Tierra Grande - January 2017

JANUARY 2017 â„¢

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

COLLEGE STATION, TEXAS 77843-2115

In This Issue Income and Housing Prices General Warranty Deed Commodities and Land Prices Residential Solar Energy Liquidity of Texas Homes Tax Rules on Condemnation Fixing Texas Taxes IRS Audits Increasing

Helping Texans make better real estate decisions since 1971

JANUARY 2017 â„¢

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

iii

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JANUARY 2017

www.recenter.tamu.edu

Director, GARY W. MALER Chief Economist, JAMES P. GAINES Senior Editor, DAVID S. JONES Managing Editor, NANCY MCQUISTION Associate Editor, BRYAN POPE Associate Editor, KAMMY BAUMANN

VOLUME 24, NUMBER 1 ™

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

14

Here Comes the Sun

The Value of Residential Solar Do solar systems add to the value of a house at resale? Available data sheds some light on the question.

BY HAROLD D. HUNT

Art Director, ROBERT P. BEALS II Graphic Specialist/Photographer, JP BEATO III Circulation Manager, MARK BAUMANN Lithography, RR DONNELLEY, HOUSTON

ADVISORY COMMITTEE: Russell Cain, Port Lavaca, chairman; Doug Jennings, Fort Worth, vice chairman; Mario A. Arriaga, Conroe; Alvin Collins, Andrews; Jacquelyn K. Hawkins, Austin; Besa Martin, Boerne; Walter F. “Ted” Nelson, Houston; Doug Roberts, Austin; C. Clark Welder, San Antonio; and Bill Jones, Temple, 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.

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: Robert Beals II, pp. 1, 2–3, 12–13, 14–15, 28; Real Estate Center files, pp. 7, 10, 25, 27; Harold Hunt, pp. 16, 17, 18; JP Beato III, pp. 19, 21; Alden DeMoss, p. 24. © 2017, Real Estate Center. All rights reserved.

2 Paycheck Reality

Texans’ Incomes Outpace Housing Prices For a good long while, personal income per capita (PIPC) in Texas grew faster than housing prices. But in the past few years, part of that competitive advantage has been eliminated.

BY WAYNE DAY AND LUIS B. TORRES

7 Seller Beware

Understanding the General Warranty Deed This most commonly used deed in real estate transactions can pose risks for sellers. Here’s what you need to know to better advise your clients.

BY RUSTY ADAMS

10 Oil, Cattle, Cotton

Commodities Affect Land Prices ON THE COVER Morning after an ice storm, Wilson, Texas, near Lubbock

PHOTOGRAPHER David Sucsy

JANUARY 2017

You might not think that Texas’ top commodities have a connection to land prices. But you would be wrong. Turns out that land prices move with the ups and downs of the commodities market.

BY LUIS B. TORRES AND CHARLES E. GILLILAND

19 Liquidity of Texas Homes Days on Market Speaks Volumes

Center research reveals that days on market reflects the health of real estate markets at the local, regional, and state levels.

BY ALI ANARI AND GERALD KLASSEN

24 This Property is Condemned, But . . .

Dealing with condemned commercial property doesn’t have to be a total bummer. In some cases, you can postpone or avoid taxes by buying a similar replacement property.

BY JERROLD J. STERN

25 Texas Tax Conundrum

How can taxing entities lower property taxes yet have enough money to cover the rising costs of schools for the state’s burgeoning population? If you know the answer, please call 1-800-HelpTXS.

BY CHARLES E. GILLILAND

28 Mind the Gap

Mind your Ps and Qs, people. The IRS is strengthening its efforts to nab taxpayers who underreport income or overstate deductions.

BY JERROLD J. STERN

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Residential

Paycheck Reality Texans’ Incomes Outpace Housing Prices

By Wayne Day and Luis B. Torres

P

ersonal income per capita (PIPC) serves as a useful measure of overall standard of living.

It represents the amount of money earned by the average individual and how much of that amount is available for saving and consumption.

Housing represents the largest single purchase and budget item from an individual’s income. With PIPC rising throughout the state, Center researchers analyzed the relationship between PIPC growth and changes in housing prices.

Incomes and Housing Prices Linked?

Housing prices are expected to keep in line with fundamentals of supply and demand. Factors affecting housing prices include interest rates, employment, changes in demographics, taxes, capital markets, availability of developed lots, and income. A major divergence from long-term “normal” relationships often leads to speculation on whether a bubble exists. A bubble occurs when homebuyers have irrational expectations of future prices that cause prices to elevate significantly above fundamental values.

While price and income changes over time generally trend upward, regional variations may

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exist. Regions across the U.S. exhibited distinct patterns, with some experiencing income growth that exceeded housing price growth, and others experiencing housing price growth that exceeded income growth.

PIPC Growth Texas PIPC registered growth rates similar to the ones observed in the U.S. from 1975 through 2015 and recently exceeded the national growth rate.

The Texas Triangle metros—Austin, Dallas-Fort Worth, Houston, and San Antonio—have matched and exceeded the U.S. average and total growth rate, a result of the industrial mix of each region.

(For a more thorough review of changes in PIPC see “What’s in Your Wallet?” at recenter.tamu.edu.)

Housing Price Growth Inflation-adjusted housing price growth in Texas has been relatively tame compared with the U.S., in great part due to the housing-supply glut through the late 1980s that depressed prices through the 1990s. During the late 1990s and early 2000s, a relatively balanced supply-demand relationship kept housing price appreciation subdued TIERRA GRANDE

while the rest of the nation was experiencing a housing boom based on loose credit conditions.

The Freddie Mac House Price Index (FMHPI) represents price activity from 1975 to 2015 (Figure 1). The U.S. exceeded Texas in housing price appreciation for most of the period. Texas and its major metros posted high rates of appreciation through the early 1980s as the Texas economy boomed from energy-related growth. The state’s economy outperformed the nation’s with greater employment rates and PIPC growth. At the same time, housing in the energy MSAs—Houston, Midland, and Odessa—exhibited strong price appreciation through 1982. he energy-driven boom prompted an increase in real estate construction in both residential and commercial markets. Lenders were quick to make construction and mortgage loans in the booming Texas economy fueled by positive oil price expectations. The national economy fell into a recession at the start of the 1980s, and the Texas economy soon followed as oil prices slipped. Further collapse in oil prices and the savings and loan crisis caused the Texas economy to falter from the mid-1980s through the

T

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230 210 190

Figure 1. Freddie Mac Housing Price Index January 1975 = 100 United States Austin-Round Rock Houston-The WoodlandsSugar Land Odessa

Texas Dallas-Fort Worth-Arlington Midland San Antonio-New Braunfels

170 150 130 110 90 70 1975

1980

1985

1990

1995

2000

2005

2010

2015

Notes: Inflation adjusted. The data are indexed to a starting base of 100 in January 1975.

Source: Freddie Mac

rest of the decade. This led to a muted Texas real estate market for years as inflation-adjusted prices, which peaked in late 1984, reached a trough in late 1990. By contrast, real housing prices in the U.S. rose during this period.

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Months 11

Figure 2. U.S. Month’s Supply and Real Year-Over-Year House Price Changes Months of Inventory U.S. (Left) Months of Inventory Texas (Left) Real House Price U.S. (Right) Real House Price Texas (Right)

10 9

Percent 25 20 15

8

10

7

5

6

0

5

–5

4

–10

3

–15

2 2000

2002

2004

2006

2008

2010

2012

Notes: Inflation adjusted.

Sources: U.S. Census Bureau, National Association of Realtors, and Freddie Mac

2014

–20 2016

It wasn’t until the mid 1990s that real housing prices in Texas began to pick up momentum after the oversupply of housing from the 1980s was reduced, paving the way for a strong recovery in new housing construction. Recovery in the broad economy during the 1990s coupled with the tech boom created a resurgence in real price appreciation. During the 1990s Austin emerged as a leader in both PIPC and housing price growth.

The U.S. recorded a drastic run-up in real housing prices from the late 1990s through 2006, right up to the housing market collapse. Texas was shielded from the severe housing price depreciation in the rest of the country primarily due to a balanced housing market. A quick look at the relationship between the months of inventory and real price changes reveals some of the differences between Texas’ housing markets and the nation’s (Figure 2). A balanced market is expected to be near six months of inventory. Housing prices are pushed higher when months of inventory is low.

Alternatively, housing prices are suppressed when months of inventory is high.

Leading up to the Great Recession, months of inventory was lower in the U.S. than in Texas, leading to higher housing appreciation rates nationally. However, as a result of loose credit in housing, adjustable-rate mortgages readjusting at higher rates, and the overall financial crisis, homeowners defaulted in masses, and months of

Definitions and Methodology

P

ersonal income per capita (PIPC) and the Freddie Mac House Price Index (FMHPI) are the two main measures used in this analysis.

PIPC is used to represent income growth.

PIPC is net of transfers because it includes government transfers. It is computed for each geography and indexed to 1975 = 100 to demonstrate income growth for each respective geography.

The FMHPI measures housing price appreciation or depreciation for the U.S., states (including Washington, D.C.), and metropolitan statistical areas (metros). The index uses a regression and repeat-sales methodology to control for any factors that do not explain the average change in housing prices. The index only includes single-family and townhouse properties that are conforming loans purchased by Freddie Mac or Fannie Mae, thus excluding nonconforming loans and planned unit developments, condos, and cooperative properties.

Both PIPC and FMHPI measures are deflated using the personal consumption

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expenditure (PCE) index to represent real housing price changes net of inflation.

The relationship between income changes and housing price changes is represented two ways. First, an index is produced that divides the PIPC index by the FMHPI. The resulting index is also indexed to 100 in 1975. From the base year of 1975, any movement in the index demonstrates the relationship between changes in PIPC and changes in housing prices. If the index increased (decreased), PIPC grew higher (lower) than housing price growth.

If the index was above (below) 100, then cumulatively PIPC grew more (less) than housing prices. econd, the ratio of housing price levels to PIPC levels is estimated. This is done by using 2015 median housing prices for each geography and multiplying by the FMHPI, where 2015 equals 1.0.

Median price for the U.S. is provided by the National Association of Home Builders and CoreLogic. Median price for Texas and its metros is provided by the Real Estate Center. The resulting housing price series is

S

then divided by PIPC to estimate the ratio between housing price and PIPC levels.

Variability PIPC and housing price movements for 1975 through 2015 are summarized based on the average change, but for any given year the change is not always the average.

Standard deviation provides a measure for this variability of growth (see table, p. 6).

Even though PIPC growth exceeded housing price growth for the U.S. and Texas, housing prices exhibited greater volatility than PIPC, illustrating that housing prices are more prone to larger swings than PIPC. Housing prices change with fundamental drivers such as incomes but may also be amplified due to overreaction, meaning irrational expectations of future price increases. If combined with currently rising income, this can fuel appreciation above fundamental values. When income growth slows or declines, a correction in housing prices can slow or decline at an amplified rate.

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inventory shot through the roof as foreclosures flooded the U.S. market. Housing prices plummeted nationally both in nominal and real terms. Texas experienced a much more limited decline in housing prices compared with the nation. Months of inventory increased moderately as sales volume dropped in Texas but not to the degree occurring at the national level.

Since the bottoming out of the market during the Great Recession, housing prices have rebounded at healthy rates.

The U.S. previously had high rates of growth from the early 2000s through the financial crisis. Texas, however, has not seen growth rates this high since the late 1970s.

Comparing PIPC, Housing Price Growth

P

300

United States Texas Austin-Round Rock Dallas-Fort Worth-Arlington Houston-The Woodlands-Sugar Land Midland Odessa San Antonio-New Braunfels

275 250 225 200 175 150 125 100 75 50 1975

1980

1985

1990

1995

2000

2005

2010

2015

Notes: Inflation adjusted. PIPC index divided by house price index.

Sources: Bureau of Economic Analysis, Freddie Mac, and authors’ calculations

IPC and housing prices have changed over the years in response to prevailing economic conditions. But has PIPC growth exceeded housing price appreciation? A comparison of the growth rates for each region yields the answer. Why is this comparison important? Income growth that exceeds housing price appreciation means more money left in the pockets of homebuyers.

The relationship between PIPC and housing price changes for the U.S., Texas, and selected metros from 1975 to 2015 is shown in Figure 3. The U.S. and Texas exhibit diverging trends.

PIPC growth in Texas has outpaced housing price growth to a greater degree than in the U.S. as a whole. Dallas, Houston, and San Antonio have followed a trend similar to that of the state. Austin was the exception among the Texas-triangle metros as housing prices consistently outpaced income growth depicted by an overall declining index since the late 1990s (Figure 3).

Concentration in the mining industry boosted Midland’s PIPC growth significantly higher than its housing price appreciation since the turn of the millennium. Large swings in the industry also gave Midland the top spot for variability in PIPC growth, which mostly occurred recently (see table, next page). Real housing prices were not as volatile during the same period and have generally increased except for 2015 (Figure 1).

Another way to illustrate the relationship between changes in incomes and housing prices is using a ratio to estimate how much more housing prices were than income levels (Figure 4). At the start of 1975, Texas (7.6) and the Triangle metros all had ratios above the U.S. (6.4). In 1988, Texas converged with the U.S. and has consistently remained below the ratio observed at the national level since then. In 2015, U.S. housing prices were 5.6 times higher than PIPC, compared to 4.9 times in Texas. Austin had a ratio of 5.7 in 2015, higher than the U.S. JANUARY 2017

Figure 3. PIPC Growth to House Price Growth Ratio 1975 = 100

Figure 4. Housing Price to PIPC Ratio

9 8 7 6 5 4 3 2 1 1975

United States Texas Austin-Round Rock Dallas-Fort Worth-Arlington Houston-The Woodlands-Sugar Land Midland Odessa San Antonio-New Braunfels

1980

1985

1990

1995

2000

2005

2010

2015

Notes: Inflation adjusted. Estimated house price divided by PIPC level.

Sources: Bureau of Economic Analysis, National Association of Home Builders/CoreLogic, Real Estate Center at Texas A&M University, Freddie Mac, and authors’ calculations

Comparing Texas Metros, Others Texas ranks 17th for PIPC growth and 29th for housing price appreciation among the states (see table, next page). Midland registered the highest average PIPC growth rate of all metros from 1975 through 2015 but ranks 87th for average housing price growth. Austin is near the top in both PIPC growth (15th) and housing price growth (34th). All of the major Texas metros have PIPC growth that exceeds housing price growth over the total period.

California has notoriously high housing prices and appreciation rates and ranks in the top five metros for housing price appreciation. Interestingly, the top five metros for PIPC growth are not concentrated in California. All California metros had housing price appreciation that outpaced PIPC

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U.S., Texas, Metros, Top Five Income and Top Five Housing Price Growth Metros, 1975–2015

Top 5 Bottom 5 Top 5 Bottom 5

Housing Price

Personal Income Per Capita

Income Year-over-Year Average Rank SD Rank

Total Percent % Rank

Housing Price Year-over-Year Average Rank SD Rank

Total Percent % Rank

United States Texas Austin-Round Rock, TX Dallas-Fort Worth-Arlington, TX Houston-The Woodlands-Sugar Land, TX Midland, TX Odessa, TX San Antonio-New Braunfels, TX

1.8 1.9 2.3 1.9 1.9 4.2 1.8 1.7

NA 17 15 72 73 1 112 119

2.4 3.1 3.8 3.4 3.9 14.2 7.7 2.5

NA 13 64 112 58 1 5 328

99.6 108.3 145.1 107.4 105.5 270.4 79.3 97.7

NA 19 15 75 83 1 205 112

1.5 0.8 2.1 0.8 1.0 1.3 1.1 0.6

NA 29 34 136 123 87 102 167

4.8 3.7 5.9 4.2 4.7 6.7 6.4 3.9

NA 37 115 218 167 90 95 236

75.3 33.9 110.7 33.1 40.0 54.2 42.9 321.6

NA 27 30 124 116 83 108 3

Midland, TX Bridgeport-Stamford-Norwalk, CT Fayetteville-Springdale-Rogers, AR-MO San Jose-Sunnyvale-Santa Clara, CA Naples-Immokalee-Marco Island, FL Danville, IL Anchorage, AK Yuma, AZ Lake Havasu City-Kingman, AZ Fairbanks, AK

4.2 3.3 3.0 3.0 2.9 0.7 0.6 0.6 0.4 –0.3

1 2 3 4 5 378 379 380 381 382

14.2 4.0 4.1 5.5 5.3 3.4 3.2 5.4 4.2 5.2

1 56 49 12 18 108 146 16 48 21

270.4 249.8 219.9 204.2 198.0 29.8 26.3 19.3 15.5 –15.8

1 2 3 4 5 375 378 380 381 382

1.3 1.7 0.2 4.6 2.4 –1.3 0.8 0.0 0.7 0.1

87 55 235 1 28 379 133 273 155 269

6.7 8.0 4.2 9.1 10.2 4.7 5.8 6.9 8.4 6.0

90 54 216 31 11 170 122 82 43 112

54.2 72.0 5.6 425.2 106.7 –44.5 29.0 –8.2 15.0 –5.2

83 57 232 1 32 379 143 308 189 284

San Jose-Sunnyvale-Santa Clara, CA Santa Cruz-Watsonville, CA San Francisco-Oakland-Hayward, CA Los Angeles-Long Beach-Anaheim, CA Napa, CA Johnstown, PA Jackson, TN Danville, IL Sebring, FL Terre Haute, IN

3.0 2.3 2.5 1.8 2.2 1.3 1.7 0.7 0.9 1.0

4 17 10 107 27 296 153 378 363 343

5.5 3.6 3.6 3.0 3.2 3.0 3.7 3.4 3.7 2.5

12 93 85 197 135 193 68 108 81 332

204.2 143.4 160.9 98.7 133.0 62.6 90.0 29.8 39.3 48.9

4 16 10 106 22 293 159 375 364 338

4.6 4.1 4.1 3.7 3.6 –0.9 –1.0 –1.3 –1.4 –1.6

1 2 3 4 5 377 378 379 380 381

9.1 8.9 9.2 9.7 9.0 3.7 2.6 4.7 10.0 3.9

31 38 29 21 36 254 367 170 14 235

425.2 337.8 321.6 261.2 258.9 –33.2 –34.0 –44.5 –54.3 –49.0

1 2 3 4 5 377 378 379 381 380

Notes: Inflation adjusted. Rankings out of 51 states including D.C., 382 metros for income, 381 metros for housing price.

Sources: Bureau of Economic Analysis, Freddie Mac, and authors’ calculations

growth. The metros encompassing the top five for PIPC growth, with the exception of San JoseSunnyvale-Santa Clara, California, outgrew housing prices over the period.

What Lies Ahead?

Texas has benefited in the past from PIPC growth that has exceeded housing price growth, preventing major disruptions and keeping housing relatively affordable. Both PIPC and housing prices have been subject to broader economic effects and cycles, such as the energy sector. Each metro area is impacted by its regional economic mix. Booms in the energy sector lift PIPC levels and also act as amplifiers to changes in housing prices. Midland, Odessa, and Houston recorded rapid increases in housing prices in the late 1970s and early 1980s and again in recent years. Austin, too, had its fair share of housing price appreciation as a result of expansion in the technology sector and its “cool” factor as a chic living destination.

Texas has continually improved its residents’ standard of living through increases in PIPC thanks to the benefits of the energy sector and other economic advantages Texas offers (for example, no state income tax, pro-business environment). From 1975 to 2015, the overall trend has been PIPC growth greater than housing price

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growth. But Texas real housing prices bottomed out in 2012 and increased faster than PIPC in subsequent years. A shortage of construction workers and the scarcity of developed lots has limited the number of new homes coming online. This has made it difficult to satisfy demand for homes, which pushed prices higher. This trend will likely continue unless the supply shortages in Texas markets are mitigated. If housing prices continue to appreciate ahead of income growth as trends suggest, the comparative advantage of greater housing affordability Texas has gained over the U.S. may narrow or even disappear in the foreseeable future.

For a lengthier discussion on this topic, see publication number 2152 on our website at www. recenter.tamu.edu.

Day (wday@mays.tamu.edu) is a research associate, and Dr. Torres (ltorres@mays.tamu.edu) is a research economist with the Real Estate Center at Texas A&M University.

THE TAKEAWAY Over time, Texas personal income per capita growth has exceeded housing price growth, increasing housing affordability in the state.

However, housing price growth has exceeded income growth in recent years.

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Legal Issues

The sign reads “FOR SALE BY OWNER.” A buyer calls, and an agreement is made to buy the property. The parties agree to leave the real estate brokers and lawyers out of this. It's a simple transaction. There's no need to pay commissions and attorney fees.

Of course the buyer wants a general warranty deed. The seller readily agrees. After all, the general warranty deed is what everyone uses.

The contract forms promulgated by the Texas Real Estate Commission even require a general warranty deed. That's how it's done.

The seller does a quick Internet search and finds a form for a general warranty deed, quickly fills it out and signs it, delivers it to the buyer in exchange for a check, and deposits the check. On the way home, the seller congratulates himself for saving money.

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Little thought is given to the legal mumbo jumbo contained in the deed. This scenario plays out all over Texas, and countless buyers and sellers put themselves at risk of being left holding the bag. They are, of course, free to do so, and brokers and lawyers are not required.

Although the most common deed in use in real estate transactions is the general warranty deed, the parties to the transaction rarely know the legal ramifications of its use, especially when real estate professionals, lawyers, and title companies are not consulted. Participants in real estate transactions should know what it means to sign (and accept) a general warranty deed.

IMPLIED WARRANTIES Generally speaking, a deed is an instrument that conveys an interest in property. While not all deeds contain warranty language, certain warranties are implied in almost every deed. The Texas Property Code provides that any time the words “grant” or “convey” are used in a deed, the grantor (seller) promises 1) that the grantor has not transferred any part of the property to anyone else, and 2) that the property is free from encumbrances (Section 5.023).

The implied warranties are made only to the grantee (buyer) in the deed. That is, they are not attached to the land. Only the immediate buyer may sue the grantor if the warranties are breached.

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EXPRESS WARRANTIES Express warranties are stated specifically in a deed.

They are similar to implied warranties, but they give greater protection to the grantee and subsequent grantees, and they expose the grantor to greater liability.

A general warranty deed contains a warranty that looks like this: And grantor hereby binds grantor, grantor’s heirs, executors, and administrators to warrant and forever defend all and singular the said premises unto the said grantee, his heirs, and assigns, against every person whomsoever, lawfully claiming or to claim the same, or any part thereof.

What does this mean? It means that the seller is guaranteeing to compensate the buyer for any failure of title, all the way back to the time of the land patent from the sovereign. In Texas, that means the original grant from Spain, Mexico, the Republic of Texas, or the State of

The seller is guaranteeing to compensate the buyer for any failure of title, all the way back to the time of the land patent from the sovereign.

Texas. Additionally, this warranty is appurtenant to the land, meaning that it is attached to the land and “runs with” the land. In other words, the seller’s guarantee is made to the buyer and to all subsequent grantees, and includes all title defects, even if the seller had nothing to do with them and had no knowledge of them, and even if they originated over 180 years ago.

When a general warranty deed is given, the grantor promises that 1) the grantor will defend and protect the grantee against the rightful claims of third parties to the property (warranty of title), and 2) the property is free of encumbrances (covenant against encumbrances).

An encumbrance is any impediment to the title that does not change the ownership of the land, but that diminishes the value or use of the land. Examples include liens, tax assessments, leases, and easements.

Note the similarities and differences in the implied and express warranties. The implied warranty extends only to the immediate grantee and only says that the grantor has not previously conveyed the property to a third person. The express warranty goes much further.

It extends to all subsequent grantees and covers every potential defect in the title.

A warranty does not strengthen or enlarge the title conveyed. It does not even guarantee that the grantor

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owns the property. It simply promises to compensate the grantee in the case of a failure of title.

BREACH OF WARRANTY OF TITLE A breach of the warranty of title occurs when a third party has a valid claim to the property—a failure of title. For example: • The seller may have previously conveyed part or all of the property to a third party.

• A previous owner may have previously conveyed part or all of the property to a third party.

• A third party may have adversely possessed the property prior to the date of the transfer of the property.

• A third party may have obtained title through a separate chain of title.

A failure of title may be total or partial. A total failure of title occurs when no interest in the property passes to the grantee as a result of the deed. A partial failure occurs when only part of the property interest passes to the grantee.

In the event of a total failure of title, damages are the purchase price paid the grantor, with interest.

In the event of a partial failure, the damages depend on the circumstances. If title fails as to a certain part of the land, then the damages are calculated by determining the value of the part to which title fails in proportion to the value of the entire tract, and then multiplying the resulting fraction by the purchase price.

If title fails as to an undivided interest, damages are calculated by dividing the price paid to the grantor for the entire tract by the number of acres in the entire tract at the time of the conveyance to obtain a price per acre and then multiplying by the percentage of undivided interest for which title failed, unless the value of the failed interest is affected because it is an undivided interest.

If the grantee obtains full title by purchasing the outstanding interest from a third party who is the lawful owner, the buyer may recover the price paid for the outstanding interest, but these damages are capped at the price paid to the grantor for the entire tract.

A grantee may also recover other costs, taxes paid, and attorney fees.

BREACH OF COVENANT AGAINST ENCUMBRANCES Encumbrances include liens and tax assessments.

Easements or restrictions on use may also be encumbrances. However, easements and restrictions are often excepted from the warranty.

An example of a breach of the covenant against encumbrances is the existence of a lien on the property.

The breach technically occurs at the time the covenant TIERRA GRANDE

is made. However, the buyer may not sue until 1) the lienholder forecloses and takes the property from the buyer, or 2) the buyer pays to discharge the lien. In this event, the grantor may be sued for the cost necessary to discharge the lien or encumbrance.

If the breach is based on an impediment, such as an easement or restriction, the damages are the difference in the value of the property without the impediment and the value of the property with the impediment.

These values are calculated at the time of the transfer of the property.

ALLOCATING RISK There are several common ways the parties to the transaction may allocate the risk involved.

Limit or eliminate the warranty. If the parties agree, a special warranty deed may be used. In a special warranty deed, the seller reduces his risk by limiting the warranty. The covenant of warranty in a special warranty deed looks like this: And grantor hereby binds grantor, grantor’s heirs, executors, and administrators to warrant and forever defend all and singular the said premises unto the said grantee, his heirs, and assigns, against every person whomsoever, lawfully claiming or to claim the same, or any part thereof, by, through, or under grantor, but not otherwise.

The effect of this warranty is that the seller is liable only for claims that arise through him. Of course, this shifts the risk to the buyer should some other failure of title occur, so a buyer may be reluctant to accept a special warranty deed. Another type of deed, called a deed without warranty, eliminates the express warranties altogether. Implied warranties still exist unless the deed expressly disclaims them.

Deeds without warranty are uncommon in real estate sales.

Usually, a deed has a section entitled, “exceptions to conveyance and warranty.” Known and existing encumbrances are listed here and specifically excluded from the warranties made in the deed.

Title Insurance. A real estate broker or salesperson is required to advise each buyer that the buyer should 1) have the abstract of title examined by the buyer’s attorney, or 2) obtain a title insurance policy. Buyers would do well to listen to this advice.

Title insurance may be purchased to protect the buyer from defects and encumbrances. When purchasing title insurance, it is important to remember a few things.

First, even though the title policy is often paid for by the seller, title insurance typically protects the buyer (an owner’s policy) or the lender, if any (a loan policy).

The buyer (or lender) is the insured, and if a valid claim is made, the insured gets paid. This is much better for JANUARY 2017

the insured than suing for breach of warranty. After all, the seller could be nowhere to be found or judgmentproof (broke).

No legal protection is provided to the seller. In fact, if a claim is paid, the title company is subrogated to the insured’s rights, meaning it could seek to recover from the seller. However, as a practical matter, title insurance is good for everybody, including the seller.

Second, the title policy only covers the property for as long as the buyer owns it. Once it changes hands, the general warranty still applies (runs with the land), and the original seller is still on the hook.

Third, title policies come with numerous exceptions, which help the title company avoid liability. Many of these exceptions may be changed or deleted by paying an additional premium for an endorsement. Ask your title company, real estate professional, or lawyer about other options for additional protection.

One pleasant side effect of title insurance is that defects may be discovered (and often corrected) during the title examination process, significantly reducing the likelihood of a claim. However, one should remember

No legal protection is provided to the seller.

In fact, if a claim is paid, the title company is subrogated to the insured’s rights, meaning it could seek to recover from the seller. that the title company examines the records to protect itself. It does not have a duty to inform of defects. If a defect occurs, the title insurer’s duty is to compensate for loss or damage, up to the face value of the policy.

The insurer also has a duty to defend as set forth in the policy.

For specific warranty deed advice, an attorney should be consulted.

Adams (radams@mays.tamu.edu) is a member of the State Bar of Texas and a research attorney for the Real Estate Center at Texas A&M University.

THE TAKEAWAY The general warranty deed is the most commonly used deed in Texas. It’s important for a seller to be aware of the potential liabilities created when real property is conveyed by general warranty deed. Parties to real estate transactions can reduce their risk by obtaining effective legal counsel and by purchasing title insurance.

9

Land Markets

oil, cattle, cotton Commodities Affect Land Prices

T

By Luis B. Torres and Charles E. Gilliland

hree historic pillars of the Texas economy are all commodities—oil, cattle, and cotton. The state’s vast territory and natural resources have allowed it to thrive through the production of these commodities.

Commodity Booms and Busts The long history of commodity price booms and busts suggests volatility is inevitable. Commodity markets occasionally exhibit broadly based massive booms and busts. There have been three such episodes since the 1950s. The first commodity cycle peaked in 1974, the second in 2008, and a third in 2014 (Figure 1).

No simplistic explanation exists for what causes such episodes, but they do share similar characteristics. The growth of GDP and industrial production accelerated strongly in the periods just preceding or marking the beginning of the commodity booms. The end of the booms were characterized by

10

substantial drops in commodity prices and coincided with a sharp weakening in GDP growth, demand, and industrial production (Figure 1).

Not all periods of sharply accelerating economic performance give rise to booming prices in commodity markets; in other words, not all commodity booms are triggered by “demand shocks.” Other preconditions have to prevail, such as tight production capacity and relatively small inventories.

Such preconditions typically emerge after prolonged periods of weak commodity prices have discouraged investment in capacity expansion and instilled a sense that supply is secure, and there is limited need for holding inventory.

Types of Commodities Commodities are placed into various categories, depending on their physical characteristics and end use. These categories are energy (for example, crude oil and natural gas), cereal grains TIERRA GRANDE

(corn, wheat, and rice), vegetable oils (soybean and palm), softs (sugar, coffee, cocoa, and cotton), precious metals (gold and silver), industrial metals (aluminum and copper), and livestock (hogs and cattle).

Prices across all categories have tended to move in the same direction in the last decade because of the dominant role of global demand as a key common driver of price changes (Figure 2). For example, oil, cotton, and corn saw a sizable decline late in 2008 following the turmoil in world financial markets. They have also shown pronounced comovement in response to financial shocks (Figure 2). Prices for some commodities such as food are less sensitive to changes in global demand, forcing a distinction to be made across producing regions.

Texas Land Prices, Commodity Cycles

160

Figure 2. Prices of Texas-Related Commodities (Index 1Q1980 = 100) WTI Cotton Beef Corn

140 120 100 80 60 40 20 0 1980

1985

1990

1995

2000

2005

2010

2016 Q2

2015

Note: Price of WTI inflation adjusted by CPI-U: All items, 1982–84 = 100.

Sources: International Monetary Fund and U.S. Energy Information Administration

Figure 3. Annual Growth of Texas Personal Income, Nonfarm Employment, and Price of West Texas Intermediate (WTI) (Percent)

10 150 Per Capita (left axis) 8 125 Nonfarm Employment (left axis) 6 WTI (right axis) Oil is currently the state’s stellar com100 4 modity. It is a major source of income 75 2 and employment through its upstream 50 0 and downstream sectors and its relationship to other industries such –2 25 as manufacturing (Figure 3). Corn is –4 0 another important Texas commodity.

–6 Commodities have a direct and indirect effect on Texas land –25 –8 prices. The state’s size and variable land characteristics have –50 –10 made it possible to produce commodities efficiently. When 1970 1978 1986 1994 2002 2010 2014 agriculture and production of hydrocarbons account for a sizeNote: Price of WTI inflation adjusted by CPI-U: All items, 1982–84 = 100. able portion of land use, prices for their production can have a Sources: Bureau of Economic Analysis, Bureau of Labor Statistics, and U.S. Energy Information Administration substantial effect on land prices. A surge in commodity prices has been associated with an acceleration in land price increases

5

Figure 1. Annual Real Growth of World GDP per Capita and Price of West Texas Intermediate (WTI) Oil (Percent)

150 130 110 90 70 50 30 10 –10 –30 –50

World GDP (left axis) WTI (right axis)

4 3 2 1 0 –1 –2 –3 –4 1970

1976

1982

1988

1994

2000

2006

2014

2012

Note: Price of WTI inflation adjusted by CPI-U: All items, 1982–84 = 100.

Sources: International Monetary Fund and U.S. Energy Information Administration JANUARY 2017

(Figure 4). Demand for recreational land is also affected by commodity prices as higher incomes allow for increased land purchases.

Most Recent Commodity Busts

R

ising commodity prices were a characteristic of the global economic expansion from 2003 to 2008. At the same time, Texas land prices increased by 98 percent in real terms from first quarter 2003 to first quarter 2009. When the global financial crises erupted and the Great Recession set in, prices crashed and the end of the commodity boom seemed imminent. Texas land prices fell 8.1 percent in real terms from 1Q2009 to 3Q2010 (Figure 4).

The global financial crisis, the Great Recession, or the ensuing bumpy recovery did not stop the commodity boom. Higher growth in emerging and developing economies such as China and supply constraints sustained the boom (Figure 5). Prices rebounded in the early stage of the recovery, and by the end of

11

2010, prices of many comInvestment Incentive Figure 4. Prices of Land and Texas-Related Commodities modities were close to or to Purchase Land (Index 1Q1980 = 100) above precrisis peaks (Fig200 Expectations determine the Land Prices ure 5). However, land prices 180 WTI value of land as well as other lagged the recovery in comCotton 160 investments. However, expecmodity prices, increasing by Beef 140 tations cannot stay out of 9.9 percent in real terms by Corn 120 line with fundamental supply 2Q2013 from 3Q2010, recovand demand conditions for 100 ering the losses registered as very long. Commodity prices 80 a consequence of the Great affect demand conditions for 60 Recession (Figure 4). land, causing rapid land price he commodity boom 40 acceleration by lifting land halted in late 2014, and 20 price expectations. Returns a bust period began 0 on alternative assets can also as the effects of the 1980 1986 1992 1998 2004 2010 2016 make purchasing land more stimulative policies impleNote: Inflation adjusted by CPI-U: All items, 1982-84 = 100. attractive.

Sources: International Monetary Fund, U.S. Energy Information Administration, mented in emerging markets and Real Estate Center at Texas A&M University Land prices rising faster and developing countries, than the rate of inflation motiparticularly in China, started vates land purchases. If the to fade. Prices began to fall Figure 5.

China per Capita Annual Real GDP growth rate of land prices is as the result of weaker global and Global Price Index All Commodities Prices higher than the return offered economic growth. by other assets, such as bonds, (Percent) In contrast, Texas land 30 14 potential investors have an prices continued to register even greater incentive to positive price growth, increas- 12 20 purchase land. A rational land ing by 17.1 percent in real investor, other things equal, 10 10 terms from 2Q2013 to 2Q2016 will not pay more for an acre (Figure 4). However, the land 0 8 than the amount required price growth rate declined in to purchase an alternative –10 6 the wake of the commodity investment that provides an bust at the end of 2014. A –20 4 equivalent return. divergence between comChina (left axis) For a given interest rate, –30 2 modity prices and land prices Global Price Index All Commodities (right axis) the price of land changes appeared after 4Q2014, in part –40 whenever the expected real 0 because the Texas economy 2000 2003 2006 2009 2012 2015 net returns on owning the avoided a recession, and interNote: Inflation adjusted by CPI-U: All items, 1982-84 = 100. land change. The expected est rates remained historically Sources: World Bank and International Monetary Fund net returns change when low (Figure 4). Compared with expected revenue or expected previous declines in commodcosts change. Such an increase could follow from changes ity prices, particularly oil prices, the Texas economy did not in commodity prices that affect land prices by raising the experience a recession. A historical low-yield environment expected net income associated with land used to produce made purchasing land an attractive investment compared with that commodity. the expected return on other assets.

T

12

TIERRA GRANDE

If investors in land believe in prospects for earnings growth, they are willing to increase their bid prices for land coming into the market. They may even attempt to sell other assets to take advantage of the higher-yielding investment opportunity from purchasing land. Land values would then increase until the expected return on land has fallen to a level comparable with returns on alternative investments. hen land values increase more than expected, current landowners’ wealth grows. Landowners who bought at lower prices realize a higher rate of return on their initial investment, incentivizing them to acquire more land even if it means doing so by debt financing.

Currently land price growth is greater than the return on a ten-year Treasury bill (Figure 6). From 1Q2010 to 2Q2016 in real terms, land prices have risen on average by 2.8 percent compared with a 0.1 percent return on the ten-year Treasury.

The differential on average between both for the same period is around 2.7 percent (Figure 7), making land purchases more

W 15

10 0 –10 –20 –30 1980

1985

1990

1995

2000

2005

2010

2015

Note: Inflation adjusted by ten-year inflation expectations.

Sources: U.S. Treasury and Consensus Forecast

Measuring Relationship

T

10 5

he next step in the Center’s research is to measure the relationship between real prices in oil, cotton, beef, corn, and land to first find causality between them and land prices, and then to see if a short-run and/or long-run relationship exists. These results will be presented for the state and its seven land regions. This could prove most interesting because land use in each region is different, and the effects of each commodity would be expected to be different.

0 –5 –10

Land Prices

–15

Ten-Year Treasury

–20 –25

20

in each period. Interestingly, the price volatility of oil also declined during the same period compared with the other commodities discussed, possibly exhibiting a relationship between oil prices and Texas land prices.

Figure 6. Texas Land Price Growth and Ten-Year Real Treasury Yield (Percent)

20

Figure 7. Differential Between Texas Land Price Growth and Ten-Year Real Treasury Yield 4Q1979–4Q2015 (Percent)

1981

1986

1991

1996

2001

2006

2011

2016

Note: Inflation adjusted by ten-year inflation expectations.

Sources: U.S. Treasury and Consensus Forecast

attractive than other assets similar to Treasury bills. Still, the growth rate of land prices declined in the aftermath of the commodity downturn at the end of 2014 and the Texas economy’s slowdown. Land price volatility fell by 12.7 percent from 1Q2010 through 2Q2016 compared with 1Q2000 through 4Q2009 measured by the standard deviation in price growth

JANUARY 2017

Dr. Torres (ltorres@mays.tamu.edu) and Dr. Gilliland (c-gilliland@tamu. edu) are research economists with the Real Estate Center at Texas A&M University.

THE TAKEAWAY Commodity prices have influenced Texas land prices directly and indirectly, impacting the economy positively when they rise and negatively when prices fall.

13

Residential

Here Comes the Sun

The Value of Residential Solar

By Harold D. Hunt

14

TIERRA GRANDE

A

driving force behind their popularity is a direct reduction in a home’s monthly electricity bill as well as a hedge against future rate increases. Many homeowners now enjoy monitoring their level of electricity generation and energy savings on their smartphones in real time. However, a solar PV system’s contribution to the market value of an existing home at resale has proven much harder to quantify.

One problem with estimating any value premium from solar PV has been system owners themselves. Academic studies have shown that people installing active solar systems tend to remain in their homes much longer than average.

Whether they are installing the systems for economic reasons, environmental reasons or both, they typically plan to enjoy their investment for an extended period. As a result, homes with solar PV seldom turn over. This has led to a scarcity of comparable sales for appraisal purposes.

A number of real estate professionals and academics have begun to look into these and other related issues in recent years as more systems have been installed. A key goal has been to expand awareness and market acceptance of residential solar.

This article examines the solar PV sector and recent research involved in accurately estimating any market premium for the systems at resale.

Grid-Tied System Most Common The three types of solar PV systems are grid-tied, grid-tied with backup power, and off-grid. Grid-tied systems are most common. The solar panels produce DC current that is then changed or “inverted” to AC current and fed back into the local utility lines.

Although not mandatory in Texas, some utility providers allow “net metering,” in which any excess electricity generated is fed back through the homeowner’s electric meter for a credit against power used. A homeowner’s electrical meter can even run backward when more power is being generated by the solar panels than is being used in the home.

“The most popular misconception I’ve experienced from homeowners with grid-tied systems is their belief that the panels will continue to produce power for the home when their utility provider has a power failure,” says Paul Roebuck, president of Texas Professional Real Estate Inspectors Association.

But that is not always the case.

Home Inspection Exemption

Residential solar photovoltaic (PV) systems are rising in popularity as they continue to fall in price.

Different from “passive” solar systems that use the sun to heat thick interior walls during winter months, solar PV panels actively generate electricity from sunlight.

JANUARY 2017

Roebuck also notes that under the Texas Real Estate Commission (TREC) Standards of Practice, solar PV systems are exempt from home inspections. Although inspectors are allowed to examine systems more thoroughly than required by TREC, Roebuck says they rarely do. Randy Barfield, owner of Barfield Inspection Services in Cedar Park, agrees.

“I just note in my inspection report that I carried out a visual inspection of the system to see if it’s running,” says Barfield.

“I actually don’t know of a place I could go to obtain a certification to inspect a solar PV system.” Barfield suggests that potential homebuyers looking at an existing home with solar PV should try to contact the system’s installer to obtain more detailed information.

15

SOLAR PANELS COVER the roof of a carport (previous page). Solar panels function as a patio cover (this page).

Some negotiation between buyer and seller may be required if the solar PV system has been financed and the note is not yet paid off, Barfield says. Installers report that companies financing solar systems may or may not use a mechanic’s lien to insure payment of the loan.

Innovative Financing Options Increasing

S

ome specialty lenders advertise that they will finance solar PV systems for as long as 15 years. One reason for the increase in residential solar popularity has been the development of innovative financing tools. However, almost none of this financing is being done by local lenders.

Grid-tied solar with back-up power is the second-most common system. A bank of batteries is installed at the home to continue providing power in the event of an outage. The length of time backup power will be available is a function of the size of the battery system and the ability of the solar panels to continue charging the batteries during the power failure.

The least common system is off-grid solar PV, where the home is totally dependent on electricity generated by the solar panels and stored in a bank of batteries. Off-grid systems are usually installed in homes located in remote areas and are often integrated with backup generators to lower the size of the battery bank needed.

Alternatives to Roof Mounts Residential solar systems are usually mounted on the roof of the home but can be mounted on the ground or on special-purpose structures such as garages, carports, or pergolas. Southfacing rooflines are most desirable but not mandatory.

16

Roof-mounted systems are generally the easiest and least expensive to install and put little stress on the roof. “A roofmounted system puts about five pounds of pressure per square foot on a roof deck,” says Scot Arey, owner of Solar CenTex, a solar PV system installer in Harker Heights, Texas. These systems should be removed by professional installers when a new roof is needed.

Ground-mounted and special-purpose systems may be more expensive, depending on the level of support structure that must be built and the distance from the utility tie-in. However, the additional cost may be offset by the dual functionality of a solar carport or pergola.

Solar PV systems are generally mounted in a fixed position, but ground-mounted versions that track the sun throughout the day are another residential option. “A two-axis tracker will produce about 36 percent more power than a fixed system,” says Arey. “Although the trackers are more expensive, the economics of the extra power can outweigh their extra cost in some cases.”

Growing, But Still Far to Go

A

ccording to the Solar Energy Industries Association (SEIA), a national trade group for the solar sector, almost 500 solar-related companies are located in Texas, employing over 7,000 people. The companies provide a variety of solar products and services, including installers and component manufacturers.

Arey says he is seeing a growing interest in solar-related employment. “More people are looking at solar as an industry of the future,” says Arey. “Folks coming out of the oil and gas TIERRA GRANDE

sector have really shown an interest lately as those jobs have disappeared.”

Cost Continues Falling Although government and utility-based incentives have helped make active solar PV systems more affordable, their cost can still be significant. However, the cost of solar PV systems continues to decline. Nationally, the total installed cost of a rooftop solar PV system has dropped about 66 percent since 2010 according to the SEIA. Bloomberg recently reported that solar panel costs alone have fallen about 69 percent during the same period and may decline another 15 percent by 2017. With global panel manufacturers fighting for market share, 90 percent of sales are now going to just a handful of large companies that have been able to survive the price declines.

Cost reductions discussed here reflect reductions before any federal, state, municipal, or utility-based incentives or rebates are considered. In December 2015, Congress passed a lastminute multiyear extension of the federal investment tax credit (ITC) for solar installations.

Value-per-Watt Best Resale Metric

S

everal recent academic studies have found that solar PV systems do contribute to the value of an existing home.

An in-depth eight-state study funded by the U.S. Department of Energy (DOE) in 2015 concluded that a net installed solar PV system cost estimate calculated at the time a home is listed for sale may be the best proxy for a solar market premium.

The study analyzed almost 4,000 homes equipped with residential solar between 2002 and 2013. Texas was not one of the eight states.

Academics generally agree that a “value per watt” is the appropriate metric for valuing PV systems, not a premium as a percentage of the home’s sale price. Using a percentage value resulted in too much variability due to large differences in size of PV systems and price of homes.

The most recent academic study published in the winter 2016 edition of the Appraisal Journal demonstrated that the cost and income approaches can also be used to calculate residential solar PV premiums.

30 Percent Federal Credit Until 2020

L

ooking ahead, homeowners will continue to receive the current 30 percent federal dollar-for-dollar credit if they install a solar PV system by the end of 2019. The credit will then step down to 26 percent in 2020 and 22 percent in 2021. The tax credit will expire entirely in 2022 unless Congress chooses to pass another extension before then.

Currently, the ITC has no cap.

For other incentives, the North Carolina Clean Energy Technology Center offers a comprehensive source of information on available energy efficiency funding programs and rebates by state, including those for solar systems at http://www. dsireusa.org.

Recent academic and government-sponsored studies have shown that although the size of residential solar PV systems can vary a great deal, they generally average about 3 to 5 kilowatts (1 kilowatt equals 1,000 watts or 1kW).

The most current studies also reveal a “gross” installed cost per watt of about $3 to $5 before incentives. The “net” cost would be at least 30 percent less assuming a homeowner takes advantage of the federal ITC at a minimum.

Based on a gross cost of $4 per watt for a 4kW system, a homeowner would pay $16,000 before incentives. The net cost would then drop to $11,200 after the homeowner received the cash benefit of a reduction in federal income taxes by taking the ITC. Payback periods to recoup the initial investment in a system can be five to eight years or longer, depending on a number of factors including lifestyle and local power cost.

JANUARY 2017

TO MAXIMIZE ENERGY production, this freestanding solar array tracks the sun as it advances across the sky.

Unfortunately, several studies have revealed that some lenders’ underwriters require appraisers to use the sales comparison approach exclusively when a home with solar PV is being appraised. As a result, if one of the comparables is not a similar home equipped with a solar PV system, some underwriters will assign zero value to the PV system.

The Appraisal Journal study also estimated an average PV system value premium of $3.78 per watt. Using an example of an existing home listed for sale that has installed a 4kW system, the value contribution from solar PV would be just

17

ELECTRICITY IS CONVERTED from DC to AC through an inverter (mounted next to the breaker box in this photo).

over $15,000. All PV systems in the study were less than 12 years old.

Major Barriers: Documentation, Education Available financing, reduced costs, and financial incentives have begun to aid in the growth of residential solar. Alternately, two major barriers to stronger solar PV growth are lack of documentation and lack of education.

Documentation Academics have suggested that, although difficult, states should aspire to implementing the following documentation improvements.

• Develop a public database regularly updated by system installers, utilities, and permitting authorities that allows practitioners to verify PV system details. It should include the PV system’s size, year of installation, and state whether the system is owned or leased.

• Label the electrical box with the same inputs found on page 3 of the Appraisal Institute’s Residential Green and Energy Efficient Addendum, making a permanent record onsite.

• The addendum should also be placed in the multiple listing service (MLS) listing as an attachment for potential buyers, other sales agents, and appraisers to use in understanding or valuing the system during the listing period.

• MLSs should include searchable PV fields that include system size in kW, system age, warranty term, and system location (ground, roof, other).

• An appraiser would ideally review the owner’s utility bill for the past year to verify the home’s utility rate and system output. They should also have access to net solar PV costs. urrently, most of these suggestions are not in effect in Texas. However, there are states where such efforts have been successful. In 2009, the Colorado Energy Office (CEO) pioneered implementation of a common set of “green” fields in all 16 MLSs across the state.

CEO worked with key partners throughout the state, including MLS and Realtor associations, the Colorado Coalition of Appraisers, and the Colorado Chapter of the Appraisal Institute. The three largest home inspection organizations in the state, lenders, underwriters, and related professional organizations took part in the effort as well.

C

Real Estate Agent Online Course The Appraisal Institute currently offers a two-day course titled Residential and Commercial Valuation of Solar to assist

18

appraisers in attaining competency. However, as of 2015 only a few hundred appraisers nationwide had taken the course.

The National Association of Realtors (NAR) offers a 12-hour green designation class, of which about 40 minutes to one hour is a discussion of solar PV systems. “There are 4,500 to 5,000 NAR Green Designees nationwide, but only 260 are located in Texas,” says Amanda Stinton, director of sustainability and green designation at NAR. Elevate Energy recently received a $445,000 grant from the U.S. Department of Energy’s SunShot Initiative to create three distinct classes about residential solar.

“Real estate agents will be offered a three-hour class via the web and through NAR’s online education outlet Realtor University for continuing education credit,” says Pamela Brookstein, market transformation specialist at Elevate Energy.

Two other classes will be developed specifically for appraisers and appraiser regulators. The first online class should be completed sometime in May 2017.

Certainty of Payback is Critical Residential solar PV systems are still a niche product in Texas.

But studies have shown that clear identification of the contributory value of solar PV systems will help sustain their growth. Although reduced electric bills are an important incentive, homebuyers will be much more willing to pay a premium for the systems if the market reflects at least some incremental increase in their value at resale.

For an extensive list of solar resources, see this article on the Center’s website at www.recenter.tamu.edu.

Dr. Hunt (hhunt@tamu.edu) is a research economist with the Real Estate Center at Texas A&M University.

THE TAKEAWAY Researchers have wondered if solar photovoltaic systems have value when an existing home is resold. Academics now maintain that there is added value.

TIERRA GRANDE

Residential

Liquidity of Texas Homes Days on Market Speaks Volumes

By Ali Anari and Gerald Klassen

Liquidity of an asset is the speed at which it can be exchanged for cash without affecting its market value. Different assets have different degrees or orders of liquidity. It may only take a few minutes to sell stocks and bonds online, but selling an office block may take several months.

Money and checking accounts are the most liquid assets followed by bonds and stocks, precious metals, real estate, and works of art.

JANUARY 2017

19

Liquidity is important for asset owners because in the future they may need to sell the assets. When investors consider a variety of assets, they use a number of metrics to evaluate asset profitability, primarily expected yield and degree of liquidity.

Prospective investors base their investment decisions on the rates of return they expect to earn over the holding period, and the ease and quickness of selling them.

Liquidity of assets depends on a number of factors, including relative strength of demand for and supply of assets in any period, costs, complexity, and legal arrangements of transactions.

Days on Market as Measure of Liquidity

F

Days

or this analysis, days on market (DOM) is the number of days a real estate property is listed for sale until it enters its final pending period (see Calculating Days on Market).

The final pending period that starts on the final pending date of a listing means the home really is off the market.

Average DOM for a regional real estate market provides valuable information for market participants and is an important indicator of regional or local real estate market status. Real Liquidity of Real Estate Assets estate markets, like other markets, are always Real estate properties are the least liquid assets in a state of flux based on the relative strengths because real estate transactions are complex, costly, of the supply and demand sides of the market, time consuming, and which deterrequire special legal mine prices and Figure 1. Days on Market arrangements. In addiquantities of real Existing Homes Sold in Texas tion, real estate marestate properties 100 kets face the problem of available. In any Days on market 90 valuation. That is, until period, higher Days on market moving average a price is agreed on (lower) demand 80 for a real estate asset, for real estate 70 nobody really knows properties relaits value in the martive to supplies 60 ket. Every real estate leads to higher property is unique (lower) prices and 50 because of its location, more (less) quan40 features, and other factities of proper2012 2013 2014 2015 2016 tors. Prospective buyers ties sold.

Source: Real Estate Center at Texas A&M University and sellers of real estate The balance assets and their brokers may use information conof power in a real estate market during any tained in recent transactions for similar properties period continually shifts toward sellers or to estimate prices, but these are nothing more than buyers, resulting in sellers’ or buyers’ markets. informed opinions of value.

Fewer (more) days on market indicate stronger (weaker) demand for real estate assets relative to supplies. Monitoring these trends Calculating Days on Market and changes in average DOM can help sellers and buyers evaluate the status of Two main problems exist when calculating days on market (DOM). the market and price properties to be put 1. Listings can go in and out of pending status multiple times during their life. Potential on the market or revise prices of properties buyers are not always able to close a transaction, so a listing could revert to active already on the market.

status from pending when an offer falls through. Is a home considered completely off the market if a pending contract fails?

2. Different MLS systems and Realtors have different ways of defining when a listing is active, so DOM can be different depending on who defines the system rules.

In light of these complexities, the Center elected to calculate a standardized DOM statistic that is consistent across all listings and overcomes these challenges. This calculation is the number of days from list date to the final pending date of a listing, which is the day the house is officially off the market.

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Texas Days on Market To monitor market liquidity of Texas regional housing markets and 26 metropolitan areas, the Real Estate Center compiled and developed monthly time series of average DOMs from January 2012 to July 2016 using the Multiple Listing Service (MLS) database. DOM was calculated for existing and new residential units sold through an TIERRA GRANDE

AN AUSTIN condominium tower (p. 19) would be much less liquid than a single-family home because of the complexity of real estate transactions.

MLS in three submarkets (single family, town house, condominium, and the aggregate of these markets).

Figure 1 presents a time series of DOM for existing single-family homes sold in Texas from January 2012 to July 2016.

The time series of DOM, like time series of home sales, displays seasonal patterns, with highs in the first two months of the year and lows in midsummer. It also shows 12-month moving averages of DOM to remove seasonality and uncover long-term trends.

Figure 2 presents moving averages of DOM for existing and new single-family homes sold from January 2012 to July 2016. It shows a long-term downward trend in average DOM for existing singlefamily homes sold during the Texas economy’s ongoing recovery from the Great Recession. Average DOM for existing single-family homes fell from 89 days in January 2012 to 54 days in December 2015 and then to 53 in July 2016.

Average DOM for new single-family homes fell from 100 days in January 2012 to 85 days in April 2014 but then trended upward to 92 days in July 2016. One caveat when comparing trends in DOM for existing and new homes is that MLS is the source of the data, and not all new homes, townhomes, or condominiums JANUARY 2017

Table 1. Texas Metro Areas Ranked by Liquidity of Existing Homes, Measured by Days on Market Rank

Area

July 2016

July 2015

Change

1 2 3 4 5 6 7 8

Dallas-Plano-Irving Fort Worth-Arlington Lubbock Austin-Round Rock College Station-Bryan Houston-The Woodlands-Sugar Land Sherman-Denison San Antonio Texas Amarillo Abilene Waco Midland Odessa San Angelo Killeen-Temple Laredo Corpus Christi El Paso Tyler Wichita Falls Beaumont-Port Arthur Victoria Texarkana McAllen-Edinburg-Mission Brownsville-Harlingen Longview

25 27 29 31 35 39 41 45 45 46 49 50 55 56 57 58 59 64 84 84 84 85 92 102 107 118 126

28 32 33 32 36 37 75 46 47 44 42 79 45 42 52 63 73 73 92 99 77 109 78 105 99 134 100

–3 –5 –4 –1 –1 2 –34 –1 –2 2 7 –29 10 14 5 –5 –14 –9 –8 –15 7 –24 14 –3 8 –16 26

9 10 11 12 13 14 15 16 17 18 18 18 21 22 23 24 25 26

Source: Real Estate Center at Texas A&M University

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Table 2. Texas Metro Areas Ranked by Liquidity of New Homes, Measured by Days on Market Rank

Area

July 2016

July 2015

Change

1 2 2 4 5 6 6 8 9 10 11 12 13

Beaumont-Port Arthur Amarillo Sherman-Denison Laredo Midland Abilene Wichita Falls Lubbock Texarkana Dallas-Plano-Irving Fort Worth-Arlington College Station-Bryan San Antonio-New Braunfels Texas Houston-The Woodlands-Sugar Land Waco Austin-Round Rock Killeen-Temple Corpus Christi San Angelo Odessa Tyler McAllen-Edinburg-Mission El Paso Longview Victoria Brownsville-Harlingen

49 52 52 55 56 61 61 64 73 75 77 80 92 93 97 99 100 100 115 115 126 128 131 143 154 172 176

157 80 64 28 56 82 142 56 222 76 74 93 88 88 88 64 104 114 74 106 92 115 146 103 118 149 101

–108 –28 –12 27 0 –21 –81 8 –149 –1 3 –13 4 5 9 35 –4 –14 41 9 34 13 –15 40 36 23 75

14 15 16 16 18 18 20 21 22 23 24 25 26

Source: Real Estate Center at Texas A&M University

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Figure 2. Average Days on Market Existing, New Single-Family Homes Sold in Texas Existing homes New homes

Days

90 80 70 60 50

are sold through the MLS. Builders often market and sell their newly built homes directly to buyers.

Average DOM for existing Texas townhomes sharply decreased from 96 days in January 2012 to 57 days in January 2014 and then drifted down to 44 days in July 2016 (Figure 3). Average DOM for new Texas townhomes also sharply decreased from 113 days in January 2012 to 81 days in October 2013 but stabilized in a range between 80 and 90 before falling to 79 days in July 2016 (Figure 3).

Market liquidity trends for existing Texas condominiums have been similar to those for single-family homes and townhomes. Improving liquidity in the condo market has reduced the average DOM from 109 days in January 2012 to 64 in July 2016 (Figure 4). But market liquidity for new condos has been volatile, as shown by the average DOM, which has fluctuated around 90 days since 2013 (Figure 4).

Liquidity of Metro Homes 2012

2013

2014

2015

2016

Texas metropolitan housing markets ranked by liquidity of existing singlefamily homes sold in July 2016, Figure 3. Average Days on Market as measured by average DOM, are Existing, New Townhomes Sold in Texas shown in Table 1. Dallas-PlanoExisting townhomes Irving with an average DOM of New townhomes 25 days ranked first followed by Fort Worth-Arlington (27 days), Lubbock (29 days), Austin-Round Rock (31 days), and College Station-Bryan (35 days). The table also shows average DOM in July 2015 and changes in average DOM from July 2015 to July 2016.

Table 2 ranks the Texas met2012 2013 2014 2015 2016 ropolitan housing markets in Source: Real Estate Center at Texas A&M University

Source: Real Estate Center at Texas A&M University

120

Days

100 80 60 40

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TIERRA GRANDE

Figure 4. Average Days on Market Existing, New Condominiums Sold in Texas

120

Existing condos New condos

110 Days

100 90 80 70 60

2012

2013

2014

2015

2016

Source: Real Estate Center at Texas A&M University

terms of the liquidity of new singlefamily homes sold in July 2016, measured by average DOM. Beaumont-Port Arthur with 130 an average DOM of 49 ranked first followed by Amarillo and 120 Sherman-Denison (52 days each), and Laredo (55 days). As mentioned, these data are from the 110 MLS and not all new homes are sold through the MLS. 100

Figure 5. Texas Metropolitan Days on Market and Unemployment Rate, July 2016 Longview Brownsville-Harlingen

McAllen-Edinburg-Mission Texarkana

What Drives Liquidity?

C

Days on Market, July 2016

enter research finds general economic conditions are the main determinant of market liquidity of Texas homes. A scatter diagram of the relationship between unemployment rates and DOM in the state’s regional markets in July 2016 is shown in Figure 5, which shows that the higher the unemployment rate, the longer it takes to sell homes in local housing markets. The correlation coefficient between DOM in the state’s local housing markets and the local unemployment rate as a measure of economic conditions is about 74 percent.

Participants in Texas housing markets can make better informed decisions about pricing real estate properties to be sold by studying DOM trends in their target markets for the best time to buy.

Dr. Anari (m-anari@tamu.edu) is a research economist and Klassen (gklassen@mays.tamu. edu) a research data scientist with the Real Estate Center at Texas A&M University.

JANUARY 2017

Victoria

90 Wichita Falls

Tyler

Beaumont-Port Arthur

El Paso

80 70 Corpus Christi

60

Laredo Killeen-Temple

San Angelo Midland

50

Odessa

Waco

Abilene Amarillo

San Antonio-New Braunfels Sherman-Denison Houston-The Woodlands-Sugar Land College Station-Bryan Austin-Round Rock Lubbock Fort Worth-Arlington Dallas-Plano-Irving

40 30 20 3.5

4.0

4.5

5.0 5.5 6.0 6.5 7.0 7.5 Unemployment Rate, July 2016 (Percent)

8.0

8.5

9.0

Source: Real Estate Center at Texas A&M University

THE TAKEAWAY Days on market is a helpful indicator of housing market conditions at the local, regional, and state levels. It can also be used to monitor and forecast trends in markets.

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Taxes

By Jerrold J. Stern

C

ommercial property condemnations can cause a cloud of despair—but tax law may provide a silver lining. Taxpayers are allowed to postpone (or permanently avoid) part or all of the capital gains tax in situations where the amount received by the owner who is losing the commercial property exceeds the adjusted basis of the property lost. The adjusted basis is typically original cost plus improvements (for example, a new roof), less tax depreciation deductions.

The tax postponement rules apply when a commercial property is lost or sold due to condemnation, destruction, seizure, requisition or threat or imminence of condemnation or requisition, and a “similar” replacement property is acquired (Code Section 1033).

Example. Assume farmland was purchased for $10,000 many years ago. Today it’s worth $30,000. The government condemns the land to build a highway and pays the landowner $25,000 for it. Tax on the $15,000 gain ($25,000 less $10,000) can be postponed if the entire $25,000 is invested in similar replacement property. But, for instance, if only $21,000 is reinvested, tax would be due on the remaining $4,000 gain ($25,000 less $21,000).

Another rule is that the deferred gain must be subtracted from the cost of the replacement property to determine its adjusted basis. In the example, the $15,000 postponed gain must be subtracted from the $25,000 cost of the replacement property for adjusted basis purposes, making the adjusted basis $10,000 ($25,000 less $15,000). If less than $25,000 is reinvested, some or all of the gain becomes immediately taxable, and the adjusted basis computations become fairly complex.

The purpose of the adjusted basis computation is to build in “gain potential” if the replacement property is ultimately sold at a gain. So, for instance, if the future sales price of the farmland is $28,000, the taxable gain recognized at the time of the future sale is $18,000 ($28,000 less $10,000). If the future sales price is $8,000, a $2,000 tax loss ($10,000 less $8,000) can be deducted, and the original $15,000 gain is disregarded.

As previously noted, the replacement property must be “similar or related in service or use.” If the property is lost specifically due to condemnation, then any type of business or investment real estate is considered similar. Thus, an

24

apartment building can be replaced by raw land to be held for investment purposes.

If the property loss is not due to condemnation, the property owner must satisfy either the “taxpayer use test” or the “functional use test.” The taxpayer use test applies to owner-investors and states that the replacement property must provide the same type of income benefit. For example, rental real estate (i.e., an apartment building) can be replaced by any other type of rental property, such as a commercial office building.

In contrast, the functional use test pertains to ownerusers. For instance, if a textile factory is lost, the replacement property must be a textile factory (a property with the same functional use). Note that any other type of factory would not satisfy the functional use test rules.

For condemnations, the replacement property must be acquired within three years of the close of the tax year during which the condemnation occurred. Thus, if a property is condemned in January of year one (and the tax year ends on December 31), the taxpayer must acquire a replacement property by the end of year four. In any other case, the taxpayer has two years to find a replacement property (starting at the end of the tax year of the loss).

“Severance awards” are treated differently. Assume the government pays $10,000 for a strip of land to be used for a road. The funds would reduce the adjusted basis of the remaining land. Thus, if all of the land originally cost $90,000, its adjusted basis would be reduced to $80,000.

Condemnation and similar transactions can lead to tax complexities. The services of a tax accountant or tax attorney familiar with real estate tax rules should be sought.

Dr. Stern (stern@indiana.edu) is a research fellow with the Real Estate Center at Texas A&M University and a professor emeritus of accounting in the Kelley School of Business at Indiana University.

THE TAKEAWAY The tax on gains from commercial property dispositions associated with condemnations and similar misfortunes may be postponed or avoided if requirements are met.

TIERRA GRANDE

Taxes

E

Billions of Dollars

veryone hates Texas’ property tax. It extracts large sums have expanded in real terms for the past 20 years. City, county, from property owners annually and spirals endlessly and special district levies generally increased during that time higher with rising values. Taxpayers complain, school as well, backtracking only in 2010 and 2011. officials plead for more funding, and politicians scramble to Higher Business Tax Eyed reduce school property tax burdens but still generate enough Seeking to further lighten the tax burden, many see businesses funding to cover the increasing costs of public education. as the preferred potential revenue source needed to fund educaMany envision imposing higher property taxes on businesses tion. The Texas business tax climate ranks 14th among the to allow reductions in residential taxes. Franchise tax reform states according to the Tax Foundation, a nonprofit, nonparwas intended to provide relief by generating revenue from this tisan research institution in Washington, D.C., indicating a “margin tax.” The new franchise tax was applied to a broadgenerally benign business ened tax base at a lower tax climate. Advocates rate to “buy down” local Texas Deflated Tax Levies by Taxing Unit of higher business taxes school tax rates, reducing 1994 = 1.000 perhaps view that ranking school taxes throughout 20 as evidence that increasing Texas. However, relief 18 business taxes might not was short-lived, with ris16 harm Texas’ competitive ing values and expanding position. development generating 14 Special District Levy However, business sizable increases in school 12 County Levy location decisions involve taxes in 2013.

City Levy 10 consideration of all busiThe total property tax School Levy 8 ness levies in the competlevied between 1994 and ing venues. To get a clearer 2015 by special districts, 6 picture of the impact of counties, cities, and 4 potential tax changes schools is shown in the fig2 requires an analysis of all ure. Amounts are expressed the different taxes levied in in billions of inflation0 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 each state in search of an adjusted 1994 dollars. A Source: Texas Comptroller of Public Accounts optimal climate for startflat line corresponds to no ing or expanding a busireal increase in taxes while ness. The 2017 Tax Foundation study provides an extensive a rising line indicates increasing real taxes. With the exception comparison. Digging into the details of the analysis reveals of the temporary reversal in 2007 following legislative school some surprising conclusions for the various taxes considered tax relief measures and a dip following valuation adjustments by the foundation. The analysis concentrates on corporate tax, inspired by the Great Recession in 2010 and 2011, school taxes JANUARY 2017

25

2017 State Business Tax Climate Index Rankings and Component Tax Rankings

Alabama Alaska Arizona Arkansas California Colorado Connecticut Delaware Florida Georgia Hawaii Idaho Illinois Indiana Iowa Kansas Kentucky Louisiana Maine Maryland Massachusetts Michigan Minnesota Mississippi Missouri Montana Nebraska Nevada New Hampshire New Jersey New Mexico New York North Carolina North Dakota Ohio Oklahoma Oregon Pennsylvania Rhode Island South Carolina South Dakota Tennessee Texas Utah Vermont Virginia Washington West Virginia Wisconsin Wyoming District of Columbia

Overall Rank

Corporate Tax Rank

Individual Income Tax Rank

Sales Tax Rank

Unemployment Insurance Tax Rank

Property Tax Rank

32 3 21 38 48 16 43 19 4 36 26 20 23 8 40 22 34 41 30 42 27 12 46 28 15 6 25 5 7 50 35 49 11 29 45 31 10 24 44 37 2 13 14 9 47 33 17 18 39 1 47

14 27 19 40 33 18 32 50 19 10 11 24 26 23 47 39 28 36 41 21 37 8 43 12 5 13 29 34 46 42 25 7 4 16 45 9 35 44 31 15 1 22 49 3 38 6 48 17 30 1 31

22 1 19 29 50 16 37 34 1 42 31 23 10 11 33 18 30 27 25 46 13 14 45 20 28 21 24 1 9 48 35 49 15 36 47 38 32 17 39 41 1 8 6 12 44 40 6 26 43 1 43

48 5 47 44 40 39 27 1 28 33 23 26 35 10 21 30 13 50 8 14 18 9 25 38 24 3 12 41 2 45 42 43 19 34 29 36 4 20 22 31 32 46 37 17 16 11 49 15 7 6 33

14 29 13 30 16 42 21 3 2 35 24 46 38 10 34 11 48 9 44 26 49 47 28 5 7 19 8 43 41 25 17 32 6 15 4 1 33 45 50 37 40 23 12 22 20 39 18 27 36 31 27

16 22 6 24 15 14 49 20 10 21 17 2 46 4 40 19 36 30 41 42 45 25 33 35 7 9 39 8 43 50 1 47 31 3 11 12 18 32 44 26 23 29 37 5 48 28 27 13 34 38 47

Note: A rank of 1 is best, 50 is worst. Rankings do not average to the total. States without a tax rank equally as 1. D.C.’s score and rank do not affect other states. The report shows tax systems as of July 1, 2016 (the beginning of fiscal year 2017).

Source: Tax Foundation

26

TIERRA GRANDE

individual income tax, sales tax, and unemployment insurance tax, as well as property tax.

In the report, rankings range from 1 to 50 with 1 being the best tax climate and 50 the worst. The Texas property tax system ranks 37th nationally, meaning that only 13 states currently rank lower. In fact, the report notes that the Texas property tax score slipped from 33rd in 2016 and that drop primarily caused a slight drop in the state’s overall ranking from 2016.

That suggests that shifting the property tax burden to businesses could cause both the property tax and overall rankings to deteriorate even further.

Personal Income Tax Ranks Sixth

P

roposals have targeted sales taxes as a preferred alternative revenue source for property taxes. However, the current Texas sales tax also ranks 37th among the states.

The 2017 ranking did improve from 38th in 2016. All this suggests that shifting tax liabilities to sales taxes could cause that ranking to deteriorate.

Texas fares well versus other states on personal income taxes, ranking sixth.

However, Texas misses the number one ranking conferred on other states that do not have a personal income tax because the franchise tax also applies to partnerships and subchapter S corporations that are considered individuals in the study.

The unemployment insurance tax ranks 12th nationally.

The foundation’s score for the Texas corporate tax ranks 49th.

This ranking focuses entirely on the franchise tax and applies despite a 21 percent reduction in the franchise tax rate in the last legislative session. Only Delaware ranks lower. Further, Texas has consistently ranked 49th on this measure since 2014, having dropped from 37th in 2011.

Searching for Property Tax Solutions Although it has been dubbed the margin tax, the franchise tax is regarded as a “complicated gross receipts tax” by the Tax Foundation. The economic inefficiencies associated with a gross receipts tax along with the complicated nature of the franchise tax contribute to this ranking. In its 2015 analysis, The Texas Margin Tax: A Failed Experiment, the Tax Foundation JANUARY 2017

estimated Texas would move from tenth to third in the nation in the overall state business tax climate index ranking if the margin tax was repealed.

The search for a solution to spiraling property taxes must weigh tradeoffs among different tax bases when substituting revenue from an alternate tax base or class of taxpayer for current property tax revenues. The Tax Foundation recognizes six principles of sound tax policy that can serve as a guide in evaluating those alternatives. The principles are simplicity, transparency, neutrality, stability, no retroactivity, and broad bases with low rates. Simplicity refers to reducing administration costs by minimizing the complexity and eliminating incentives to avoid taxation. Transparency refers to “sound legislative procedures and careful analysis” (Tax Foundation, 2012). The public should have a good understanding of how the tax system works. Neutrality means the tax system should not favor certain industries and the system should not influence economic decisions.

Stability means tax policies should not fluctuate with the whims of the political system and economic shocks. Short-term measures make longrun planning impossible. No retroactivity is similar to stability.

It means that taxpayers should be able to rely on the current tax climate when negotiating transactions. Broad bases and low rates mean that tax revenue will be more stable with fewer incentives to avoid taxes with costly litigation. Currently, both the sales tax and property tax apply to limited tax bases with relatively high rates. Because a personal income tax appears to be out of the question, the search for an adequate substitute tax base continues.

Dr. Gilliland (c-gilliland@tamu.edu) is a research economist with the Real Estate Center at Texas A&M University.

THE TAKEAWAY According to the nonprofit Tax Foundation, Texas property taxes and sales taxes both rank 37th among U.S. states for business tax climate. The franchise tax ranks 49th.

27

Taxes

H E T G D AP N I M

By Jerrold J. Stern

S

ome taxpayers underreport income, overwealth accumulation, and those sources are comstate deductions, or both to reduce their pletely legitimate. tax bills. Such behavior gives rise to the As noted, large discrepancies between income and “tax gap,” taxes owed but never paid to the U.S. wealth can trigger an audit. Understating income is Department of the Treasury. Estimates of the tax fraud and can result in fines and possibly criminal gap average roughly $400 billion. Nearly 85 perpenalties, including jail sentences. Some celebrities cent ($340 billion) of that is attributed to underwith such tax troubles include Willie Nelson, who reporting of income, three-quarters ($255 billion) paid $15 million in back taxes after the IRS seized of which is associated with individual taxpayers. nearly all of his assets. Wesley Snipes spent over While new and intensified audit techniques two years in jail and paid $7 million in back taxes. are mainly focusing on cash businesses (such as Baseball player Pete Rose spent five months in jail coin laundries, beauty salons, and coin-operated and paid over $1 million in fines and penalties due to businesses), some will undoubtedly affect nonunreported income. s expected, the IRS also scrutinizes expenses. cash business audits as well. Some real estate A new approach is to compare deductions owners and businesses are certain to be on the with industry averages. Thus, in the real IRS radar. estate area, comparisons may be made in the areas On average, the IRS spent 41 cents to collect of expense margins, meals and entertainment, mile$100 in tax revenue during its 2015–16 fiscal age, advertising, profitability over time, real estate year, matching the low-cost results for previous taxes, and cash transactions of any kind. The audityears. However, over the last six years, the IRS ing agent may also look at the size of a mortgage was forced to cut its workforce to 82,000 from compared with the approximate value of the home. nearly 94,000, a 13 percent decline. This reduced Taxpayers being audited should respond promptly the number of returns that could be examined to all audit requests but should not provide informa(see figure) and put more pressure on the remaintion not specifically requested by the IRS, and should ing agents to make up the difference via audits. or example, IRS auditors are examining not discuss details of the audit on social media. the assets and liabilities listed on homeUnder the new audit procedures, the IRS routinely buyer mortgage applications and comparreviews social media as part of its investigations. ing them with the level of income reported on Perhaps the most important action a taxpayer can tax returns. Anecdotal evidence suggests that take is to hire a tax accountant or tax attorney knowlsome homebuyers inflate the asset values edgeable in real estate matters, especially one listed on mortgage applications to convey experienced in representing clients for IRS Number of Returns Examined a higher level of financial strength hopaudit purposes.

Fiscal Years 2010–15 ing to increase the likelihood of obtainDr. Stern (stern@indiana.edu) is a research fellow with 2.0 ing a loan or more preferable loan terms. the Real Estate Center at Texas A&M University and a The problem is that erroneous mortgage All returns professor of accounting in the Kelley School of Business applications are fraudulent, and the IRS 1.75 at Indiana University. may turn the evidence over to other law enforcement agencies for prosecution.

1.5 THE TAKEAWAY Why is the IRS interested in assets per

A

se? The interest in assets stems from an intensified audit technique known as “net worth” auditing. Assets and income are linked because of the relationship between accumulated wealth and the income stream that produced it. Of course, loans, inheritances, and gifts may explain high

28

Millions

F

1.25 Individual returns

1.0

2010

Source: IRS Data Book, Table 9a

2015

Due to the continuous rise in underreported taxable income, the IRS has intensified its previous audit techniques and created new ones. These steps may adversely affect homeowners and real estate businesses.

TIERRA GRANDE

FINDING A COMPLETE OVERVIEW OF THE TEXAS ECONOMY IS AS EASY AS

Our monthly economic update of everything from housing to jobs, from energy to trade. www.recenter.tamu.edu/research/the-texas-economy JANUARY 2017

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