Texas’ single-family construction levels for 2009 through 2011 are roughly equal to those of 1993–95 at around 70,000 units per year (Figure 7). The monthly permit numbers suggest that home construction in Texas may have bottomed at around 5,000 units per month (Figure 8). The tax credit programs created an artificial rebound in 2010. It appears that new home construction

Figure 7. Texas Single-Family Building Permits

103,252 Permits 1983

Percent of 1983 Peak 1984 82% 1985 66% 1986 57% 1987 43% 1988 35%

166,203 Permits 2005

Percent of 66,900 2005 Peak Permits 2006 98% 2011 2007 72% 2008 49% 2009 41% 2010 41% 2011 40% Sources: U.S. Census Bureau and Real Estate Center at Texas A&M University

67,870 Permits 1980

APRIL 2012

may linger at or near the current bottom for another year or so before registering a significant recovery. But any improvement will be modest and limited. Nationally, the differential between new home and existing home prices is at a historic high and qualifying for home loans remains difficult. Homebuilding will not stop as there is always demand for new homes versus existing homes. Overbuilding and excess inventories within the major Texas urban markets tended to be localized in specific neighborhoods rather than across the whole market. Single-family construction in the major Texas metro markets generally followed the same pattern as for the whole state. The pace of recovery may be similar to the 1980s, when it took several years for new home construction to approach a reasonably strong level, much less to equal the prior peak. At present, it appears that the level of new single-family construction has bottomed and should experience an uptick in 2012 in each of the major metro areas.

Figure 8. Texas Metros Single-Family Home Permits 50

Permits (Thousands)

The change in the median price in individual Texas metro politan areas was mixed in 2011 (Table 2). Nineteen areas experienced median price declines, three areas were flat, and 25 metro areas reported higher median prices.

Dallas

0 1980 1988 1996 2004 2012 50

Austin

0 1980 1988 1996 2004 2012 50

0 1980 1988 1996 2004 2012

Houston

San Antonio

0 1980 1988 1996 2004 2012

Projected Permits Source: Real Estate Center at Texas A&M University

What Lies Ahead There is reason to expect that the remainder of 2012 will be the beginning of a general economic and housing upturn. Sales and new construction should be showing signs of expanding and prices should stabilize. By year end, most of the major economic indices should be registering modest but positive increases. These gains should carry into 2013, indicating sustained market improvement, which should prevail in most local Texas markets. Dr. Gaines (jpgaines@tamu.edu) is a research economist with the Real Estate Center at Texas A&M University.

THE TAKEAWAY Recovery in the Texas housing market is occurring slowly, much like the pace of recovery after the housing market crashed in the early 1980s. For the rest of 2012 and into 2013, sales and new construction should expand and prices should stabilize. Major economic indices should show sustained improvement.

Land Markets

TIERRA GRANDE

n 2011, Texas land markets reflected continuing demand for secure investments through sustained price increases for cropland. Market pressures were especially strong in irrigated cropland markets, helping to stabilize overall price levels statewide. Prices increased in the Panhandle and South Plains, West Texas, and Wichita Falls regions. Panhandle and South Plains prices shot up 20 percent. However, the stability in these regions contrasted with falling prices in many other locales, where markets were challenged by slow volume. The more urban areas in the northeast and far south posted weaker prices. This mixed bag of results led to a statewide price per acre of $2,150 (Figure 1), a 3 percent overall increase from 2010. The real or inflation-adjusted price of $396 per acre in 1966 dollars was still less than the record-setting 2008 level of $424 but marked a 2 percent rise from the 2010 annual price.

Tract Size and Volume of Sales Small-sized transactions continued to dominate the overall market as the 2011 median of 74 acres exactly matched the 2010 typical size (Figure 2). That size remains much smaller than the 100-acre levels seen from 2000 to 2005. Large properties were mostly absent from the mix of sales. Brokers reported the impasse over pricing continued between potential buyers and sellers of larger tracts. The 4,520 sales reported fell just short of the 2010 total of 4,747 (Figure 3). If reported sales were indicative of current market activity, sales volume had returned to late â&#x20AC;&#x2122;90s levels. The year-to-date annualized trend toward stable volumes prevailed in virtually all of Texas. Statewide, the volume trailed 2010 levels by just 4.8 percent. The decreased number of large transactions was reflected in the total acreage sold (Figure 4). Sales in 2011 transferred a total of 1,044,474 acres compared with 1,052,957 acres in 2010. APRIL 2012

Texas Statewide Size-Adjusted Rural Land Index Price Nominal

Year 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Weighted Year-to-Year Average Index Percentage Price per Acre Change $ 173 184 192 201 213 230 249 324 405 410 441 464 521 584 671 780 805 833 865 867 723 634 608 596 589 546 565 560 605 632 681 695 744 788 846 886 977 1,075 1,279 1,491 1,827 2,077 2,246 2,085 2,091 2,150

– 6 4 5 6 8 8 30 25 1 8 5 12 12 15 16 3 4 4 0 –17 –12 –4 –2 –1 –7 3 –1 8 4 8 2 7 6 7 5 10 10 19 16 23 14 8 –7 1 3

Real Deflated Annual Weighted Compound Average Index Year-to-Year 5-Year Price per Percentage Growth Rate Acre* Change – – – – – 6 6 11 15 14 14 13 10 8 10 12 12 10 8 5 –1 –5 –6 –7 –7 –5 –2 –2 0 1 5 4 6 5 6 5 7 8 10 12 16 16 16 10 7 3

$172 177 177 177 178 184 191 236 270 250 254 252 264 273 287 305 296 296 296 288 235 201 186 175 167 149 151 147 155 159 168 168 178 186 195 200 217 235 271 305 363 402 424 389 388 396

3 0 0 1 3 4 23 14 –7 2 –1 5 3 5 6 –3 0 0 –3 –18 –15 –7 –6 –5 –10 1 –3 6 2 6 0 6 4 5 3 9 8 16 12 19 11 6 –8 0 2

Annual Compound Pretax Growth Rate

Volume of Sales

Median Tract Size (acres)

– – – – – 1 1 6 9 7 7 6 2 0 3 4 3 2 2 0 –5 –8 –9 –10 –10 –9 –6 –5 –2 –1 2 2 4 4 4 4 5 6 8 9 13 13 13 7 5 2

6,414 5,672 5,168 5,302 4,464 5,251 5,959 5,208 5,495 3,709 4,389 4,535 4,152 3,873 3,361 3,699 3,285 3,855 4,017 3,957 3,181 3,072 3,629 3,679 3,768 3,773 3,882 4,101 4,762 3,921 4,185 4,424 4,400 4,854 4,663 4,685 5,611 6,871 7,558 8,005 7,891 7,344 5,880 4,139 4,747 4,520

125 118 109 101 112 113 125 157 154 129 131 124 128 135 139 125 106 114 128 119 117 130 140 140 137 138 147 140 132 122 111 141 139 120 117 101 105 100 100 100 96 80 90 73 75 74

*In 1966 dollars. Note: 2011 volume of sales was estimated by annualizing the actual number of sales reported in the first three quarters. Nominal prices reflect actual prices paid. Real prices represent nominal prices adjusted for inflation. Source: Real Estate Center at Texas A&M University

TIERRA GRANDE

Figure 1. Texas Rural Land Prices 2008 $2,245.73 Per Acre

2011 $2,150.00 Per Acre

Nominal Real or Deflated

2011 $396.00 Per Acre

1966 $173.20 Per Acre

These circumstances reflect the general discomfort in the economy as the world continues to grapple with the problem of excessive debt creating turmoil in financial markets. These disquieting forces create a heightened apprehension of risk and suggest buyers will continue to expect price erosion while sellers resist sales at prices below recent historical norms. Anecdotal evidence suggests that cropland investors continue to actively seek land. However, dismal yields followed last yearâ&#x20AC;&#x2122;s historic drought, and the threat of substantial changes to government crop supports threaten the basic forces supporting demand. While these circumstances have

Source: Real Estate Center at Texas A&M University

By contrast, 3,086,339 acres sold in 2005. Subdued sales volumes began at the end of 2008 and continued through 2011.

Market Trends

n 2011, renewed interest in cropland combined with a fear of inflation to put upward pressure on cropland prices. However, for the third straight year, large properties sold less frequently than in past years. Sales volumes lagged the transaction Figure 2. Texas Typical Tract Size numbers from recent years and 1973 1997 posted volumes 157 Acres 140.47 Acres last seen from 1966 126 Acres 1990 to 2000. These facts reinforce information gathered from appraisers and brokers who 2011 report potential 74 Acres buyers continue Source: Real Estate Center at Texas A&M University to make low offers presuming that prices will drop eventually. Buyers are hesitant to pay current prices, but increasing numbers have grown weary of delaying their purchases. Lacking an external shock to the economy, market prices have firmed. However, transactions involving an unusually low number of acres continue for the third straight year.

Figure 3. Texas Land Market Volume 2005 8,005 Sales

2011 4,520 Sales

Source: Real Estate Center at Texas A&M University APRIL 2012

1966 2,183.9 Acres Sold

2005 3,085.3 Acres Sold 1987 2,250.7 Acres Sold 2011 1,044.5 Acres Sold

Source: Real Estate Center at Texas A&M University

not weakened demand for cropland, they have muddled prospects for the future. Rangeland markets face formidable challenges as potential buyers anticipate lower prices and sellers refuse to accept lowpriced bids. Transitional tracts near urban areas still face slack demand over the coming year. On the other hand, bustling activity in the oil patch continues to inject cash into Texas communities. Mineral producers and royalty owners have realized substantial profits with no end in sight. Evidence is beginning to emerge indicating that some of this prosperity has begun to focus on land. Given these confusing trends, statewide prices may modestly increase in 2012. However, sales volume is not likely to expand in the near future. Dr. Gilliland (c-gilliland@tamu.edu) is a research economist, Klassen (gklassen@tamu.edu) a research analyst and Garcia a research assistant with the Real Estate Center at Texas A&M University.

THE TAKEAWAY

1966 6,449 Sales

1987 3,077 Sales

Figure 4. Number of Acres Sold in Texas

Texas markets struggled to post a small gain with a continuing dearth of large tract sales. Gains appeared to be concentrated in West Texas, the Panhandle and High Plains. Uncertainty and high commodity prices fueled strong demand for cropland. For the third straight year, fewer acres than historic patterns forecasted changed hands in Texas.

International Economy

Japan was the economic wonder of the world in the 1970s and 1980s. Profits were pouring in. Interest rates were low, and bank lending was aggressive. The Japanese stock market peaked in 1989 and then collapsed. Bank losses were huge. The real estate market did the same thing. Real estate all over the country was “underwater.” It sounds eerily similar to what the United States has been dealing with in the past four years. Why should we care about Japan’s experience? Because we don’t want to repeat it. Twenty-two years after the Nikkei Index peaked, it is still down 78 percent. Commercial real estate dropped in value for more than a decade, and prices haven’t recovered. The Japanese government runs deficits every year, and Japan is one of the most heavily indebted nations on earth. Interest rates are extremely low, but economic growth is not occurring.

Beginning of Boom The Japanese economic expansion began as a result of cheap currency, low interest rates and aggressive bank lending. The Japanese yen was introduced to world currency markets in 1871, when it was worth one dollar. After World War II, the official exchange rate was 360 yen to the dollar. When a foreign country makes its currency artificially cheap, it is virtually

TIERRA GRANDE

ARTIFICIALLY CHEAP currency in the 1980s allowed Japanese automakers to produce cars superior to American-made ones and sell them for the same price. Hundreds of thousands were exported to the United States.

economic history for America. But it took some time for the results of this meeting to be felt in the broader global economy. n March 1987, President Reagan imposed 100 percent tariffs on selected Japanese electronic products. On July 1, nine congressmen assembled on the lawn of the Capitol and smashed a Toshiba television with sledgehammers. The same day, the Senate overwhelmingly approved the Omnibus Trade Bill requiring import penalties that prohibited Toshiba from exporting products to the United States for two to five years. The yen appreciated against the dollar by 40 percent in 1985 and continued to appreciate into 1987. This rapid appreciation made Japanese exports more expensive and resulted in a contraction in Japanese manufacturing output. From its trough of 263 yen to the dollar in February 1985, the yen appreciated to 129 per dollar in November 1987 (Figure 1). This was the beginning of the end of the Japanese Miracle. It was also the beginning of a bubble of massive proportions in the Japanese stock market and real estate market.

impossible for American companies to compete. So American manufacturing plants close and relocate to other countries. Fast-forward to the 1980s, and you can see how Japan could offer superior quality cars compared with Americanmade cars for the same price. ome refer to the 1980s as the “Japanese Miracle.” Japanese banks paid low interest rates on savings accounts and loaned money to major corporations at low rates as well. The combination of cheap currency and aggressive bank lending at low rates created plenty of fuel for economic growth. Consumer debt increased from nine trillion yen in 1979 to 67 trillion yen in March 1991. At the peak of the frenzy, Japanese banks conducted business as though real estate prices would never fall. With real estate as collateral, it didn’t matter whether a business or a building generated enough cash flow to support the loan. If the loan went bad, they could always sell the property and repay the loan. The United States, Germany and the United Kingdom went along with this Japanese scenario for many years. By 1985, the flow of wealth out of those countries to Japan became alarming. U.S. Treasury Secretary Donald Regan went to Tokyo in 1984 and famously pounded his fist on a table to demand that Japan

APRIL 2012

revalue their currency. Partially in response to this, Japan started building factories in the United States in areas where labor unions were scarce. In 1986, mounting anger in the United Kingdom and the United States led to open threats of retaliation. The Senate prepared a bill involving mandatory retaliation against trading partners with large trade surpluses. In 1985 and 1986, four of six U.S. producers of 256k dynamic random access memory chips stopped producing them for commercial sales because Japanese competitors were dumping the chips into the market. The U.S. semiconductor industry lost more than $1 billion in 1986, and layoffs resulted in Figure 1. Foreign Exchange Rate the loss of 60,000 jobs from Japanese Yen to One U.S. Dollar 1984 to 1986. January 1970 Americans became increas¥358.02 ingly concerned about losing wealth to Japan. Amidst this concern, a meeting of finance Shaded areas indicate U.S. recessions. ministers from Germany, the United Kingdom, the United States and Japan convened at the Plaza Hotel in New York City in September 1985. The goal of the meeting was to ask Japan to stop keeping its currency artificially low. The result of this meeting was January 2012 ¥77.04 called the Plaza Accord. This was a watershed moment in

Source: Board of Governors of the Federal Reserve System; 2011 research.stlouisfed.org

WHEN THE YEN ROSE against the dollar, the Japanese bought enormous amounts of U.S. real estate. Among the more iconic purchases was the Pebble Beach golf course on the California coast.

The Japanese real estate market, like its stock market, had become a bubble. By 1990, it had a theoretical value of two quadrillion yen, four times the value of all real estate in America. The estimated value of real estate in Tokyo alone was greater than the value of all real estate in America. New construction expanded dramatically. Condominium prices in Tokyo rose to more than ten times the average wage-earner’s salary. Land prices in central Tokyo increased by 75 percent in 1986.

Collapse of the Miracle

In May 1989, the Japanese central bank started raising interest rates to slow the frothy economy. The discount rate increased from 2.5 percent to 6 percent by the end of 1990. From 1988 to 1991, Japan’s gross domestic product (GDP) grew by an average of 4.9 percent annually. But from 1992 to 1997, annual real growth of GDP in Japan averaged only 1.4 percent. The Nikkei stock index hit its all-time high in December 1989, with intraday trading at 38,957 (Figure Figure 2. Nikkei 225 (Osaka) 2). By October 1990, 40 the Nikkei had lost 48 35 percent of its value, and 30 300 trillion yen of wealth 25 was gone. By 1993, the 20 market had fallen over 15 61 percent to 15,000. 10 The decline finally hit 5 1985 1990 1995 2000 2005 bottom in March 2009, when the index traded at Source: Yahoo Finance 7,054. The Japanese stock Yen (thousands)

apan went on a foreign buying spree in 1986. It bought U.S. Treasuries, stocks and real estate as well as corporations all over the globe. Everything on earth looked like a bargain. Large office buildings in New York and Los Angeles and hotels in Hawaii beefed up Japanese portfolios. In 1986, Shuwa Investment Corporation purchased Arco Plaza in Los Angeles for $620 million, the biggest all-cash transaction in U.S. history at that time. Mitsui Real Estate Development purchased the Exxon building in Rockefeller Center for $610 million. Cosmo World purchased Pebble Beach, planning to make it a private club and sell memberships. Japanese car companies built new factories in America, creating thousands of jobs. Back in Japan, the stock market was on fire. The Nikkei 225 rose from 11,500 in January 1985 to 38,900 in 1989. The Nikkei became the largest market in the world in terms of capitalization of listed companies. One stock, NTT, went public with a price-earnings ratio of 250. Japanese banks were rolling in the profits from their stock holdings. They were allowed to count 45 percent of their stock market gains as capital, so a bank’s capital adequacy became dependent on stock market prices. At one point, the five largest banks in the world were Japanese. The banks aggressively made real estate loans. Underwriting and risk analysis was not a high priority at the time. The assumption was that real estate always goes up in value.

market had declined 82 percent over a 20-year period. After the stock market crash, most people didn’t think real estate prices would fall. Japanese central bankers implemented credit controls on real estate loans to slow the growth of the bubble. Little new credit was flowing into real estate. The market was virtually frozen. The central bank committed to producing an “orderly decline” in land prices. Prices fell for nearly 15 years before finally hitting the trough in 2007. By late 1991, bid prices for real estate in Tokyo and Osaka were estimated to be 30 to 50 percent below the “official” prices set by the National Land Agency. Transaction volume plummeted, so it was impossible to know what the real value of real estate was. rices for detached houses in Tokyo had declined by 37 percent. Sellers refused to sell and take a loss. The capital gains tax on property was increased to 90 percent for properties held less than two years and 75 percent for those held two to five years. This discouraged owners from selling. Japanese banks were not required to disclose nonperforming loans, and they could report income from a troubled loan for a year after they stopped receiving

2010 Dec. 16 2011

TIERRA GRANDE

payments. When the real estate bubble burst, bank loan collateral vaporized. The banking system was virtually insolvent overnight. Banks had already taken severe losses on stocks they owned when the market crashed. The combination of massive losses in stock portfolios and real estate loans overwhelmed the banking system. he label “zombie bank” was used to describe banks that were insolvent but still alive, unable to make new loans. The country was teeming with zombie banks and zombie companies. The 1990s became known as the “lost decade.” Banks hoped they could hold on to their nonperforming real estate loans throughout the downturn without having to sell the collateral in a depressed real estate market. In April 1992, Japan’s finance ministry tried to raise confidence in the banking system by explaining that bad debts at 24 financial institutions totaled eight trillion yen, an amount the government considered manageable and much lower than had been reported. Shortly after, a confidential central bank study estimated the losses at 29 trillion yen. After more disclosures, those losses ballooned to 56 trillion yen. In 1997, a series of Japanese banks failed, further eroding confidence in the system. The government injected $1.8 trillion yen into the largest banks, but that failed to resolve the crisis. Finally, in 2002, Heizo Takanaka became minister of state for financial services and created the “Takanaka Plan,” which audited banks and forced them to write off hundreds of billions of yen in bad loans. By 2005, Japanese banks had written off roughly 96 trillion yen in loans. Today, the Japanese economy is still moribund, and the stock market remains 78 percent below the peak.

Dr. Dotzour (dotzour@tamu.edu) is chief economist with the Real Estate Center at Texas A&M University.

THE TAKEAWAY When Japan’s stock market crashed and a real estate bubble collapsed in the early 1990s, the country adopted a policy of “extend and pretend.” The results serve as a cautionary tale for the United States, which is in a similar situation now. APRIL 2012

JAPANESE LESSONS When a country keeps its currency too cheap, it consumes jobs and wealth from its trading partners. Japan experienced this in the 1970s and 1980s. China is doing the same today.

Japan bought U.S. Treasury bonds to manipulate its currency. China is doing the same today. Japan couldn’t sell its U.S. bonds and keep currency low. China can’t either (see “China’s Crisis, America’s Hope?” p. 2) .

When a central bank keeps interest rates too low for a long time, as Japan’s central bank did, speculative bubbles occur and subsequently burst. The United States found that out first hand with the 2007 bubble in residential and commercial real estate. As the Fed keeps interest rates at zero, more bubbles are likely to form.

When Japan tightened credit on real estate, the bubble burst. In America, real estate credit has been and is still tight and declining.

Japanese banks refused to recognize the colossal losses they had incurred in real estate loans. This led to a decline in real estate prices that lasted for more than a decade. The United States adopted an “extend and pretend” mentality to avoid recognizing losses, too.

The stronger yen made Japanese manufacturers less competitive in the global economy, so they purchased land and built factories in America, employing American workers.

After 20 years of stock market declines and declining real estate values, the Japanese are reluctant to buy stocks, so they buy government bonds with 1 percent interest rates. Americans, too, are losing confidence in the U.S. stock market.

While the stock market crash happened in 1989 and the real estate bubble didn’t burst until 1991, the Japanese economy continued to expand until 1996, when it finally contracted into recession. This illustrates how even the strongest economies cannot overcome a prolonged banking crisis.

When the Japanese yen started to appreciate, the Japanese bought lots of real estate in America at extremely high prices. As Chinese currency appreciates in coming years, the Chinese are likely to do the same.

Texas Economy

Shale of the Century

Small Towns Dazed by Eagle Ford Influx By Harold D. Hunt

Technology has a way of humbling those brave enough to forecast our energy future. In an April 1977 speech, President Jimmy Carter declared, “The oil and natural gas we rely on for 75 percent of our energy are running out.” Federal Reserve Chairman Alan Greenspan also took a stab at predicting the future of U.S. energy in 2003, testifying before Congress that “(natural gas) futures prices suggest that we are not apt to return to earlier periods of relative abundance and low prices anytime soon.” 22

oth predictions proved to be wrong. Technical advances in horizontal drilling and hydraulic fracturing (more commonly called fracking; Figure 1) have led to dramatic increases in new U.S. oil and gas discoveries. Subsurface shale deposits spread across the country are the primary sources for increased production. Natural gas from shale rock increased from a mere 2 percent of continental U.S. production in 2000 to 34 percent by September 2011. That share will balloon to 60 percent by 2035 according to a recent IHS Global Insight study. One of the most successful shale formations being tapped today is the Eagle Ford Shale. The 50-mile-wide by 400-milelong formation touches 24 Texas counties between the Mexico border and northeast Texas (Figure 2). The economic impact generated by the Eagle Ford is impressive. A 2011 UT San Antonio study estimated that $2.4 billion in lease payments were made to mineral owners in 2010 alone. By 2020, the Eagle Ford is expected to generate $21.6 billion in total economic output and support more than 67,000 full-time jobs according to the study. TIERRA GRANDE

Rural Towns Overwhelmed About a dozen counties in the Eagle Ford are home to the bulk of the shale drilling activity. Several are sparsely populated, claiming no more than a few thousand residents. McMullen County, the smallest of the group, reported a 2010 population of just 707. Drilling activity in the Eagle Ford ramped up quickly. The first well was drilled in central La Salle County in 2008. Today, more than 250 rigs are operating in the region. Rural towns were largely caught off guard by the tremendous influx of oilfield workers. Officials in communities such as Cotulla and Carrizo Springs assert their populations have easily doubled as a result. “We have one red light in a county the size of Rhode Island,” says Jay Watson, broker and owner of Tierra Roja Real Estate in Cotulla. “But we have five new hotels that are all full or will be full when completed.” Hotel room rates in and around the hottest part of the Eagle Ford are generally running $140 or more per night with no vacancies. Hotel construction is by far the most active real estate sector, with three to five new hotels completed or under construction in most towns.

Housing Shortage Severe

and other types of so-called “man-camps” have popped up to handle the overload. arly on, many of the RV parks were located inside the city limits of towns in the Eagle Ford. However, the congestion and strain on city services has resulted in some towns refusing to permit any new parks. Most new RV facilities are outside the city limits. Cities such as Carrizo Springs and Three Rivers are witnessing the arrival of hybrid temporary housing facilities such as extended-stay hotels, corporate apartments and full-service, high-amenity manufactured housing “lodges.” The list of amenities in these facilities can be extensive, including housekeeping, 24-hour food service, workout rooms and high-speed, wireless Internet service. Kitchens, washerdryer facilities and satellite TV reception are common in extended-stay properties.

Gun-Shy Developers Brokers and local government officials in several small towns report that new apartment and retail developments are being discussed. However, they also believe that some developers remain hesitant based on their memories of the late-1970s/ early-1980s oil boom. During that time, oilfield activity built up rapidly but fell just as fast. Businesses were as unprepared for the fall in economic activity as they were for the rise. New retail construction in the rural towns within the Eagle Ford has generally been limited to a few select big-box retailers. “We have had an unprecedented run-up in our sales tax revenue in the last year,” says Ray Kroll, executive director of Karnes County economic and community development. “And we’ve basically done it with a Walmart, an H-E-B and a Tractor Supply.”

atson also states that owners would rather rent a single-family home in Cotulla than sell it. “I only have two homes listed for sale,” he says. “But to rent a three-bedroom, two-bath house would cost you about $1,500 per month right Figure 1. Horizontal and Conventional Drilling now. There is little incentive to sell a home when rents are so high.” Fracking Conventional Well Well Surprisingly, new home construction is almost nonexistent in many of these booming small 0 towns. Lack of developable land is a big factor. Large ranches surround many of the towns, and Aquifer 1,000 owners are in no hurry to sell their land for new residential subdivisions. Another factor is financing. Even if land were 2,000 available, credit is still extremely tight for proposed new development in most rural areas today. Borehole 3,000 Getting a buyer qualified is a major hurdle. Credit standards have become much tougher for potential homebuyers since the mortgage indusFracking Fluid Injected At 4,000 try collapse. High Pressure Creates Fractures And Releases Natural Gas Finally, homebuilders would have to be brought in from distant cities such as San Anto5,000 nio or Laredo. Assuming builders and their subGas Reservoir contractors could be found, the problem would (Sandstone) 6,000 Seal then become finding a place for workers to stay Horizontal Drilling during construction. The lack of available housing has not been 7,000 Gas/source Rock limited to single-family homes. Most of the (Shale, Coal Bed Methane) smaller towns in the hottest part of the Eagle Hydraulic Fracturing 8,000 Ford have not constructed any new market-rate Source: nationalgeographic.com/news/2010/10/101022-breaking-fuel-from-the-rock/ apartments in decades. As a result, RV parks

APRIL 2012

Feet

While this economic growth is welcome in light of the national economic downturn, such rapid growth can be painful to smaller communities. The activity is clearly having an impact on a few specific real estate segments in and around the region while other segments remain relatively unaffected.

Kroll believes the City of Kenedy can support much more retail. “We have people making good money going to San Antonio to spend it when they could be spending it here,” he says. Kenedy is one of the few rural communities in the Eagle Ford with any major new development in the pipeline. “Kenedy Station, a 166-acre, $78 million mixed-use project, will break ground this year,” says Kroll. The development will include single-family and multifamily residential housing, retail development, office-warehouse space and hotels. “We’ve needed new residential housing for 40 years,” says Kroll. “Luckily, this was planned before the Eagle Ford came online and the timing couldn’t be better.”

Drilling, Exploration Employment Concerns An important question being pondered by many real estate professionals is how long the drilling-exploration employment will remain in the Eagle Ford before it’s replaced by a smaller permanent production workforce. The IHS Global Insight study argues that the distribution of drilling-exploration jobs to production jobs in shale gas areas will be the same in 2035 as it was in 2010. According to the study, “The high levels of capital investment seen in the infrastructure phase will continue as natural gas production increases in step with natural gas demand.” If true, this would mean sustained oil and gas employment levels that are higher than in the past. IHS has calculated an employment multiplier of 3.0 for the shale gas industry. In other words, every direct job created in oil and gas will result in the creation of three additional jobs. DESPITE MUSHROOMING demand for housing, new home construction is almost nonexistent in small Eagle Ford Shale communities. Instead, manufactured housing “man camps” and extended-stay hotels and are popping up, including this one in Three Rivers.

HS maintains that the relatively high multiplier of 3.0 is because it is a capital-intensive industry that spends significant money for services. Also, oil and gas suppliers are largely domestic firms, keeping a high percentage of spending in the United States to support American jobs. The Dallas Federal Reserve has calculated a more refined multiplier of 4.7 from the creation of every oil and gas “exploration” job. The multipliers are smaller for oil and gas refining jobs (2.1) and oil and gas manufacturing jobs (3.5).

The average oil and gas wage is more than double the overall average wage in most Eagle Ford counties according to the Texas Workforce Commission. As a result, many local residents have been eager to obtain oilfield-related employment. lthough this has been a boon for local economies, some cities have suffered from a reduction in their available labor pool. “We’ve had restaurants here in Kenedy that have had to close at 3:00 in the afternoon because they don’t have enough staff,” says Kroll. A common scenario is playing out in some smaller towns. Because of insufficient local oil and gas talent, workers are brought in from other areas. When they arrive, housing is limited. They bid up available housing, displacing lower-income local residents. These residents leave the area, shrinking the labor pool for non-oil-and-gas employment. “We have had local residents whose rents have been virtually the same for years,” says Lydia Saenz, a real estate agent for Prime Properties Winter Garden in Carrizo Springs. “Now we see rents that have doubled or tripled in some cases since the oilfield activity arrived. The low-income renters can no longer afford the higher rents, so they are often displaced.”

Migration to Larger Cities Migration patterns will be important if oil and gas activity in the Eagle Ford continues another ten to 20 years as expected. While some small-town residents may be pushed out, others may be pulled out, enticed by better job opportunities or a perceived higher quality of life in larger regional cities. Quality of life is an important variable affecting migration patterns. Individuals will decide for themselves what an acceptable quality of life is. If the definition includes multiple entertainment options, easy access to medical facilities and a variety of retail choices, cities such as San Antonio, Victoria or Corpus Christi may be chosen over rural towns. Transportation infrastructure is an important variable that favors larger cities. The hottest section of the Eagle Ford is divided into thirds by I-35 and I-37. As a result, commutes to San Antonio or Corpus Christi from the southern counties are relatively efficient but long. Future land availability will be an obvious determinant for smaller cities in the Eagle Ford’s southern region. If they remain relatively landlocked, significant new development will prove difficult. Alternatively, other cities farther north outside big ranch country such as Cuero are already developing new residential subdivisions to meet demand.

What Could Go Wrong? A drop in the price of crude oil would be an obvious detriment to oil and gas activity in the region. However, recent declines in the price of dry natural gas have been offset by the sustained price of accompanying natural gas liquids (NGLs) such as TIERRA GRANDE

Figure 2. Wells Permitted and Completed in Eagle Ford Shale In Relation to Major Texas Aquifers As of December 2, 2011

FREESTONE MCLENNAN

MILLS IRION

CONCHO

MASON

Aquifer Legend Edwards–Trinity Plateau Trinity Edwards Carrizo–Wilcox Gulf Coast

VAL VERDE

3,131 Approved Permits 512 Producing Oil Wells 540 Producing Gas Wells

WILLIAMSON

SUTTON

KIMBLE

GILLESPIE

KERR

EDWARDS REAL

BLANCO

COMAL

BANDERA BEXAR

KINNEY

UVALDE

MEDINA

LEE

San Antonio

Carrizo Springs

LIBERTY

AUSTIN

Houston

COLORADO

GONZALES

HARRIS

FORT BEND

GALVESTON

LAVACA

ATASCOSA

FRIO

ZAVALA

MONTGOMERY

FAYETTE

WHARTON

WILSON

MAVERICK

SAN JACINTO

WASHINGTON

CALDWELL GUADALUPE

WALKER

GRIMES BRAZOS

BASTROP

HAYS

KENDALL

College Station BURLESON

Austin

TRAVIS

MADISON POLK

MILAM

BURNET

LLANO

TRINITY

ROBERTSON

BELL

MENARD

HOUSTON

LEON

FALLS

LAMPASAS SAN SABA

SCHLEICHER

LIMESTONE

CORYELL MCCULLOCH

Well Legend

ANDERSON

HAMILTON

TOM GREEN

RUSK CHEROKEE

NACOGDOCHES

BOSQUE

COMANCHE

BROWN

HENDERSON

NAVARRO

HILL

ANGELINA

COLEMAN

ELLIS

ERATH

CHAMBERS

RUNNELS

COKE

EASTLAND

CALLAHAN

TAYLOR

WALLER

STERLING

NOLAN

BRAZORIA

Cuero

DE WITT

KARNES

VICTORIA

Kenedy

JACKSON

Victoria

MATAGORDA

GOLIAD CALHOUN

LA SALLE

Cotulla

DIMMIT

Three Rivers MCMULLEN

REFUGIO

BEE

LIVE OAK SAN PATRICIO

WEBB

Laredo

DUVAL

JIM WELLS

ARANSAS

NUECES

Corpus Christi

KLEBERG

ZAPATA

JIM HOGG

BROOKS

KENEDY

Sources: Railroad Commission of Texas and Texas Water Development Board

butane, propane and ethane, a favorite of the petrochemical industry. Many of the Eagle Ford discoveries are high in NGLs, which are priced relative to the price of crude oil, not natural gas. Some of the region’s gas wells are so productive in NGLs that producers could afford to give away the natural gas for free and still break even from NGL profits. Federal regulation of well fracking is another unknown that could have a negative effect. The Environmental Protection Agency is currently conducting a national study of the effects of hydraulic fracturing on drinking water resources. It is scheduled to release initial study results this year and an additional report in 2014.

Technological Advance, Not Boom Although hype can often be bigger than reality, all signs point to the Eagle Ford providing significant economic benefits for Texas for many years to come. APRIL 2012

“Don’t call the Eagle Ford a boom. Call it a technological leap that allows us to produce oil and gas we’ve known was there but just couldn’t produce,” says Ben Tinnin, commercial development consultant for Project Consulting Services Inc., a Houston-based oilfield consulting firm. “That’s not near as sexy as calling it a boom. But it’s a lot more profitable in the long run.” Dr. Hunt (hhunt@tamu.edu) is a research economist with the Real Estate Center at Texas A&M University.

THE TAKEAWAY Increased oil and gas activity in the Eagle Ford Shale has dramatically boosted the economies of many small South Texas towns. However, the influx of oilfield workers has caused severe housing shortages and is straining local infrastructures.

Residential Markets

By Ali Anari

n free market economies, the prices of goods and services are determined by peoplesâ&#x20AC;&#x2122; willingness and ability to pay for them. In the short run, home prices are determined by supply and demand conditions in local housing markets, credit availability and mortgage rates. But in the long-run, family income is the single most fundamental factor in determining home prices. As past home price boom-bust cycles in many regions of the United States and other countries have shown, changes in credit availability and short-run market conditions can generate home price booms, but whether the booms end in bust depends on whether homeownersâ&#x20AC;&#x2122; incomes can cover the costs of homeownership. Prices can deviate from their long-run values because of market conditions and the availability and

costs of credit, but eventually prices revert to their fundamental values as determined by family incomes. An analysis of the relationships between home prices and family incomes in regional residential markets can help determine whether home prices reflect their fundamental values and the extent to which they may deviate from those values. eal Estate Center researchers studied the relationships between home price distribution and income distribution in Texas real estate markets and found that home price distributions in the state and its major metropolitan areas are closely aligned with income distributions. The alignment is especially strong for homes priced from $100,000 to $300,000 and family incomes more than $50,000 but less than $200,000.

Table 1. 2009 Home Price Distribution in Texas, Austin, Dallas and Houston Number of Owner-Occupied Residential Units Home Price Less than $100,000 $100,000 to $199,999 $200,000 to $299,999 $300,000 to $399,999 More than $400,000 Total

Percent of Total

Texas

Austin

Dallas

Houston

Texas

Austin

Dallas

Houston

2,023,535 2,061,552 719,083 287,031 339,499 5,430,700

45,852 147,324 78,731 37,703 50,588 360,198

353,427 588,832 224,913 93,707 108,322 1,369,201

359,821 533,621 180,976 75,439 98,168 1,248,025

37.3 38.0 13.2 5.3 6.3 100.0

12.7 40.9 21.9 10.5 14.0 100.0

25.8 43.0 16.4 6.8 7.9 100.0

28.8 42.8 14.5 6.0 7.9 100.0

Austin = Austin-Round Rock; Dallas = Dallas-Fort Worth-Arlington; Houston = Houston-Sugar Land-Baytown Sources: U.S. Census Bureau and Real Estate Center at Texas A&M University.

TIERRA GRANDE

The homes in this category are more evenly distributed among the three regional markets. bout 13.2 percent of total housing units in Texas were in the third quintile, with values from $200,000 to $299,999. Austin had the largest share of homes in this bracket (21.9 percent), followed by Dallas (16.4 percent) and Houston (14.5 percent). Roughly 5.3 percent of the stateâ&#x20AC;&#x2122;s homes were priced between $300,000 and $399,999. This price range accounted for 10.5 percent of housing units in Austin, 6 percent in Houston and 6.8 percent in Dallas. Only 6.3 percent of Texasâ&#x20AC;&#x2122; owner-occupied housing units were priced higher than $400,000 in 2009. Again, Austin had the largest share of these expensive homes, 14 percent, compared with 7.9 percent for Dallas and Houston (Table 1).

Texas Income Distribution

Determining Home Price Distribution

o compare home price distribution and income distribution in Texas, the project divided 2009 U.S. Census Bureau home price data and family income data into five parts, or quintiles (Tables 1 and 2). There were 2,023,535 housing units priced less than $100,000 in Texas in 2009, accounting for 37.3 percent of housing units. Austin-Round Rock had the smallest percentage of housing units in this quintile (12.7 percent) followed by Dallas-Fort Worth-Arlington (25.8 percent) and Houston-Sugar Land-Baytown (28.8 percent; Table 1). Housing units valued from $100,000 to $199,999 accounted for 38 percent of total residential units in Texas, 40.9 percent in Austin, 43 percent in Dallas and 42.8 percent in Houston.

In 2009, 2,647,123 families in Texas had annual incomes less than $50,000, accounting for 44.4 percent of all state families (Table 2). Austin had the smallest percentage of families in this quintile (35.7 percent), followed by Dallas (38.3 percent) and Houston (40.5 percent; Table 2). Texas families with annual incomes from $50,000 to $99,999 accounted for 32 percent of total Texas families with 33.8 percent in Austin, 32.7 percent in Dallas and 30.7 percent in Houston. The numbers of families in this income bracket are more evenly distributed among the three regional markets. About 13.8 percent of Texas families had annual family income between $100,000 and $149,999. Austin claimed the largest share of families in this income bracket (17.3 percent), followed by Dallas (16.5 percent) and Houston (15.5 percent). Roughly 5 percent of the stateâ&#x20AC;&#x2122;s families had annual incomes between $150,000 and $199,999. This income range accounted for 7.1 percent of families in Austin, 6.5 percent in Houston and 6.2 percent in Dallas. Only 4.8 percent of Texas families had family income of more than $200,000 in 2009. This income bracket accounted for 6.2, 6.4 and 6.7 percent of families in Austin, Dallas and Houston, respectively (Table 2).

Table 2. 2009 Family Income Distribution in Texas, Austin, Dallas and Houston Number of Families Family Income

Texas

Austin

Dallas

Percent of Total Houston

Texas

Austin

Less than $50,000 44.4 35.7 2,647,123 137,706 583,929 577,324 $50,000 to $99,999 1,905,820 130,390 498,137 438,222 32.0 33.8 $100,000 to $149,999 819,045 66,696 251,580 220,807 13.8 17.3 $150,000 to $199,999 295,835 27,393 95,039 92,985 5.0 7.1 More than $200,000 288,544 23,800 96,989 95,947 4.8 6.2 Total 5,956,367 385,985 1,525,674 1,425,285 100.0 100.0 Austin = Austin-Round Rock; Dallas = Dallas-Fort Worth-Arlington; Houston = Houston-Sugar Land-Baytown Sources: U.S. Census Bureau and Real Estate Center at Texas A&M University. APRIL 2012

Dallas

Houston

38.3 32.7 16.5 6.2 6.4 100.0

40.5 30.7 15.5 6.5 6.7 100.0

Home Price

40 Percent

Family Income

30 20

Figure 2. Home Price Distribution by Income Austin-Round Rock-San Marcos, 2009

Home Price

Family Income

Percent

Figure 1. Home Price Distribution by Income Texas, 2009

30 20

Le $1 ss Th 00 an , Les 000 $5 s Tha 0,0 n 00 to $10 $1 0,0 99 00 ,99 9 to $50, $9 00 9,9 0 99 to $20 $2 0,0 99 00 ,99 to $100 9 $1 ,0 49 00 ,99 9 to $30 $3 0,0 99 00 ,99 to $150 9 $1 ,0 99 00 ,9 Mo 99 $4 re Th 00 an Mo ,000 $2 re Th 00 an ,00 0

Source: Real Estate Center at Texas A&M University

Figure 3. Home Price Distribution by Income Dallas-Fort Worth-Arlington, 2009

Home Price

Percent

Analysis of Home Price Distributions And Income Distributions A visual inspection of home price and income distributions in Texas, Austin, Dallas and Houston (Figures 1–4) shows a close association between the two. However, more sophisticated statistical methods exist to investigate the strength of the association. Pearson’s correlation coefficient is one simple statistical measure of the strength and direction of a relationship between two variables. The values of this measure vary from minus one to plus one. Applying this to the pairs of home price distribution and family income distribution, positive (negative) values of the correlation coefficients indicate a relationship in which as income values increase (decrease), home prices also increase (decrease). If home price and family income have a strong positive linear correlation, the correlation is close to plus one. his research found a positive correlation coefficient of 0.95 for income and home price distributions for Texas (Figure 1). The coefficient increases to 0.99 percent for family income brackets of more than $50,000 and home price brackets of more than $100,000 (Figure 1). The correlation coefficient for the relationship between Austin home prices and incomes was 0.53, but for income brackets more than $50,000 and home prices more than $100,000, the coefficient rose to 0.98 (Figure 2). The Dallas metro area’s correlation coefficient was 0.85, increasing to 0.99 for income brackets more than $50,000 and home prices more than $100,000 (Figure 3). The Houston metro area had a correlation coefficient of 0.85, which rose to 0.98 for income brackets of more than $50,000 and home prices more than $100,000 (Figure 4).

Source: Real Estate Center at Texas A&M University

Family Income

House Price

Family Income

Figure 4. Home Price Distribution by Income Houston, 2009

Source: Real Estate Center at Texas A&M University

Market Segments Identified

urther analysis of these relationships reveals that the state’s housing market is divided into three price and income brackets. The first bracket consists of annual family incomes less than $50,000 and home prices less than $100,000. The second bracket comprises homes valued at more than $100,000 but less than $400,000, and family incomes of more than $50,000 but less than $200,000. Home prices and family incomes in this bracket were found to be highly correlated. The third bracket includes homes valued at more than $400,000 and annual family incomes above $200,000. The close alignments of home price distribution and family income distribution in Texas and in the state’s major metropolitan areas confirm that the state’s residential real estate markets are driven mainly by family income, the fundamental economic variable in residential real estate markets. This means a major home price drop in Texas is unlikely given gradual, small changes in family income over time. Dr. Anari (m-anari@tamu.edu) is a research economist with the Real Estate Center at Texas A&M University.

THE TAKEAWAY Research shows that Texas homebuyers tend to trade up as their income rises, especially in the lower home price ranges. This trend lessens as family income goes up because, at some point, people decide they don’t need a bigger house even if they get a pay raise. TIERRA GRANDE

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